Lots Of Questions About Where The Economies Are Headed

Where is this economy and stock market going to go from here? Is it a suckers rally or just the stock market doing what it always does — discounting future growth? Here’s a trio of bearish views from the U.K. and one from this side of the pond.

Perma-bear Ambrose Evans-Pritchard pulls out a bunch of historical numbers to bolster his argument that this is a false Spring. He notes that Japan had four significant bear market rallies during its lost decade and there were seven during the Great Depression. Looking for more recent support for his negative views he cites the run up in what he refers to as “trash stocks.”

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.

Evans-Pritchard limps along like this for awhile but then begins to make a bit more persuasive case as he focuses on some real hurdles:

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”.

The argument here seems to be whether we have indeed entered a period of recovery or are just in a restocking mode that provides the illusion of recovery. Essentially, are the world’s economies just seeing a basic rebuild of inventories that will peter out as aggregate demand fails to recover in any meaningful way.

Finally, Evans-Pritchard gets to the key issue, at least for Europe:

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.

His observations about the state of the banks dovetails with an article in the Guardian.co.uk which postulates that the U.K. is heading for a third wave of crisis in its banking system.

The Bank of England is concerned that the UK’s banking system is heading for a third wave of crisis that could snuff out fragile signs of recovery in the economy.

On Thursday the Bank surprised the City by announcing that it would pump an extra £50bn of new money into the economy despite recent stock market rallies.

Now the Guardian has learned that this increase in quantitative easing was driven by fears in Threadneedle Street that the credit crunch is still sucking the life out of the British economy and the banking sector remains in deep trouble.

The new mood of caution chimes with comments from business leaders yesterday, who warned that apparent green shoots in the economy had shallow roots.

Richard Lambert, director general of the CBI, said: “The fact is that for all the injections of taxpayers’ money, the credit markets are still not working properly.”

Bank of England officials are concerned that big banks now supported by the taxpayer, such as Royal Bank of Scotland and Lloyds Banking Group, are struggling to increase lending volumes, as they had promised in return for help from the government.

The governor, Mervyn King, and several other members of the Bank of England’s monetary policy committee are said to be unconvinced by talk of green shoots that has helped propel the FTSE 100 share index up by more than 20% over the last month.

Fears of a false dawn echo the mood at the beginning of the year, when apparent recovery in financial markets was wiped out by a second wave of crisis led by RBS and Lloyds.

This week both banks again warned of sharp increases in bad loans to British business customers. RBS said yesterday it was seeing little sign of green shoots.

While the Guardian article speaks to the problems with U.K. banks, it’s equally applicable to the European banks. As you can, it also squares with Evans-Pritchard’s concern about the banking sector. The question is does it have any implications for the U.S. banking sector. There is a palpable sense that the worst is over for the U.S. banks. The stress tests turned out better than most had expected, the market has run up the shares substantially and private capital seems inclined to invest in them.

Still, the words of warning for the European banks might indicate that there are pitfalls. The U.K. was arguably ahead of the everyone else in grappling with their banking problem but still seem to have issues. Whether there is a third wave for the U.S. banks remains to be seen but based on the U.K. and European experience it may be wise not to become overly sanguine with our banking system.

Another dour assessment comes from the Telegraph.co.uk. While it starts out in a green shoot vein, it ends with a reminder that any recovery is facing a mountain of problems it will need to climb. The author points out, correctly I believe, that any recovery is going to run straight into the imperative for governments to repair their financial condition.

Accordingly, even if the global economy does continue to improve a bit in the next few months, leading to apparently improved prospects here, I suspect that the UK recovery could stall.

We must not forget that this is not a normal recession. It is a balance sheet/banking crisis. And there is plenty of evidence that the aftermath of such crises can last for many years. Households still need to raise their saving rates. Banks still need to build up their capital. House prices still need to fall further. At best, western economies are facing a long period of sluggish economic growth. At worst…

I think that this might be as important a point as any. Whatever route recovery takes there are a number of structural impediments to its vigor not the least of which will be strained government finances. I’m not sure the markets are discounting this eventuality. If they continue to run at the same pace as the last month, I will be sure that they aren’t taking it into account.

I won’t excerpt from the Clusterstock article in order to keep this post at a reasonable length. Suffice it to say, that Henry Blodget has many of the same concerns that are expressed in the articles I’ve already cited. He sees a secular bear market that has more time to run, though he doesn’t necessarily think we’ll go back to the lows. On the other hand, he also has some analysis from Merrill’s David Rosenberg who does see the market falling back.

I think that in this country we are probably, at least for the time being, over the worst of the crisis. That’s not to say that events elsewhere might not put up back but I doubt that barring some true catastrophe the recovery however feeble will be arrested.

Longer term I’m not so sanguine. I don’t see the necessary attention being paid to the adjustments that need to take place in consumer and business balance sheets. Those problems are not going to go away and combined with the increasingly desperate condition of governmental finances may well trigger another downward move.

I’m moving more and more to the camp that sees a replay of the double dip of the 1980’s. Remember the second dip in that one was the real monster.

You can leave a response, or trackback from your own site.

Leave a Reply