The Good News: Bank Profits, Productivity and Less Capacity

(MoneyWatch)  (Note: This item is part two of a series on the good economic news that may be missed by the media. For other posts in the series, see links at the bottom of this item.)
In my previous post, we discussed some of the good news about the economy. There's more.

While credit losses will continue to be a problem, the basic business of banking (interest margin) is at a very healthy level as the Fed keeps the cost of funding at close to zero and credit spreads are at historically high levels. This is helping to restore bank profitability and will help strengthen balance sheets over time. We're seeing the effects of the wide spreads in some of the better than expected first quarter bank earning reports.

Also, while the typical experience is that productivity falls during recessions (as businesses are reluctant to cut employment), productivity has been rising during this recession. That's an extremely good sign for future corporate profits. When the economy recovers, profits should grow rapidly.

Finally, while it is painful in the short term, the destruction of capacity (both industrial and retail) bodes well for the future profitability of the remaining players. For example, Best Buy is likely to benefit from the demise of Circuit City. That is why it is so important to let the process work, and not try to prop up failed companies. It only makes the recovery process for every one that much more difficult.

I don't make market forecasts because the record shows that it is a fool's game. And it is also why one of my favorite sayings is that "those whom the Gods would destroy, they first make market forecasters."

What I do know is the following. Not all the news is bad. The Fed's strategy of driving up the price of risk (by driving the risk free rate to essentially zero) is beginning to work. We see that as investors are showing signs of being willing to take risks again. For example, two dormant markets -- junk bonds and initial public offerings -- showed signs of life. On April 15, investors purchased $2.7 billion in junk bonds, and in the same week, Rosetta Stone became the first IPO to price above its expected range since last May.

And finally, you should keep this in mind: Given the sharp drop in prices, the market has already discounted plenty of bad news. Thus, even if the bad news continues, just as long as it is not worse than expected, you should earn high returns. Only worse than already expected news should drive prices lower.

Follow the series "The Good News":

• Part one: New Policies, Commodities, Interest Rates and Credit Markets
• Part two: Bank Profits, Productivity and Less Capacity