On The Recovery- Three Steps Forward, One Step Back

When we speak of the recovery, we need to be clear about where we are pointing to. The healing of the credit markets is ongoing. Major financial institutions have successfully tapped the markets to the sum of $78 billion in shares and bonds to satisfy the Federal Reserve and Treasury and replenish their respective balance sheets. Aside from some of the banks themselves, most agree the capital raise was necessary as the losses on mortgages and declining assets values will continue to haunt them for some time to come.

The equity markets continue to stubbornly hold the high ground. Investors, both individual and institutional, continue to bid up stocks and only become more aggressive buyers on any weakness. The extreme pessimism and fears of financial Armageddon have largely left the markets, leaving investors to focus on company earning power and valuations. With lean inventories and streamlined head counts earnings power could be turbo charged should the stimulus plan prove to be just that, stimulus not stimu-less.

The economy is no longer in a free fall. Stabilization appears closer, expansion a bit further out. The US Purchasing Managers Index continued its’ winning streak inching ever closer to the 50 number. In fact the US Institute of Supply Management (ISM) Manufacturing Survey showed the New Orders Index crept above 50 for the first time since November 2007. Couple that with the Purchasing Managers Index (PMI) of India and China breaking above 50 as well. More supportive evidence that the US consumer alone will not be required to do all the heavy lifting to jump start the global economy.

So, three steps forward, now one step back. Interest rates are inching higher. Rather, leap frogging higher. We can have a spirited argument whether it is dollar related, the avalanche of supply or optimism of the rebound of the US economy and reflation or all the above. That is for another column. The attempt by the Federal Reserve Chairman, Ben Bernanke to hold rates down should prove unsuccessful. They have been aggressively expanding their balance sheet, purchasing Mortgage Backed Securities, Treasuries and doing just about whatever is necessary to stimulate lending. Now that investors have rejected abnormally low returns on treasuries and demanding higher yields, the Fed is left attempting to hold down rates or at the least allow for an orderly retreat. Its' akin to holding down the brakes in your car while simultaneously flooring the accelerator. Slowly but surely you move forward. Interest rates need to be monitored closely. Individuals and corporations still need to refinance loans that otherwise may fall into default. Any dramatic interest rate hikes may prohibit these moves impairing bank balance sheets once again.

I remain cautiously optimistic on the equity markets and have not changed my 2009 target for the S&P 500 of 1050-1100. The news on the economy got yet another kernel of good news this morning with the release of the National Federation of Independent Business (NFIB) showed improvement coming in at 88.9, just below 90 which would signify the business climate for small companies is expanding. Further, this survey has a history of prognosticating economic activity within 1-2 quarters, which would fit in with the views for the economy to resume expansion mode by the 3rd quarter. All in all very good news.