Credit Markets, Stock Performance, and Emergency Economic Stabilization Act
Today, the House of Representatives passed the Emergency Economic Stabilization Act by a vote of 263 to 171. The stock market reaction as of 2:45 pm EST today has been rather subdued, indicating that despite the ongoing discussion regarding the bill, its passage was largely expected.
The largest concern for the markets at this point is the health of the credit markets. Every day, people are hearing more and more about companies being unable to raise cash and banks that are unwilling to lend. Suffice to say that this is not for a lack of money in the system. The world is still awash with liquidity. However, until the banks trust each other, and the system has some additional stability, we will likely continue to see tight credit markets, which will in turn cause business fundamentals to contract. We still believe that most of the world, including Congress, understands this issue and will act accordingly to correct it.
Even though the EESA has passed, there is still a long road ahead and likely more fiscal policy response that will be necessary around the globe. At this point, while we believe the EESA plan has many strong merits that will help to put stability back in the system, we and others are unclear as to whether or not it will be enough. If it encourages private investors to also start recapitalizing the banks, garners confidence in the balance sheets of larger financial institutions, and generally works towards loosening a very tight credit market, then it will go a long way towards its objective. Many people we know who are following the situation believe it will take at least the full $700 billion to make this happen. If done correctly, the ultimate cost to the U.S. taxpayer should be minimized.
The market participants will continue to watch the situation to determine if the credit markets are loosening, and if money begins to flow again. Of course, people will react to economic news that is either better or worse than expected. The stock market is a forward looking mechanism in the short run. Stocks trade on speculation, rumor, fear, and greed. In the long run, stock markets are much more closely tied to long-term corporate earnings. We do not know the future, but we do know that market participants often paint their current view of the future for an indefinite time period. The same human logic that made the NASDAQ market trade at over 75 times earnings ("tech stock earnings will increase indefinitely"), and house prices to skyrocket to levels unseen in the past ("houses never lose money"), is the same logic that ultimately makes the stock market fall to levels that are overly pessimistic. As we have said in past writings, we don't know at what level that will be. We may or may not already be there. However, we do expect that it will be a very bumpy ride - especially until we get a return of credit and confidence to the market. Today's decision is a great first step towards that end.
