This is a “helluva rally”, says Miles Zyblock of RBC Capital Markets. The MSCI index of 23 developed countries is up by a fifth since early March. American stocks have had their best fortnightly run since 1938, with the S&P 500 gaining 22% from its latest trough. On Monday alone, the S&P Financials index jumped by 17% after the government announced its plan to rid banks of toxic assets and thus try to encourage them to lend again. British stocks are up by around 12%. Sentiment has improved across the board: emerging markets are in the black for the year and commodities have joined the rebound. “This is the most convincing rally of this bear market,” says John Authers in the FT.
But will it mark the end of the bear, or is it “yet another” bear market rally, as Albert Edwards of Société Générale reckons? This has all the hallmarks of a “dead cat bounce”, says Neil Hume in the FT. Much of the upward impetus has come from short-sellers closing bets; and the sector that fell furthest, financials, has rallied most. New bull markets are rarely spearheaded by the industries that led the decline.
The past few months show that “investors’ optimism can come and go as quickly as US bank bail-out packages”, says David Wighton in The Times. US Treasury Secretary Timothy Geithner’s new scheme is “hardly a slam dunk”. It will be some time before it’s clear whether it will clear up the toxic assets problem. A major worry is that the incentive for banks to sell their dodgy assets “is far from compelling”, says Damian Reece in The Daily Telegraph: they would have to write off their value immediately and thus crystallise more losses, which may “exacerbate the credit squeeze”.
Meanwhile, we’ve heard “the same old claptrap” about how valuations are “too cheap to ignore” and how stocks pre-empt recovery by six to nine months, says Edwards. So far, there’s scant evidence of the global economy recovering anytime soon. The Organisation for Economic Co-operation and Development leading indicator, for instance, isn’t pointing to a rebound. And while stocks are cheap, they’re not as dirt cheap as they’ve been in previous major bear markets.
So when will the next bull market finally arrive? Dirt cheap valuations would be a buy signal, regardless of fundamentals, and there are also three “signposts” that will point to the start of the next economic growth cycle, says Morgan Stanley’s European strategist Teun Draaisma. One is the trough in earnings, which, given the severity of the ongoing downturn, the bank now expects to fall by 63% peak-to-trough across Europe, with the bottom only arriving in mid-2010. The expected peak-to-trough fall in US annual reported earnings is now 95%, the worst in 140 years, says Tim Bond of Barclays Capital.
We would have to have the bottom in US house prices in sight too, says Draaisma. At present, prices and sales are still falling year on year and, with foreclosures still climbing, supply is still rising. There is still almost ten months’ supply on the market; five to six would be consistent with a balanced market, says Draaisma. Pencil in mid-2010.
Then there’s the state of banks’ balance sheets. Once the proportion of lending officers tightening in the Fed’s quarterly survey slips to 20% (the latest figure was 64%), deleveraging will have gone far enough for growth to resume. But none of this is in sight. And although stocks typically bottom a few months before earnings and house prices, in a severe crisis equities may lag the fundamentals. In the 1930s, European and US equities troughed six months after US house prices, rather than a quarter or two ahead of the nadir, as is typical.