Well it had to happen sooner or later. Stocks rallied. Vikram Pandit leaked a memo from Citibank showing the bank made a profit in the first two months of the year. The S&P went up by six percent.
Phew! Thank goodness that whole thing about toxic assets is over. Now we can get back to passively investing in stocks that only ever go up.
There is a serious case of denial coming from institutional investors and the financial media about what’s ahead. Sure, it’s tempting to think that because things have been so bad they won’t get any worse. But what exactly emerged yesterday that changed the situation banks and investors face?
Not much, that we can tell. But that’s because this is not a subjective crisis. Whether the situation has really improved does not depend on how you perceive a bank’s balance sheet or a company’s earnings. It depends on whether that balance sheet is actually healthy and the company can actually grow earnings.
But let’s not quibble. The job of the Bear is to lure investors back in so he can smack them back down later. Frankly, the bear was gorging himself a bit anyway and getting a bit lazy.
Stocks were down on average about twenty percent in major Western markets. Consumer confidence levels were low and getting lower. The Bear needs fresh meat. And he can only get that if he can attract more investors back to the market. In you go!
The major economic news released yesterday is at odds with the way the market behaved. We’re talking about the news from China that exports dropped 25.7% in February. Imports were down 24.1%.
If China makes and the world takes, China is making less because the world is taking less. And of course, China takes from Australia to make for the rest of the world. If China is making less, it will take fewer Australian resources.
There is a raft of data that need sorting, though. First, fixed asset investment in China actually grew by 25%. Fixed asset investment could be roads, bridges, and buildings-the sort of investment that needs copper, nickel, zinc, coal and iron ore. Or it could be commercial real estate-the kind of shovel-ready government busy work that doesn’t lead to any bottoming in commodity prices ore sustained resource demand from China.
Also comes the news from Japan on thermal coal negotiations between Chinese utilities and major coal sellers Rio Tinto and Xstrata. It now looks like thermal coal prices for 2009-2001 are going to come in around US$70-72 per tonne, according to Matthew Stevens in today’s Australian.
That’s a 44% decline from last year’s price of around $125 per tonne. But it’s still higher than the spot price of US$60. And it’s still 25% higher than the price for 2007-2008. So, as big as the percentage decline is, it’s coming off a large base.
That doesn’t make coal stocks an instant buy. But here is a clear difference between the extractive resource industries and the financial industries. Prices are responding to changes in demand. Resource producers are not being bailed out or directly subsidised by the government. There is a lot more transparency about what’s going on the industry.
What’s missing, to use a word analysts love, is visibility. No one can see that far ahead for the economy. This makes reliable price forecasts for commodities difficult to make, which makes earnings estimates hard to make, which makes valuations difficult to make.
Our suggestion? Keep it simple. Focus on companies with cash, little debt, and world class ore bodies (poly metallic for metals miners).
It’s a bit nauseating to be told over and over the problem is confidence. We suspect this is a political tactic. Blame the credit bubble and resultant insolvency of the financial system on confidence! Then, give the people a dose of free money, which may numb the pain of the approaching second freight train to hit them.
That freight train is the credit market not responding to increased central bank liquidity in the desired fashion. “Libor’s creep shows credit markets at risk of seizure,” reports Bloomberg. “The cost of borrowing in dollars is rising as the global recession deepens and central bank efforts to prop up the financial system fail to prevent a growing number of banks from requiring government bailouts.”
It is still a bear market in trust within the financial system. Central Banks are more than willing to lend to banks. But banks are hoarding reserves. The only upside of this is that banks haven’t relent expanded reserves into the real economy. That would be the engine of inflation.
The downside is that increased bank reserves don’t do much to improve the value of the assets on bank balance sheets. To address that, expect G20 finance ministers meeting in London to make a lot of noise about mark-to-market accounting. They want to change the rules so that firms don’t have to constantly revalue assets to their current market value.
In any event, the action in the credit markets-Vikram Pandit’s ray of sunshine not withstanding-suggest that the financial system is just as vulnerable to trillions more in losses and failures now as it was six months ago. Not a single thing has changed in the last few days to alter that fact.
Nonetheless, the market may rally anyway. The G20’s political leaders meet in London in early March. This could be a world-historic event, but not for any positive reasons. We are pretty sure the leaders of the G20 nations are not going to gather together to ratify and sign an agreement that solves all the problems.
On the other hand, all their quarrels and divergent national interests will be on full display for investors and savers the world over. Investors are going to realise this problem is bigger than even big government’s ability to contain it. What happens after that should be interesting…
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