— by Mitchell Clark, B. Comm.
Reality is starting to set in for the marketplace and that’s a good thing. There’s no point in a bear market rally that gets overextended only to have it reverse harshly. The numbers are so far coming in pretty much as expected, but they are really starting to soak in. We’re in a recession and corporations are feeling the pain. It’s difficult to justify a rallying stock market when the numbers are this lackluster.
The financial sector is still the main driver of stock market sentiment (since September last year) and this is likely to remain the case for the rest of this year. Investment bank Morgan Stanley recently reported a worse than expected loss in its latest quarter, while Wells Fargo reported record first-quarter profits that were in-line with previous estimates. But don’t think that things are all rosy again in the banking sector. Even the relatively successful Wells Fargo is saying that its borrowing costs are rising. This means that credit isn’t flowing in the banking system like it once did and this is why businesses and consumers are saying that credit remains tight. It’s difficult to imagine a growing economy when credit isn’t flowing.
Right now, most of the first-quarter earnings results are coming from large-cap companies. It will be very interesting to see what smaller-cap companies report about the first quarter. Large-cap companies always get the headlines, but smaller businesses employ most of the people in the economy. Small business has always been the engine of the economy and what small public companies report about the economy is critical to developing an outlook for the future.
So, with tight credit conditions still being the major factor hampering recovery, just about every facet of the economy is in a funk. This is a major issue facing the auto makers and, until credit loosens around the world, there will not be any sustainable economic recovery.
Wall Street’s tight credit has the cascading effect of holding back the entire Main Street economy. It’s like what economists refer to as the “trickle down” effect if a manufacturing plant closes. With tight credit, however, it isn’t just a town that’s at risk when workers lose their jobs; it’s like a broad-based plant closing that affects the entire country.
For the most part, policy-makers have done a lot to try to increase liquidity in the banking system, but government can only do so much. You can’t force banks to lend money on good terms if the global system isn’t offering them. So, again, it’s the time factor that’s required for the current tight credit condition to balance itself out. But, when the system itself went so far the other way (like wacky subprime mortgages, big lines of credit, and lofty credit-card offers), I think it’s only reasonable to expect that it will take a long time for the system to correct itself. The stock market is just realizing this now. The time factor for recovery is huge.