The Crooked Road to Recovery

Story Highlights:

• Stock market drops and recoveries are seldom straight lines.
• Markets rose in eight out of nine weeks and gained nearly 40% since the March 9th low.
• Wednesday's retail sales numbers gave investors a pause but aren't a worry-worthy trend.
• Many positives today remain underappreciated, including continually improving credit markets.
• Don't be discouraged if the market takes a breather. The upward trend should resume before long.

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The end of a bear market and the beginning of a new bull generally resemble a "V"—the pace of the recovery roughly matching the pace of the decline. But neither the drop nor recovery happens in a straight line. Rising markets include upward spikes interspersed with brief pullbacks. While some investors choose to "take profits," during these pullbacks, long-term investors should avoid veering from a prudent strategy. The stock market rose in eight out of nine weeks recently, gaining nearly 40% from its March 9 low so don't fret a brief breather as investors digest new developments.

As we've noted, differences between investor expectations and reported statistics can move markets. Wednesday, the S&P 500 dropped -2.7% after the US Department of Commerce reported retail sales likely fell -0.4% in April, slightly worse than anticipated, but better than the -1.3% drop in March. But mildly negative April sales don't indicate a worry-worthy trend. And though largely ignored by the media or wrongly portrayed as a negative, the retail sales report also contained some encouraging news—inventories declined -1.0% in March (April numbers are not yet available). Low and falling inventories are a positive sign new purchases will quickly result in new orders to restock shelves as consumer fear subsides.

Many other positives remain underappreciated, including healing credit markets. As Treasury Secretary Geithner noted Wednesday, "The financial system is starting to heal." The Latin origin of the word "credit" is trust. In the panic last fall, banks lost trust in each other, and interbank lending rates skyrocketed. But fears are subsiding. The costs of interbank borrowing—as measured by the London Interbank Offered Rate (LIBOR)—have improved markedly. The 3-month LIBOR has fallen below 1% from a peak of nearly 5% last fall. Banks' willingness to lend to each other is a dramatic indication of healthier lending overall—banks depend on their brethren for funds to lend to consumers and firms.

The "TED Spread" is another handy measure of credit market health. Calculated as LIBOR minus the yield on 3-month US Treasury Bills, TED spreads are below 1% today, compared to 4.6% in October. Company borrowing costs have also declined. Yields on BBB-rated corporate debt fell -2.5% from last fall. US Corporate credit spreads—the premium investors demand to lend money to firms above what they charge the federal government—have also fallen. The spread on the highest rated corporate bonds has dropped to 1.4% from a recent peak of over 5%. High yield spreads—for riskier borrowers—fell from almost 16% down to just over 10%. Increased risk appetite of bond investors is another positive sign.

Credit markets are healing, and expect more convalescence ahead. As conditions continue to improve in coming quarters, stock prices can rise in a flash. So don't be discouraged if stock prices rest briefly before resuming their ascent.