Whither (Wither?) the Markets?

Equity investors feel like they've gotten smacked around pretty hard over the last 12 - 18 months. Yet, if you compare the equity markets to the credit markets, the equity markets have done quite a bit better in many respects.

So does this mean that the equity markets have to head even lower?

Here are some reasons to say "yes":

1) The economy is in bad shape ... and getting worse. This week's economic data is only confirmation for what a lot of us have been thinking/seeing/forecasting for some time. And the data is probably going to get worse at least through the first quarter of 2009.

2) Mortgage borrowers are in deep trouble. It doesn't matter where you look ... subprime, work-outs, ARMs, even prime borrowers are seeing distress and rising delinquencies. As unemployment and payroll declines are likely to increase, it's reasonable to assume that defaults and foreclosure have still higher to rise.

3) Credit curtailment. If you want to spend money these days, you're pretty much stuck with spending your own money. Banks are willing to lend to prime customers who want to buy worthwhile assets, but the days of cash-out re-fi's to buy motorcycles and Coach bags are over for the time being.

4) Consumer retrenchment. All of the above suggests that people won't have the cash, the liquidity, or the willingness to hit the stores and keep buying. Ultimately, this spreads out from the retailers into the general economy.

5) Global malaise. Corporate investment (capex) and exports can help for a quarter or two, but it's kinda like trying to lift a tank with children's birthday balloons ... the U.S. is a consumer economy and there just isn't enough lift in the export sector to outweigh the consumer sector.

That's an admittedly grim outlook ... but there's one factor to consider.

This mortgage meltdown was fueled (in part) by people with little-or-no-money-down mortgages. When these mortgages reset to untenably high levels, the borrower really doesn't have a lot of equity on the line. Consequently, leaving the keys on the kitchen table and walking out doesn't represent a major hit to the personal balance sheet (at least in states where there's no recourse beyond the mortgaged property).

So, for these people, maintaining the credit cards is more important than the mortgage. As long as they can revolve their debt, they have "money". And as long as they have money, they can spend.

A lot of people, then, when faced with higher mortgage payments and little or no equity (or negative equity), may be strongly tempted to say "screw it ... I'll go back to an apartment". And in so doing, so long as they have credit cards, they can keep spending.

That's admittedly not a strong argument in support of the market, but it's an early Saturday morning theory on why the equity markets might still be a little more buoyant than you would think they should otherwise be.