naked capitalism

The markets are making wildly different interpretations of the news and economic prospects. Record low T-bill prices and a sudden fall in commodities suggests that a serious slowdown and deleveraging pose major risks, yet equities had a strong showing, with the Dow up over 260 points. What gives?

We’ve had repeated head-fake rallies in this bear market, and with prospects for housing poor for more than the usual anticipatory horizon for stocks (six months), the foundation for optimism seems questionable. More specifics come from John Authers at the Financial Times and Roger Ehrenberg.

First from Authers:

Can the stock market now indulge in a brief bear market rally?

Yesterday’s Merrill Lynch survey of fund managers made clear that the preconditions are in place.

More global fund managers are overweight in cash, compared to their benchmarks, than at any time since the survey started in 1998. Fund managers also believe that equities are undervalued by the biggest margin since the bear market bottomed in 2003, and that bonds are overvalued.

So, there is a lot of cash on the sidelines, in the hands of managers who believe stocks are cheap, and the end of the quarter is close. Many may want to use that cash to buy stocks before the quarter is up.

There is another reason to expect a rally: the bounce from Monday’s panic levels, as traders realised that Wall Street’s banks were not about to collapse one after another, has led to a rash of predictions that the bottom has been hit.

There are also hopes that the authorities have at last found a “silver bullet” to end the crisis. False hopes have been invested in several other putative silver bullets, but the news that Fannie Mae and Freddie Mac, the powerful US mortgage agencies, will be allowed to buy more mortgage-backed securities is as good a candidate as any.

History’s biggest bear markets have all had several big rallies when investors thought the worst was overDoes a bear market rally need a catalyst? Not necessarily. Tuesday’s surge was triggered by terrible results from two investment banks. Given how negative sentiment had become, the mere fact that they were not epochally disastrous was enough to trigger a rally.

In the short term, the mere absence of bad news (which is not a given) might allow the markets to enjoy a bounce.

Now Ehrenberg:

What we saw today is yet another example of the “dead cat bounce.” And I believe this baby is going to be bouncing for a little while, after which in all likelihood the rally will cease, fear will return and the market will continue its march downward in the face of massive de-leveraging. There is no choice; it is the case of the irresistible force (investors hoping and wishing for the bad times to be over, courtesy of the Fed) meeting the immovable object (the disastrous fiscal and financial market realities facing the U.S.). The Fed can lower rates to 0% – but that in and of itself doesn’t create jobs, make banks more willing to lend and stimulate economic activity. What it will do, of course, is cause a massive capital flight out of the U.S. and its debased currency, fueling a downward spiral of economic activity in tandem with upward pressure on prices that will hit with devastating effect. Not a scenario I am looking forward to.

The rally in the dollar would seem to argue against Ehrenbergs’ point about debasing the currency, but that looks to be triggered by the Fed merely debasing it more slowly than anticipated. Hardly a cause for long-term optimism.