Now that the DJIA has dropped below 7,500 it is clear that its next stop may be much lower. The market is still terribly concerned about the banking system. Rumors about better access to credit are overblown. Unemployment should be 9% by the end of the year. Even the Fed is willing to admit that. There is no reason to believe that corporate earnings will improve, and cash is getting tight at companies, even some very big ones.
What has to happen to keep the market from dropping another 20%?
First, the government has to acknowledge that the stock market is as important as housing and employment if equities are going to recover. Savings, both individual and corporate, are locked up in stocks. The ability of companies to expand and the chance for people to retire will get much worse if the stock market continues to fall.
The market is looking for a few things, a remarkably small number of things, to make believers out of people who own equities.
The first issue that confuses the market is what the stages of the economic stimulus package will be. The government will have to lay out when it intends to begin projects and get capital back into the economy. The stock market is not willing to guess about when cash that could help earnings and employment will be deployed.
The next thing that investors need to know is when the balance of the TARP money will be released and what it will be used for. If banks are going to be saved by large infusions of capital that are set up using preferred shares which will keep common shareholder fairly whole, the stocks in the financial sector will stage a furious rally and help push the market higher with them.
If Congress and the Administration do not say that the $275 billion of mortgage assistance is a sure thing and indicate when the first home loan will be saved and where it will be saved, people will remain skeptical. The government often says it will do things and then either does not do them or does them so late that the actions do not matter much.
And, of course, there is Detroit. The Treasury can tell the public what it will do about the auto industry sometime before the end of this month, or it can drag the process out for another four or five weeks. If there will not be a resolution by the end of March a Sword of Damocles will hang over the job market. If the failures of two large car companies are about to put hundreds of thousands of people out of jobs, the stock markets are going to trade lower.
Because investors are afraid, both the man with $50,000 in the market and the hedge fund manager, they will consider selling before the 50% losses they have suffered become 60% or 70%. They will give up the notion that they can get their money back due to a rally that might begin toward the twilight of the year.
The market runs on hope. If there is none to go around, it will keep dropping.
Douglas A. McIntyre