Shadows Over Green Shoots

What isn't right about the rally.

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Stocks are rallying, the economy looks like it's (possibly) bottoming, and Ben Bernanke says growth could resume this year. So what's not to like? One word: Credit.

In a lengthy post, ContraryInvestor.com (re-posted in full at Zero Hedge) outlines why a sustained recovery in the credit market remains the province of wishful thinking. Without the Federal Reserve's help, sickly markets for mortgage- and asset-backed securities and even commercial paper might still be threatening to swamp the entire financial system just as they did during the worst of the crisis late last year. Scarily, stocks might simply be ignoring that fact. From the post:

The equity market has certainly caught the attention of the investment community as of late. Time to take a much needed and very important detour in this discussion. Right to the point, let’s review the character of the credit market. Certainly a general sense of optimism has risen as the equity market has levitated as of late. And that sense of optimism engenders the thinking that the economy and general financial market conditions MUST be getting better because rising equities are simply foreshadowing such an outcome. In other words, history has taught us that equities lead and so if equities are rising, the implication is better days lie ahead. But in the current cycle, we all know that credit market issues have been the locus of distress and the exact cause for a dramatic loss of wealth in financial assets really globally. So although it’s certainly fun to watch the equity markets romp higher, it’s the credit markets that deserve a really big piece of our attention. Better days lie ahead as a generic comment when both the equity and credit markets are healing in simultaneous fashion.

This should give bullish investors real pause. We've slowly been creeping back into picking stocks, touting fundamentals, eyeing breakout sectors, and all the rest of the usual analysis that gets done when the threat of systemic market disruption is absent. It isn't, and we should take care not to pretend otherwise.

  • Kirk Shinkle

    Kirk Shinkle is a senior editor for U.S. News Money and manages the Best Funds portal. Follow him on Twitter @KirkS or email him at kshinkle@usnews.com.

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