To explain, when a market gets oversold and pessimistic as this one has become, a turn on the dime becomes a little hard to appreciate. The mechanics of the markets are such that we were not only experiencing the true sellers, but we were also seeing those folks who had become super bearish and were shorting the markets. This creates the perfect time for a bear market rally, often referred to as a “dead-cat bounce.” (I hope all of you animal lovers will forgive me, but I am just quoting a very old saying.) The arrival of huge participants in the markets could signal an enormous correction, should several of these players start moving in the same direction. In this case, most of the buyers who were short the market began to cover and a strong rally is only natural.
At least that was my first reaction. Don’t forget we are still experiencing a horrible housing market, the credit crisis certainly hasn’t improved, the unemployment situation is forecast to only get worse and the general mood of the public remains negative. With all of that in mind, of course I was skeptical. So why am I having second thoughts? Because three major financial institutions did something out of the ordinary, they announced that for the first two months of the year they experienced positive earnings. Normally, this information is held until the end of the quarter. These financial institutions are: Citigroup, JP Morgan and B of A. These implications are significant. It could mean that all of the work done by the Federal Reserve and the U.S. Treasury is beginning to pay off.
My intuition tells me that this is more than a correction in a bear market. It could possibly be the beginning of the end of the recession should the markets continued to improve. If the markets have reached the bottom, then within the next few months this recession should begin to subside.
The important piece to this puzzle came when the Federal Open Market met on March 18 and announced that after the meeting they were going to continue purchasing mortgage-backed securities in the additional amount of $750 billion. The most encouraging part of the announcement was the fact that the Federal Reserve was also going to purchase $300 billion worth of longer-term U.S. Treasuries over the next six months. That is extremely important because we are talking about a known buyer of a huge amount of Treasuries, so naturally the prices will rally and the yields will decline. In a normal market, mortgage rates are priced off of ten-year Treasuries. This should lead to a 30-year mortgage rate below five percent and probably closer to four and one-half, which is also very good for the overall economy.
Several factors need to align: the credit crisis improves, housing supply begins to shrink, rates remain low, consumers begin to spend again and the recession ends sometime in the second half of 2009. If this were to happen, I believe The Economy Might be Back on Track, as the title of this month’s FYI states. Let’s all hope I am right!
