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Fed's
Mixed Blessing
Has
Bernanke's success in calming markets clouded investors' view
of the long road ahead?
By Colin Barr
June
12, 2008
[continued,
page 2]
 Yet
even with sharp selloffs Tuesday and Wednesday inspired by
the surge of crude oil past $130 a barrel, the S&P 500
is up 10% off its Bear Stearns-inspired lows on St. Patrick's
Day.
"The
euphoria in the equity market has been breathtaking in the
past few months," Merrill Lynch economist David Rosenberg
wrote in a report Monday. "Are we believers that this
is sustainable? The answer is no."
He compares
the recent run-up in stocks to a rally that followed the Sept.
11, 2001, terrorist attacks. Back then the S&P 500 jumped
21% during the six months that ended in March 2002, but the
gains didn't last for long. The blue-chip index proceeded
to lose a third of its value before it bottomed out in October
2002, as hopes for a quick economic recovery were dashed.
Rosenberg
says expectations that the Fed will raise rates before the
end of the year—investors in the Chicago Board of Trade
futures market are putting a 57% chance on a 25-basis-point
rise—are similarly misguided. The economist, who has
said he expects to see the Fed's overnight lending target
fall to 1% from the current 2% over the next year and a half,
notes that the futures market priced in a sharp rise in the
fed funds rate back in early 2002, only to see the Fed resume
its rate cutting later that year as a rebound failed to materialize.
That's
not to say all is doom and gloom. The U.S. has so far avoided
an official recession even in the face of the housing bust,
the surge in energy prices and the near collapse of a major
investment bank. Other big economies continue to grow, if
at a slower clip, boosting U.S. exports. Big financial firms
have managed to raise billions of dollars in capital to offset
some of the damage they endured during the past year.
But there's
reason to believe there's more pain ahead. Merkel says he
believes the overhang of unsold houses will keep housing and
mortgage securities markets under pressure for at least another
year. He also says history shows the slowing economy will
likely lead to a spike in defaults among lower-rated corporate
borrowers. Retailer Linens N Things was a recent casualty
of the slowing economy and a hefty debt load, but it won't
be the last. "We're not through that part of the typical
credit cycle" yet, he says.
"I
think the safety level is overdiscounted right now,"
Merkel adds. "People are pretty happy."
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