The Worst is Over

Credit markets are getting healthier. High-grade borrowers are borrowing record amounts to pay off debts or to finance their investment activities. Perhaps more importantly, high-yield borrowers are also floating large bond issues for the same purpose. Risk spreads have narrowed considerably and should continue to do so. Despite the rise in energy costs and the slower pace of growth, corporations have managed to maintain profit margins at high levels. With profits still strong, they have the means and the motivation to finance investment in their businesses. Export growth is robust, which is keeping the manufacturing sector in reasonably high gear. Job losses are fairly small and effectively offset by rising wage rates and growth in personal income. And interest rates are likely to remain low, at least until economic conditions clearly improve.

...but the Economy Will Likely Just Muddle Along for a While

Even with all the observed improvements in the financial environment, it is very likely that the recovery will take time to gather any meaningful momentum. It is evident that getting a mortgage is now far more difficult, requiring more income, assets, and a better quality credit report. So, it will also take some time to clear out the entire overhang of homes for sale on the market. The sizeable run up in crude oil prices is diverting disposable income from discretionary spending. Consumers might also remain cautious about spending, since household net worth has taken a solid hit. And domestic problems have spilled over to weaken foreign economic growth, too.

From the above, it should be readily apparent one could make either a bullish or a bearish case, depending only on which data one wishes to cite. The problems hurting the economy are real, but so are the improving conditions. Most of the negative factors will be become less significant over time. For example, the unsold stock of homes will decline in the face of low interest rates and new construction that is well below demographic needs. So, time will fix this problem. As markets work better, capital will be allocated to the businesses that can most readily use it first. Policies to stimulate growth here and abroad will work in due course. The situation may not improve as quickly as some of the more impatient observers might prefer. (That's most of us.) But, the process is now well underway. This environment favors the patient investor, who purchases quality and waits for the slowly improving economy to turn healthier and more robust.

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