Why stocks can shake off mortgage meltdown

Turmoil in the credit markets is sparking a global sell off, but are investors overreacting?

By Grace Wong, CNNMoney.com staff writer

LONDON (CNNMoney.com) -- The threat of a broad credit crunch has jittery investors rushing for the exits, but those concerns may be overdone.

Problems in the risky debt and subprime mortgage sector have sparked wild swings in the market recently - these days few bat an eye at 100 point-plus drops and gains on the Dow Jones industrial average.

Investors have been rattled by a wave of credit woes that has hit leveraged buyouts and the mortgage sector. The worry is that a tightening of credit will have a broader impact on consumers and the economy.

There are reasons for concern. American Home Mortgage (Charts) said Tuesday lenders had cut off its access to credit and that it may have to sell off its assets. The collapse of companies like American Home and other mortgage lenders could make home loans more expensive for borrowers.

And after two years of rapid-fire deal making, the buyout boom is facing a lull. As a debt crunch starts to squeeze private equity firms, the boost take-private deals have provided for stocks could start to crumble.

Uncertainty about how wide credit problems will spread is likely to persist, which means investors are in for more sharp swings in the market. (Watch how you can protect your portfolio -- 6:07.) But there are a number of reasons why stocks aren't likely to fall off a cliff, analysts say.

Stock valuations are reasonable For one, stocks aren't too pricey and sell offs are likely to bring in buyers looking for a bargain.

"A lot of stocks are looking reasonably cheap," said Peter Dixon, strategist at Commerzbank in London. "On the basis of valuations, you've got to continue to favor equities," he said.

In the U.S., the S&P 500 index is valued at about 15 times 2008 earnings, which makes stocks attractive investments, according to Stephen Leeb, president of New York-based Leeb Capital Management.

Deals not doomed Private equity buyouts have helped support the stock rally in the U.S. and Europe as investors have bet that nearly any public company could be taken over.

The outlook for these deals is looking murky as buyout firms face hurdles securing financing, but a slowdown in leveraged buyouts isn't going to have a substantial impact on stocks.

"The exit of private equity is not going to be what caps this market. There are lots of corporate buyers out there willing to step up to the plate and fill the gaps left by private equity," Leeb said.

Economy still fundamentally strong Turmoil in the credit markets is being caused by a repricing of risk, and not from problems stemming from the broader economy, many say.

"In our opinion this is a financial market event rather than a real economy event," said John Ip, senior economist for Morley Fund Management in London.

As a result, highly leveraged companies and financial firms are likely to feel the pain. But so far, it doesn't look like the upheaval is affecting the ability of companies on sound footing to get credit, he said.

Treasury Secretary Hank Paulson said Wednesday that the fallout from subprime problems was contained and that the global economy remains strong, Reuters reported.

In a sign of the strength of the worldwide economy, the International Monetary Fund last week revised its global growth forecast for 2007 and 2008 to 5.2 percent, up from a previous forecast of 4.9 percent.

Plenty of cash out there Despite problems roiling the debt markets, liquidity - or the amount of money available for investing - remains plentiful worldwide.

China and Russia, for example, have accumulated massive reserves. The global economic boom has also helped drive corporate profits, and many companies are sitting on loads of cash.

"Liquidity is quite abundant and it will cushion the world's economy and the financial markets against the current turmoil," Tony Crescenzi, chief bond market strategist at Miller Tabak and Co. in New York, wrote in a note this week

The tumult in the credit market may persist for some time, but it's likely that "credit formation will return to levels sufficient to power a continuation of the global economic expansion," he wrote. Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.