Why Wall Street loves the bailout

The takeover of Fannie and Freddie removes a huge cloud over the markets and could be a sign that the economic pain is closer to the end than beginning.

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By Paul R. La Monica, CNNMoney.com editor at large

Now that the fates of Fannie Mae and Freddie Mac are clear, some market strategist say that it could turn out that stocks hit their low point of the bear market in July.
Do you think the government takeover of mortgage buyers Fannie Mae and Freddie Mac was a good move?
  • Yes. It just might save the housing market
  • No. Its too risky to taxpayers
  • Its too soon to say

NEW YORK (CNNMoney.com) -- Wall Street has been holding its breath since mid-July due to fears about the fate of Fannie Mae and Freddie Mac. Today, investors finally exhaled and started buying.

The government's stunning takeover of Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) this weekend may be a sign that the market has bottomed and that the economy could be ready to begin a long-awaited recovery.

Overseas stock markets surged Monday and the Dow and S&P 500 both skyrocketed more than 2%.

It's now worth asking: Was the Dow's low point of 10,962.54 on July 15 the bottom?

"Hopefully, this bailout will be the last thing we'll need for the markets to move forward. This is a huge step in the right direction," said Ted Parrish, co-manager of the Henssler Equity fund.

And if you subscribe to the notion that the economic woes are largely due to the housing mess and credit crunch, it's hard to not be encouraged by the end of the Fannie-Freddie deathwatch.

"This removes a major piece of uncertainty on Wall Street," said Alan Skrainka, chief market strategist of Edward Jones in St. Louis. "This should lead to lower mortgage rates and put the financial industry on solid footing for a recovery."

Skrainka adds that with lots of investors sitting on piles of cash, waiting for a reason to put it to use, the Fannie-Freddie news might just be that catalyst.

"Nobody can pinpoint a bottom. But when you're at the bottom, everyone that wants to sell has already sold so the first hint of good news sparks a big rally," Skrainka said.

Sure, skeptics may write off today's rally as just a short-term blip, the actions of bearish short-sellers rushing to cover their positions. After all, there was a similar state of joy following the Federal Reserve's rescue of investment bank Bear Stearns back in March.

And Parrish concedes that the rally may not last. A bigger spike in oil prices as Hurricane Ike inches toward the Gulf Coast could mean that today's euphoria is fleeting, as could more bad news about the overall state of the economy.

Along those lines, Parrish said he doesn't expect the housing market to improve overnight.

Credit and currency markets cheer the news too

But it's important to note that the dollar rallied against the euro and the yen and bonds slipped, sending the yield on the benchmark 10-Year U.S. Treasury sharply higher, from 3.66% on Friday to 3.75% Monday morning. Bond prices and yields move in opposite directions.

Quincy Krosby, chief market strategist for The Hartford, said that the action in the bond market was another indication that investors are confident that the Fannie-Freddie takeover bailout will eventually help get the housing market back on track.

"This should help spur the housing market which translates directly over into the credit markets. One of the most direct manifestations of whether Wall Street believes in this takeover will be what the credit market does," Krosby said.

She added that the sell-off in bonds Monday is also a recognition by large investment firms that they think stocks might finally be attractive again.

"The rise in long-term yields is a very good sign. It tells you that investors are willing to take on more risk," she said.

Halfway through the downturn?

If July winds up being the bottom, that could mean that this rough patch for the economy could be closer to the end than the beginning.

"The stock market appears to be anticipating the end of recession. Investors may now begin to look forward instead of backward," Skrainka said.

As I've been pointing out for some time in this column, it's likely that this downturn, recession or whatever word you want to use to describe it, began late last year. And we now know that the economy shrunk in the fourth quarter.

Skrainka said that in recession-fueled bear markets, stocks tend to hit their nadir about midway through the recession. So if the recession began in say, November of last year and it turns out that stocks did reach their low point in July, then that would put the economy on track for a rebound in March 2009.

Of course, that doesn't minimize the pain that many Americans have felt during this downturn. In addition, this is likely to be a longer recession than usual.

According the the National Bureau of Economic Research, recessions in the post World War II era have tended to last, on average, 10 months. If it turns out that this downturn goes from November 2007 through March 2009, that's 16 months.

Still, for the first time in a while, investors (and perhaps even the average consumer and homeowner on Main Street) has reason to cheer - even though Fannie and Freddie had to completely meltdown.

"It's a shame that it came to this," Parrish said. "But people are breathing a breath of relief. The bailout was inevitable and It's a big step in the right direction." To top of page

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