Despite quite a few warnings, the stock market rally continues to grind upwards. Although past is not always prologue, this upswing has not featured a new leadership group, as enduring bull markets normally do, nor has it reached the crushing valuation lows (PEs of 5-8 versus roughly 11 in early March), Moreover, despite the mythology to the contrary, bottoms of major bear markets coincide with rather than precede the upturn. And according to Carmen Reinhart and Kenneth Rogoff, stock market declines in countries suffering major financial crises take 3 1/2 years to bottom.
Ambrose Evans-Pritchard gives some other reasons to be cautious, particularly for possible late entrants. Note that he sees the risk of deflation and is not certain that the heavy duty pump priming by major central banks will prove sufficient.
From the Telegraph:
Bear market rallies can be explosive. Japan had four violent spikes during its Lost Decade (33pc, 55pc, 44pc, and 79pc). Wall Street had seven during the Great Depression, lasting 40 days on average. The spring of 1931 was a corker.
James Montier at Société Générale said that even hard-bitten bears are starting to throw in the towel…That is a tell-tale sign.“Prolonged suckers’ rallies tend to be especially vicious as they force everyone back into the market before cruelly dashing them on the rocks of despair yet again,” he said. Genuine bottoms tend to be “quiet affairs”, carved slowly in a fog of investor gloom.
Another sign of fakery – apart from the implausible ‘V’ shape – is the “dash for trash” in this rally. The mostly heavily shorted stocks are up 70pc: the least shorted are up 21pc. Stocks with bad fundamentals in SocGen’s model (Anheuser-Busch, Cairn Energy, Ericsson) are up 60pc: the best are up 30pc.Teun Draaisma, Morgan Stanley’s stock guru, expects another shake-out. “We think the bear market rally will end sooner rather than later. None of our signposts of the next bull market has flashed green yet. We’re not convinced the banking system has been fully fixed,” he said
Mr Draaisma said US housing busts typically last nearly about 42 months. We are just 26 months into this one. The overhang of unsold properties on the US market is still near a record 11 months. He expects the new bull market to kick off later this year – perhaps in October – anticipating real recovery in 2010.
Keep an eye on the upward creep in yields on the 10-year US Treasury,….This alone threatens to short-circuit the rally. The yield reached 3.3pc last week, up over 1pc since January and above the level in March when the US Federal Reserve first launched its buying blitz to pull rates down. Bond vigilantes are taunting the Bank of England in much the same way, driving the 10-year gilt yield to 3.73pc.
The happy view is that this tightening of the bond markets is proof of recovery fever, but there is a dark side.
Governments need to raise $6 trillion (£4 trillion) this year to fund bail-outs and deficits, led by this abject isle with needs of 13.8pc of GDP (EU figures). China fired a warning shot last week, saying the West risks setting off “inflation for the whole world” by printing money. It hinted at a bond crisis.Yes, the glass is half full. China’s PMI optimism gauge has jumped back above the recession line. The global PMI has been rising for seven months. But this usually happens after a crash as companies rebuild battered inventories for a quarter or two.
Note that container volumes in Shanghai fell 17pc in January, 22pc in February, and 9pc in March. Rail freight volumes in the US were down 32pc in April on a year earlier.The Economic Cycle Research Institute (ECRI) says the US recession will be over by summer, insisting that its leading indicators have never been wrong – except once, in the Great Depression. Quite.
SocGen’s other bear, Albert Edwards, says the new element in this slump is that GDP is contracting in “nominal” terms, not just real terms. Money incomes are flat. It is a crucial difference.
“This is like drinking hemlock. The US is gradually slipping further towards outright deflation, just as Japan did,” he said. As companies retrench en masse they risk tipping the whole economy into Irving Fisher’s “debt deflation trap”.
If we are spared – still a big if – we can thank a handful of central bank governors and policy-makers who tore up the rule book, defied tabloid opinion, and took revolutionary action in the nick of time….
We can now test the Friedman-Bernanke hypothesis that the Fed could have halted the Depression by letting rip with bond purchases. Japan was not a proper test. It eked out a recovery of sorts earlier this decade by embracing QE, but only in the context of a global boom and a yen crash.
There is at least one more boil to lance before we put this debt debacle behind us. The IMF says eurozone banks have so far written down a fifth of likely losses ($750bn) compared to half for US banks. They must raise $375bn in fresh capital. Good luck.
Germany’s BaFin regulator goes further, warning of $1.1 trillion of toxic assets on German bank books. Landesbanken are a calamity. If the IMF and BaFin are right, Europe has not yet had its crisis. When it does, we will see a second stress pulse through Eastern Europe and Club Med.
The echoes of 1931 are ominous. That year began with green shoots, until Austria’s Credit-Anstalt buckled in the summer and took Central Europe with it. Continentals who still thought it was an American crisis learned otherwise. Plus ça change.
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Who will be this year’s Credit-Anstalt? Likely candidates include, but are not limited to UBS, RBS and BAC.
