Stocks Surge as GM Goes Bankrupt
The long outdated notion that what's good for General Motors is good for America was finally put to rest this week. What we've had instead is yet another case of the stock market ignoring bad news by rallying when many expected it to decline.
On Monday, GM entered its long-awaited bankruptcy. The Standard & Poor's 500 jumped 2.6 percent to its highest level of 2009. And the Dow Jones industrials jumped 221 points, perhaps partly in celebration of the fact that GM shares will no longer hold the Dow back. Citigroup shares won't either. GM and Citi are to be replaced by Travelers and Cisco Systems effective Monday.
All told, the S&P at Monday's close had soared 39 percent from its March 9 closing low. Yesterday, the market was hit with heavy profit taking, particularly in commodities-related issues. Then the market rebounded today.
The rally has been fueled most recently by some evidence of possible growth in manufacturing around the world, reflected particularly in surging commodity prices.
Crude oil has been one of the commodity stars, with prices more than doubling from their lows. Yet inventories of crude are sky high. Gasoline prices have jumped too, adding a potential dampener to the economy at a critical time. And long-term interest rates have climbed sharply from their extremely depressed lows. So mortgage rates have risen too, effectively raising the cost of buying a home.
It's evident that the investors who have chosen to participate in the equity rally are looking beyond the deep valley of recession to higher ground somewhere ahead.
But for the large number of investors who are under allocated to equities, it's all too obvious that the stock market has come too far, too fast, and that the fundamentals provide little foundation for such speculative excesses. This camp strongly believes that stocks are in for a hard fall and a possible return to new lows.
We've previously stated our view that the stock market is unlikely to return to the lows of October 2008-March 2009 in the near future. This belief strengthens with each day. But we also reiterate that a pullback is to be expected and would be healthy. Our longstanding operating principle that a market correction of 10 percent or so can occur at any time is particularly relevant now.
Use New Money for Market Leaders
We trust you're happy with the significant profits our recommendations have generated over the last three months. Yet it would be foolish to deny that stocks are due for a pullback—and not to be prepared for it.
But it would be equally foolish to ignore two critically important elements that help explain why equities are doing so much better than the economy. First is the positive if erratic benefit of massive government economic stimulus, liquidity injections and low interest rates.
The second key factor is the huge amount of investor cash—earning practically nothing—on the sidelines that gradually has been moving into investment vehicles with better potential returns.
These two trends ultimately will run their course, and the impact may well prove unpleasant indeed. But we're not near that point yet. So we advise viewing the investment world as half-full rather than half-empty.
You probably know our core advice by now: Buy quality on market weakness. In our view, the best areas to focus on are tied to vehicles that benefit from improving global economic growth—even though it will occur primarily outside the U.S. Think oil and metals; emerging markets; corporate bonds; and inflation protection.
Why U.S. Recovery Will Lag
The U.S. economy continues to show signs of stabilizing, or at least deteriorating at a slower rate than before. But the resumption of growth will be slow and prolonged, as we've previously advised.
One of the many reasons is that banks and their willingness to lend will remain under pressure for quite a while. New evidence of this comes from the Federal Deposit Insurance Corp., which has issued a report that overall loan quality of U.S. banks continues to deteriorate rapidly.
The FDIC reported that some 7.75 percent of the U.S. banks' loan portfolio totaling $7.7 trillion at the end of March was showing some sign of distress. That was up from 6.9 percent at the end of 2008 and from 4.1 percent a year earlier. It also exceeded the previous high of 7.26 percent set in 1990-91, during the last banking crisis.
The numbers consist of loans that are more than 30 days behind in payments. The percentage of loans that are (1) at least 90 days overdue, (2) on which the bank has stopped accruing interest or (3) the bank has written off is at its highest level since 1984.
Perhaps the most troubled loan category is consumer credit cards, where almost 14 percent of loans are at least 30 days overdue and banks are taking write-offs for bad debt at an annual rate of 7.8 percent.
Real estate is #2 on the list. Some 8.77 percent of real estate loans are considered troubled. But construction and development loans are the worst subcategory, with 17.7 percent of loans troubled.
Loans on commercial buildings, including retail and offices, are considered highly vulnerable. Just 4 percent of such loans are deemed troubled now, less than half the peak of the early 1990s. But many of these loans will have to refinanced over the next few years. This likely will prove difficult in many cases where real estate values have fallen sharply.
