The Bear Is Still Alive

A colleague approached me holding the front pages of The Washington Post ("An Economy Thrown Into Turmoil," read its lead headline) and USA Today ("Signs of a Growing Crisis") and grinning from ear to ear. End-of-the-world pronouncements of this sort are usually great contrary indicators that the worst is over, or about to be, on Wall Street.

And sure enough, the next two days, the stock market went wild, the Dow Jones industrial average gaining 277 points on July 16 and another 207 points the next day. Only days earlier did Standard & Poor's 500-stock index officially confirm the existence of a bear market by dropping more than 20% from its previous high, reached last year.

So it's fair to ask whether the bear is dead. Are better days in store for the stock market? Nobody can say so with certainty. There are reasons to be optimistic. More likely, however, we're having a market respite, to be followed by lower lows.

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First, financial stocks had taken a terrible pounding -- mortgage giants Fannie Mae and Freddie Mac in particular. They were due for some good news, and they got a lot of it this week. First, the government trotted out a rescue plan for Fannie and Freddie, to ward off rumors of insolvency.

Next, the Securities and Exchange Commission announced restrictions on some forms of short selling -- that is, selling borrowed shares in hopes of buying them back later at a lower price. Some big banks finally delivered some encouraging earnings reports, starting on July 16 with Wells Fargo, followed the next day by JPMorgan Chase. Finally, oil prices, after peaking at $147 a barrel, began to tumble.

The combination of these forces became explosive, sending prices sharply higher those two days, particularly the deeply depressed shares of financial companies.

But Morgan's earnings call with analysts provides plenty of fresh, sobering details that hint at tons of trouble ahead. Morgan is a good-guy bank in the mortgage fiasco, having kept itself relatively clear of subprime lending. But it reported that its prime mortgage loans are rapidly turning sour. Chairman Jamie Dimon says his current expectation is for losses on prime mortgages to triple by sometime in 2009. "They're staggering numbers," he told analysts. "We have all the politicians telling people it's okay not to pay your mortgages."

Now the bank's home-equity borrowers are beginning to experience negative equity in their homes -- a new worry for Morgan. Laments Dimon: "You saw subprime go first, then home equity, and now you're seeing prime go. You know, it's very early in the loss curves."

Translation: Morgan minded its Ps and Qs, and even its best mortgages are going bad. What, then, lies ahead for the banks that were less cautious and more aggressive during the home-price bubble? Just more and more bad news.

For a bear-killing rally to occur, you will need some sign that bank write-downs on bad loans are easing, that banks will find the necessary capital to keep functioning and that credit is expanding again. None of those things is happening yet -- indeed, the trends are still in the wrong direction. And it's hard to think of the entire stock market rising on a sustained basis without the participation of the financial sector.

That day will come, maybe sooner than you think. And while you wait, there are plenty of sectors doing just fine, thank you. Railroads are in the fifth year of a bull market, able to raise rates even though traffic levels are stagnant. Farmers have money in their pockets like never before, and so do the businesses that serve them. Export-driven manufacturing is humming along. Many commodities remain in tight supply, which benefits companies that provide them. You have plenty of good investment opportunities even though the market as a whole staggers under the burden of all that bad news from the banks.

So don't give up. As Kiplinger.com columnist Steve Goldberg notes, bear markets have a habit of ending with a bang -- a good bang. Recoveries are very sharp, meaning that a lot of the money is made by investors who refuse to sit on the sidelines and stick it out.