From Market Watch:
1.The jobs picture darkens
2. Energy prices continue to vault higher
3. Interest rates start to escalate
4. Contrarian indicators like the VIX reach new extremes
5. Corporate earnings results disappoint
Only 1 or 2 of the above could wind up being the market’s “justification” for taking the prices lower.
The problems are not over yet. Not by a long stretch. It will take longer than 18 months to unwind the excesses of the past 25 years. Analysts at Morgan Stanley reckon that the 15 largest banks which between them have shrunk their balance sheets by about $3,600 billion so far in this crisis, will shed another $2,000 billion in 20091. If you do not share my pessimism, please take a quick look at chart 3 below. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off with total household debt now at 96% of GDP vs. 47% in 1982.
Reinhart and Rogoff offer a more realistic approach (see chart 8 ) [to estimating the cost of crisis]. Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn’t even bother to produce a worst case scenario – it all got too depressing!
Obviously, governments may buy a portion of these bonds themselves, but they cannot afford more than a fraction of the total unless they want to challenge Mugabe as the ultimate master of illusion. Neither should investors hold out for sovereign wealth funds to do the dirty work. As is clear from chart 9, the total amount of wealth accumulated in these funds is pocket money when compared to the projected bond issuance over the next few years.
Hence it comes down to the price at which governments can attract sufficient demand from people like you and me. One of two things may happen. Either this crisis will ignite such a bout of deflation that investors will happily own government bonds yielding 2-3% or the deflation scare goes away ultimately, the global economy recovers and bond investors demand much higher yields for taking sovereign risk. I am not yet sure which scenario will prevail, but I do know that both are quite bad for equities longer term. Take your profits!
For a while, Swamp Report thought we were the only ones who thought it possible that the government might need to actually engineer a crisis as a way to sell all the Treasury bonds it needs to sell. No we find several others of the same opinion. For example, in another related post to Jensen’s, Clive Maund argues just that:
“The storm that is threatening to break is the combined collapse of the bond market and the dollar, which are joined at the hip. Late in April the bond market crashed important support and it dropped significantly again late last week. The dollar finally succumbed this past Friday, crashing important support. They both look set to plunge together – a scenario that will require immediate and drastic action to avert. What is the best way to rescue them? – why, to create another vicious cycle of deleveraging of course. The idea is to get the rabbits to flee out of commodities and the stock market and into the perceived safety of the Treasury market, just like last year, which will require them to buy dollars with which to buy Treasuries.”
It’s a wild world we live in…
Zero Hedge points out that unemployment typically peaks six months after the S&P 500 has bottomed. Highlighting that San Francisco Fed president Janet Yellen predicted the unemployment rate would continue to rise into 2010, Zero Hedge argues it’s too early for the stock market to rally:
“Assuming a very early Q1 peak, the implication is that the market is headfaking this number yet again (which jives with Roubini’s point earlier) and this is merely yet another bear market rally, as the real equity lows will not be evident until Q3 of 2009.”
Our previous post of Fitch’s economic outlook tends to validate an assumption of at least first quarter 2010 before the bottom of unemployment can occur:
“However, while the forecast assumes that policy measures aimed at stabilising the financial sector gain traction, ongoing household de‐leveraging will weigh on private‐sector demand, keeping GDP growth in 2010 well below potential. Consequently, Fitch projects the unemployment rate to continue rising to a peak of 10%, implying additional job losses of around 3 million, on top of the 5 million to date since the end of 2007.”
Mark Hulbert, at MarketWatch has an excellent piece out on the nature of the rally we are seeing right now.Â His idea is that this rally is so violent that it is probably not a new bull.Â Below are a couple of pastes, but read the whole peice here.
According to them, bear market rallies are almost by their very nature powerful and impressive. If we were to endow the bear market with intent, we would say that the very purpose of a rally is to draw as many gullible investors back into the market before the next leg down commences.
It turns out that the recent rally has been markedly more powerful than the average beginning of prior bull markets. Over the last two weeks, for example, the Dow has gained 18.8%. The Dow’s average gain over the first two weeks of past bull markets, in contrast, has been 8.4%, or less than half as much.
We want to stay clear of traps, yet, bull or bear rally, there’s a profit to be made in all this volatility.