“The incoming economic data in both the US and Canada have improved and for the most part [are] bettering expectations. The dilemma is that market pricing has moved far beyond the fundamentals. Despite the temptation to jump into a ‘liquidity-induced’ rally…they cannot be sustained without a durable organic economic expansion. The problem is that the global economy in general, and the US economy in particular, is operating on so much medication that it is difficult to conduct an appropriate examination of the patient at the current time. All we know is that the markets seem to have very rapidly now priced in three years worth of recovery.
“The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation – usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs – during this extremely flashy move, the US has shed 2.5 million jobs (as many as were lost in the entire 2001 recession).”
The markets rise. The economy sinks. It is not sinking as fast as it was. But it is still going down. Month after month, the number of people without jobs increases. Even Paul Krugman says that unemployment won’t reach its peak until 2011.
And house prices? Hard to tell what is going on. As Rosenberg puts it, this patient is so hyped up on drugs it’s not possible to make a diagnosis. Still, he doesn’t look good. There are millions of mortgages that still haven’t been tested. Interest only…Alt A…commercial…even prime mortgages. They are facing reset…and refinancing…with collateral prices down 20-30-40%. How can you refinance when you are underwater?
Let’s look at the basics. We had a nice thing going. From 1945-2007, consumer spending and credit increased. As long as lenders were willing to lend…and consumers were willing to go further into debt…the economy expanded.
Towards the end, it got a little crazy. And then it blew up.
As predicted, the feds rushed in to save the situation. But they only have one trick – adding more cash and credit. That works every time…until it stops working. And it stopped working in 2008.
Banks don’t want to lend against falling house prices. And consumers don’t want to borrow when their incomes are going down.
Ergo…the end of consumer credit expansion. Get over it.
But the feds keep at it. And with their help, the markets have bounced up. Of course, a bounce is one of the most reliable features of a market economy. A 50% bounce in the Dow – roughly equal to the bounce after ’29 – would take the index to 10,300. We’re not there yet.
So, there’s nothing unusual or unexpected about this situation. The markets have done what they were supposed to do. The feds have done what they’re supposed to do.
So what next?
Ah…dear reader…if only we knew the answer to that question…
Here we are in uncharted territory…terra incognito…
Never before has there been an international monetary system based purely on paper. And never before has it been run by people who believe they can force the market to do their bidding. They are convinced that they can avoid the Japan situation – where the economy dragged along for twenty years – by adding more cash and credit. Bernanke said he would drop it from helicopters if necessary.
Just one problem…. Bernanke can inflate…but only until the Chinese tell him to stop. When China pulls the plug on the bond market, the party comes to an end. That’s why the helicopters are still on the ground. And it’s why they will only take off when the situation becomes desperate.
In the meantime, we await the ordinary…that is, an ordinary end to a post-crash bounce. That will come with another crash. And another. And another. Until stocks finally hit bottom…and bubble-era delusions are finally all crushed out.
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