And it was nice to see you pointed out again the myth of the stock market’s six-months-ahead-of-recovery prescience. I’ve checked and rechecked the data since WWII and a myth it certainly is.
The Danniger article on FNM is worrying, and I will recommend it again here in case anyone missed it. Maybe that makes FNM the modern day Credit Anstalt?
Finally, I still do not know what a ‘green shoot’ is, or rather, what data constitutes one. If it is the combination of the uptick in consumer confidence and the stock market rally, I think they could be termed tautological indicators. Otherwise, nothing else seems to be sprouting other than complacency.
The dash for trash – Krispy Kreme Doughnuts quadrupled. Martha Stewart and Overstock.com more than doubled, in the face of bad earnings reports, poorly explained departures from the boardroom, and Overstock’s change of auditors.
When does it all blow up? Dash for trash indeed. The stress tests were a joke considering we are already in what they deemed as the worst case scenario. How do they keep getting a free pass on what is really happening? Pretty soon with all this money sloshing around inflation has to take off.
“Plus ça change” you can believe in.
If in deed this is a bear market rally the end will be sudden and new lows will come very quickly once the roll over starts.
Mr Evans-Pritchard says:
“If we are spared – still a big if – we can thank a handful of central bank governors and policy-makers who tore up the rule book, defied tabloid opinion, and took revolutionary action in the nick of time….”
This statement is beyond belief. We wouldn’t be in this mess if businessmen in league w central bankers didn’t go hog wild.
Assuming things normalize, we can (in the US) principally thank the good sense of the people, who cut back spending, kept their money in the banks, continued to go to work every day so long as they had jobs, and even stayed peaceful when forced to live in tent cities while banksters received trillions in bailouts.
I am starting to see parts of the economy going different ways. Manufacturing especially here in the UK is picking up a little, whether that is due to the end of inventory reductions or currency devaluation I am not sure. In contrast there are service industries, which cannot really be used to gain competitive advantage which are just beginning to tank. All the while construction seems to be getting ever more dire. In my book the unemployment rate will begin to tell on manufacturing again during the summer.
As for the potential triggers to a downward spiral, then despite the precarious position of some European banks, I think Europe can if it chooses to be aggressive as the US. Eastern Europe, switzerland or the UK can be converted to the Euro, Europe can print money. If there is to be a problem it is more likely to come from an unexpected direction. Certain gulf states for instance have their own problems, and Chinese banks having been given a free hand to lend will no doubt in some cases get into difficulty with bad debt. For me the one engine of potential recovery is India and it maybe here that I would look for a triggering event.
As Jim Kunstler has observed, correctly, in my view, the only bottom we have reached, and here I paraphrase, is in people’s ability to accept the nature of the epochal change that is upon us.
All that needs to happen prospectively to totally turn the apple cart upside down is for the “stress test” limits to be exceeded and we will have a panic the likes of which will completely overwhelm our already fragile financial institutions. And that is certain to happen in my view. Here is one thing to keep one’s eye on. In a matter of weeks, the BIS will be reporting on OTC derivatives. If they announce an increase in these instruments then count on another even more crushing leg down coming. Having said that, that is just one outcome of many that will put the kibosh all of the fraudulent gloss jobs the government has been engaged in.
This posting assumes that everything that is going on is not “breaking the rules”… Meaning, this author is making the assumption that the system must deleverage without someone else leveraging… I am not completely sure about that.
What we do know is that banks are now allowed (and encouraged) to leverage 1 to 25 times. We also know that quant activity (especially GS) have been doing almost (March – 37%) half of the activity that has been going on. Do we know for sure if they are going to deleverage? If I had by conspiracy hat on, I would say that the PPT would rather lose the money than risk loosing everything they have worked to achieve…
To assume that things will happen as they have historically I think forgets that the level of intervention historically has been the same, which it has not. Meaning, I strongly suspect the Great Depression would have turned out differently if the Federal Reserve had not had to worry about gold reserve limits. None of those limits apply today…
In short.. In my opinion, the only safe space right now is sell off exposure, and sit on the sidelines and wait. The risk in the short term (3 months) inflation is minimal, and the risk of being caught in the crossfire of much larger players is large.
Ambrose Evans Pritchard is right to keep an eye on the upcreep in 10 year yields, but probably for the wrong reasons. The upcreep in yields indicates a lack of demand failing to keep up with the exponential increase in supply over the next few quarters.
Everyone here can recall what a little bit of demand destruction in crude oil did to crude oil prices in 2H 08. They fell 78% in six months. By the same token, treasuries may be crashing simply due to demand failing to keep up with the exponential rise in supply.
Oddly enough, if this is what is playing out, this should actually be bullish equities near term. The short bonds/long equities trade will not be unwound until the crash in treasuries end. That is to say, the stock market is not sensitive to rising rates acting as a constraint on the economy at the moment. What it is sensitive to is the huge monetary and fiscal stimulus from central bankers and govts around the world.