The US housing market was a bubble that has well and truly burst.It is estimated that we are heading for 2 million foreclosures this year a figure not heard of since the Great Depression. What's more, the Fed's half point rate cut is not expected to stem the slide.Then there has been the sub-prime crisis.The top financial institutions of the nation have disclosed losses of billions of dollars on loans made to borrowers with poor credit histories. Retail sales are slowing and so is industrial output. To make matters worse energy prices are at record levels.
Yet the stock markets have proved everybody wrong with the Dow rising from about 12800 in mid August to 14066 on Friday, a gain of about 1200 points in a month and a half.
So what is behind this huge rally.Conventional wisdom would have had us believe that the housing crisis was bound to affect the other sectors of the economy causing stock prices to fall. At least that's what always happened in the past. But not this time round. So far the housing market crisis appears to have been contained in as much as it has not noticeably affected other sectors of the economy. The sub-prime crisis at one time threatened to get out of hand. But the Fed's rate cut indicated that it was willing to step in to inject liquidity into the system as and when required.This reassurance seems to have been all that the stock market needed.
The weaker dollar has also helped a lot.While the domestic economy has slowed, world economic growth has remained robust.The weak dollar has enabled top US corporations to increase overseas sales and reap bumper profits.It is these large corporations which have the largest weightage in the stock market indices.Record energy prices have ensured windfall gains for the giant oil companies.These too have a significant weightage in the indices. If these companies do well the stock market will continue to do well.
The disclosure of losses by the financial companies has been seen as a welcome sign of transparency and there is a belief that the worst is over.The latest jobs report shows that more jobs were created in September than expected and the August report was also revised upwards showing a rise instead of a decline.These figures indicate that far from a recession the US economy will continue to grow at a moderate pace.
Experts however warn that we are not out of the woods as yet and that the sub-prime crisis may come back to haunt us later in the year.Also interest rates are not likely to fall much further, meaning that easy availability of cash is a thing of the past.High interest rates also discourage merger and acquisition activity, which reduces premiums which are offered for companies' stocks. With less cash to spare buybacks by companies also get reduced and this depresses share prices.
Experts are clearly divided on where the markets are heading.Morgan Stanley says that its indicators are showing a 'full house' in terms of sell triggers.Many others predict that even if there is no collapse the markets have topped off. Some feel that the markets will be higher in December from where they are today.
Investors would therefore do well to closely watch events unfold over the next few months and take necessary steps to protect their investments rather than have things blow up in their faces.