What is going on with the banks? What are they doing with all that government TARP money? Are they crumbling, are they lending, are they solvent, are the toxic assets causing them to fail or are they just fine? As usual the answer isn’t simple and depending upon who you ask, you will get a different answer. It all depends on your perspective.

As a bank executive your job is keep your bank alive. The primary reason companies fail is they spend more cash than they collect, In other words, they are cash flow negative. Based on recent financial reporting announcements, banks are cash flow positive due to increased fees from transactions they have facilitated and increased deposits. Many still have negative earnings due to write downs (on bad loans) but they can pay their bills and keep the lights on. So bank executives are relieved that the panic seems to be over and that their banks can remain viable ongoing concerns.

The U.S. economy remains mired in a deep recession. How deep, well fourth quarter’ GDP declined 6.3% which was the biggest drop in output in 26 years. GDP figures for the first quarter are not available yet but are expected to be down an equivalent amount. Earnings and profits will also be down substantially in the first quarter after falling 20% in the fourth.

These are horrendous results. There have been encouraging signs in recent weeks and the panic has subsided, but the recession is not over. The economy is still contracting, and though the rate of decline seems to have moderated, there are still problems to overcome. Hope is growing that things will improve even though the banking system is not yet operating normally. In Federal Reserve Chairman Ben Bernanke's words, there are signs of "green shoots," through snow in early spring. The economy is no longer in free fall, but it is still in intensive care and the markets may be getting ahead of themselves.

Stocks have now advanced around 35% from their lows in early March. The Dow and S&P indices are down only in the mid single-digits for the year while the Nasdaq is actually up 5%. I fully expect that we will give some of this back. It is normal for the markets to bounce around like this when the market is making a bottom. Volatility will remain high and the market bounces will be erratic and chaotic until the economy is clearly in recovery.

The emerging markets are beginning to come back to life especially China. The government’s massive stimulus program has helped China avoid sliding into a very severe recession. The Chinese economy is not hampered by many of the same problems plaguing the U.S. The state-dominated economy was able to successfully implement a massive stimulus program in November and without any delays started massive infrastructure projects. This has partially offset slumping export of Chinese goods. One note of caution, in order for China to have a sustained rally, demand for Chinese products from the rest of the world must begin to recover.

The U.S. markets rallied for their fourth week. We are now well up from the lows experienced in early March. Last week the S&P 500 rose 3.3% to 843 and the Nasdaq Composite advanced 5.0% to 1,622. Value stocks finally showed strength because the Financial Accounting Standards Board revised the mark-to-market rule giving bank stocks a boast. Value stocks however still lag growth stocks year-to-date. In fact, large to mid-cap growth stocks are now positive for the year.

Though the current rally has provided much needed relief, it does not mean the markets are only headed up. We have seen rallies galore since we started this ascent into hell last year. This is the fifth 10%-plus move we have seen in the past year and the previous rallies did not hold. For this rally to be sustainable the banks and the credit markets have to be functioning and stable.

The U.S. stock markets rallied for a third week. The S&P 500 index was up 6.2% last week. Stocks have now rallied approximately 25% up from their lows of less than three weeks ago. The rally has pushed the S&P 500 index into single digit losses for the year (down 9%) and for a few days moved the Nasdaq briefly into positive territory until it fell on Friday.

The market loved all the positive economic news it received last week starting with the 5.1% increase in existing home sales followed by a 4.7% increase in new home sales. Durable goods orders rebounded 3.4% and consumer spending rose 0.2%. All these indicators came in at better-than-expected levels. These could be signs that the economic recession may be moving past its peak but it is still too early to tell.

The U.S. stock markets rallied for a third week. The S&P 500 index was up 6.2% last week. Stocks have now rallied approximately 25% up from their lows of less than three weeks ago. The rally has pushed the S&P 500 index into single digit losses for the year (down 9%) and for a few days moved the Nasdaq briefly into positive territory until it fell on Friday.

The market loved all the positive economic news it received last week starting with the 5.1% increase in existing home sales followed by a 4.7% increase in new home sales. Durable goods orders rebounded 3.4% and consumer spending rose 0.2%. All these indicators came in at better-than-expected levels. These could be signs that the economic recession may be moving past its peak but it is still too early to tell.

For the second week in a row, equities managed to post a positive gain despite heavy profit-taking at the end of the week. The S&P 500 gained 1.6% to close at 769. From the early March lows the market is up 20%.

The big news is the Federal Reserve’s announcement to institute a program to buy $1 trillion worth of mortgage-backed and Treasury securities in an effort to boost economic growth. The market for mortgage-backed securities has been frozen for months. The Fed's attempt to thaw this market has been well-received. The move is designed to lower mortgage rates so many homeowners (that are not under water and have jobs) can refinance. This should increase homeowners' cash flow and reduce foreclosures. In addition, this may induce prospective buyers to begin purchasing homes, thus bolstering the battered housing market.

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it rains.” - Bradley’s Bromide
 

It is storming in the financial markets and the banks want their umbrellas back and in some cases are they are then closing their doors. This is the complete restructuring of the U.S. financial system and everyone is hoarding umbrellas.

“History is merely a list of surprises. It can only prepare us to be surprised yet again.” - Kurt Vonnegut

Having experienced a multitude of market crises, I realize that history never repeats itself exactly, so I’d be arrogant not to admit that almost anything can happen from here. It is a distinct possibility that things will get worse before they get better in the stock market. Even if the economy holds up, fear and pessimism could cause of investors to panic and send the market down further than justified by long-term economic fundamentals.

The Third Quarter was another roller coaster ride that almost defied gravity on the downside and upside. The average general domestic stock fund was up 1.2 percent, according to Morningstar. The S&P 500 (a proxy for large stock performance in the U.S.) was up a respectable 2.1% (the ETF proxy used in the adjacent chart outperformed the index, generating a 3.1% return). The small and mid cap sectors of the U.S. markets did not fare as well.
International stocks in developed countries persevered and performed well. Interestingly, many specific country markets were down for the quarter which validates keeping your international portfolio diversified across countries and regions.

A substantially weaker dollar bolstered returns from international investments this quarter so their returns were as good as or better than that of the S&P. The average foreign stock mutual fund gained 5 percent for the quarter.
International emerging-market funds continued on a tear, up 17%. Emerging markets refers to countries that are under developed and rural in nature. China and India are countries commonly referred to as having emerging economies. Growth in these regions has been astronomic (up 35% year-to-date).

While the majority of the economic news remains positive there are negatives looming out there. For instance, there is slower U.S. employment growth, tightening credit, higher gas prices, slowing corporate earnings growth, and falling housing prices). Despite the negatives, the current situation does not warrant selling and walking away. Corporate earnings are still strong and P/E ratios are still reasonable.

Many market specialists assert that the current concerns will play out similarly. Weaknesses like those in the market for subprime mortgages issued to borrowers with weak credit will not threaten the broader financial markets, these experts say, because the world economy is growing, corporate profits are rising, and consumers with good credit are not defaulting at high rates.

Most of us (especially those living in areas with very high housing costs) are aware that lenders have pushed the envelope in recent years and granted loans to enable people to buy homes they would otherwise be unable to afford. In so doing, many of these buyers have stretched themselves financially and have little margin for error. Low starter rates and temporary interest-only terms are winding down or expiring. The rates on these loans are resetting at a much higher level because interest rates are rising. As a result, defaults among subprime mortgages have climbed sharply.