Will the Stock Market Continue Its Upward Trend?

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 |  Includes: DIA, FMCC, FNMA, QQQ, SPY
by: James Kar

The big news yesterday was, of course, the bailout plan for Freddie Mac (FRE) and Fannie Mae (FNM) over the weekend. The world stock markets celebrated the Freddie / Fannie bailout before the US stock market opened Monday morning. Except for the Chinese market, global stock markets were up significantly. The Dow was up more than 300 points at the open and then gradually faded away. The market had some momentum toward the closing and ended up close to a 300 point gain. The question is then: will the upward momentum continue?

Some say this is the catalyst the market needs: removing the uncertainty for both FRE and FNM. At the same time, we all know that the mortgage crisis and the financial sector cannot be cured in one day. The underlying problem may be deeper than everyone has thought.

Although this is good news for the stock market, I am not sure whether this is the bottom yet, because the economic fundamentals are still weak, including continuing high unemployment and lower prices in the housing market. People need to have a steady job before they canbuy a home, and people will not buy a house yet if they believe the price will continue to drop.

However, the good news is that the US government will do whatever it takes to support the housing market. So, the US government is taking a pro-active role to prevent further deterioration of the housing market. Now, the government starts to buy mortgage paper on the open market.

This action can ease some credit crunch. Hopefully, this will give the lenders more confidence to start lending again. As a result, we may see the mortgage rates begin to drop, and this may give home buyers an incentive.

But the bailout also has negative implications.

The US government is basically holding a lot of problematic mortgage papers. If the housing market continues to weaken, the mortgage paper value will continue to drop. This may cause the US dollar to go down. If global investors lose confidence in US dollar, then the Treasury bond price will suffer and rates will go up. If this is the case, the housing market will not be in better shape. Actually, we may end up with a lower US dollar and higher inflation with higher interest rates.

No one knows what the market will do. It really depends on how the market interprets the bailout. The bailout will no doubt have both positive and negative implications. The question is what investors will focus on – the good or the bad.

Bottom line: The main issue is whether the lenders start lending and home buyers start buying. If not, the US may be in deep financial trouble for a while.

Disclosure: none