— The bottom is in. Stocks rallying in the face of bad news is bullish. France and Germany have a plan to save Europe. China is headed for a soft landing…
— It reminds us of this line from the original Star Wars film: ‘These aren’t the droids you’re looking for.’
— It’s a quote from Ben Kenobi, the Jedi Knight. He was using his mental power to stop the imperial storm troopers taking vital information from his droids. The storm troopers, being lazy, unthinking types, wander off, leaving the droids they were looking for behind.
— What’s our point? Don’t be a storm trooper!
— It’s easy to look at share price movements and draw conclusions. With the strong rally you’ve seen over the past week, it’s easy to think the worst is behind us. But the stock market isn’t easy. It’s designed to deplete the unthinking of their wealth and reward those who question the consensus.
— Making matters harder today, finding a consensus view is difficult. If you take the finance industry – the brokers, strategists and advisors – the consensus is bullish. This shouldn’t really come as a surprise. When is it ever different?
— Career risk plays havoc with a person’s judgment. To be wrong at ‘the turn’ can literally be career ending. Our guess is there are many who remember not being bullish enough in March 2009 who don’t want to make the same mistake twice.
— But the reason they weren’t bullish enough in March 2009 was because they were too complacent about the events that preceded that point. The 2008/09 market action was a true bear market in that it demoralised just about everyone involved. Eventually, there was no one left to sell. Along with trillions of dollars of stimulus spending, demand for shares soon overwhelmed supply. The market took off.
— Let’s have a look at the rollercoaster ride that the market was back then.
Click here to enlarge
— By 10 October 2008 the All Ords had fallen more than 42 per cent from the peak reached in November 2007. Many thought a bottom was in. Within two trading days, the index jumped nearly 10 per cent. Yep, it looked like a bottom.
— Maybe not. Over the next three days the All Ords fell by 8.5 per cent to test the 10 October low. It passed the test and by 21 October it rallied another 7.8 per cent. The bulls were felling confident.
— But the bear was just getting started. By Tuesday 28 October the market dropped another 11.7 per cent, taking out the October low. A rally into early November saw the index claw back 530 points, or over 14 per cent. The rallies were vicious and deceptive, which is what bear market rallies are. From the 5-20 November the market plunged another 22.2 per cent.
— Things were getting ugly and the ever-optimistic bulls were running out of steam. The capitulation was near. Santa Claus came to town and from the November low to 7 January, the market rallied nearly 12 per cent. Combined with the optimism that a new year brings, this gave the bulls hope.
— It was soon shattered. Throughout January, February and early March, the market tanked another 16.3 per cent – to it’s ultimate low. By then, very few had the conviction, energy, or any dignity left to call a bottom.
— So are there parallels with today’s markets? We think there are. Although instead of the sub-prime crisis being the catalyst for the financial dislocation, today you have two candidates – Europe and China.
— Whatever the politicians dream up, Europe’s problems come with no easy solutions. You can recapitalise the banks all you want but unless you write down the bad debt too, it’s a pointless exercise.
— And even this ‘solution’ is coming up against some barriers. Apparently the bankers are none too keen to raise equity at this point. They reckon they wouldn’t be able to anyway. Private investors know write downs are coming so why would they want to stand with their capital in front of that oncoming truck?
— Their strategy is to sell assets and shrink their balance sheets instead. It sounds like a bluff. Why would they sell their good assets and keep their junk? The audacity of these blokes is mind blowing. They’re just trying to make the politicians think they’ll reduce lending and threaten economic growth if they don’t get their way.
— Anyway, the European solution will either be a debacle or a slow-motion train wreck – take your pick.
— And in China you’re beginning to see the beginning of the end of the credit bubble. Despite the fallout from the US credit bubble bust, there is an incredible lack of understanding or comprehension about just how damaging credit booms can be.
— The end of China’s credit boom is manifesting in slower economic growth. Like the US in 2007, the consensus view is that this is a run-of-the-mill slowdown and, well, ‘These aren’t the droids you’re looking for’. We think time will show that to be another example of flawed credit market analysis.
— Ambrose Evans-Pritchard of the London Telegraph weighs in with his latest:
It is proving harder than expected for the central bank to manage a calibrated “soft-landing” after letting rip with credit to counter the Great Recession. The loan spree raised credit from 100pc to almost 200pc of GDP (on IMF estimates), including off-books trusts, letters of credit and sub-radar loans from Hong Kong.
The 30pc annual pace of loan growth is unprecedented in any major country in modern history. It is double the pace of America’s housing boom and Japan’s Nikkei bubble in the late 1980s. It may match US loan growth in the late 1920s.
The Communist Party is now struggling to cope with the fall-out. On Monday, the state investment fund Central Huijin began buying stakes in China’s four top banks to restore confidence and halt the slide in share prices.
The relief rally ignited bank shares on Tuesday. Agricultural Bank of China surged 13pc in Hong Kong. Shanghai’s bourse jumped 4pc but is still down 60pc from its peak in late 2008.
China’s finance ministry is quietly intervening to underwrite China’s railway system. This behemoth is drowning with $300bn of debts after breakneck expansion, is in arrears on $25bn of debts to its two largest suppliers and has run out of money to pay workers on the Lanzhou-Chonqing rail project.
We’ve never seen a government or central bank who could manage the other side of a credit boom. We don’t think China’s about to be the first.
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