I did a double take when I saw this news:
The inspector general for the $700 billion TARP scheme tallied about 50 initiatives set up by the Bush/Obama administrations and the Federal Reserve and came to the conclusion that “the US government’s maximum exposure to financial institutions since 2007 could total nearly $24 trillion, or about $80,000 for every American.”
Sheesh… for those who have a million dollars or more in their bank accounts, $80,000 to save the financial markets is chump change but for most blue collar workers, that could very well be their net worth.
To be sure, the $24 trillion is the gross and not net exposure. Most likely, the full amount will not be used. But the astronomical amount of money at stake makes the effort of most Americans who have turned to frugality and saving money seem insignificant.
Anyway back to the stock market. After seven consecutive sessions of gains, market sentiment has turned slightly cautious. Technically, the averages show that stocks are overbought, which increases the risk factor but because they have broken out above early June highs, the upward momentum is not likely to fizzle out immediately.
Indeed, the stock market rally has fooled many investors with its longevity and I am glad that I did not sell off all my stocks. Blow-out earnings from leading banks (Goldman Sachs and JP Morgan) renewed market optimism and reversed a bearish head and shoulders pattern.
Strong profits from the financial sector are actually not surprising considering the low interest rates (effectively 0%), mark to market accounting thrown aside, and the value at risk for trading activities soaring to record levels. In addition, low earnings forecasts across the board make it easier to surpass expectations.
Investors were further emboldened after a temporary reprieve for CIT from bankruptcy and a string of better-than-expected corporate earnings filtered in. Nevertheless, the euphoria for commodities and equities might prove to be transitory. Thus, I am not keen to add to my positions amid increased appetite for speculation.
Due to weak consumers’ demand, it is still highly suspect if earnings from the real economy can consistently outperform expectations in the months ahead. Before the financial crisis, most individuals and businesses stretched their budgets and leveraged to the hilt. Well, it finally hit home that nobody get rich by spending beyond their means.
The years of easy credit is unsustainable and most likely over. If Americans are squirreling money away for a rainy day, then the only hope for the global economy to power ahead lies with emerging markets.
A case in point is the booming Chinese market. China reported an impressive 7.9% growth in their economy in the 2nd quarter while the U.S. and Europe remain mired in recession. China’s 4 trillion-yuan ($585 billion) stimulus package has worked like a charm – domestic consumption and infrastructure works have more than compensated for the decline in exports.
We are also told that China’s stockpile of currency rose by a record $178 billion in the second quarter. The US definitely need China’s continued support to fund unprecedented amounts of debts. In a further show of strength, China has overtook Japan as the world’s second-largest stock market by value for the first time in 18 months. Slowly but surely, Japan’s large but ailing economy is losing its influence.
At the moment, I am sticking to my view that the stock market rally is overdone and there is a good chance of buying on the dips again. We have come a long way from the March lows when stocks fell far below their peak, and a stock market rally is justified by long-term fundamentals. As more disbelievers wade in to capture a piece of action before they miss out on more profits, the stock market rally stretched into months.
However, the recent rally has priced in very rosy earnings for many sectors in anticipation of a full-fledged recovery. Such optimism will allow bears to force the stock market lower in the later part of 2009 when the outlook for earnings in the real economy turns bleak or more time bombs in the commercial and prime mortgages explode.
Instead of a lengthy consolidation, the stock market has broken its previous resistance aggressively. Though investors are now behaving like sex-starved addicts in a harem and are ready to invest at any hint of positive news, do not forget that market sentiment can turn on a dime. The result is that there are air pockets instead of firm support at the bottom, and that makes a major correction inevitable.
Some experts have postulated that we are entering a 20-year bear market, with rallies occurring intermittently and the worse is yet to come. We are now a few weeks away from challenging the record “longest” stock market rally of 155 days which happen in November 1929. The drastic stock market correction and prolonged economic malaise thereafter is something which I do not hope for, but nevertheless a distinct possiblity.
A major correction will really test investors’ resolve. After experiencing these bear traps a few times and the stocks retreat to unprecedented lows, investors will give up stocks altogether. Judging from the buoyant mood in the stock market. we are not at the depressed level yet.
So far, we have seen complex toxic financial instruments, frauds, Ponzi schemes and creative accounting come out of the woodwork. Usually, the greater the deception, the more severe will be the depression. We can heave a sigh of relief if most ills in the financial system has surfaced already. Unfortunately, that is a tough guess.
As for the housing sector, there is a renewed spat of buying. It is true that houses are much cheaper than in 2007 but they are not necessarily more affordable. The falling prices is a reaction to lower income and employment. Credit has also dried up as mortgage lenders become more cautious about whom they lent money.
Another property bubble could be brewing. Speculators are hanging on to the common refrain that “houses always go up in price” and are rushing to snap up new offerings. Prices may have stabilized currently but not bottomed yet. Thus, hopes for huge capital gains may not be realistic.
That is not to say we should shun properties. If you intend to stay in your house, then it is a good place to park your surplus cash. A house offers you a roof over your head and is a very durable asset (which cost money to maintain). When you take on a 30 year fixed rate loan, chances are that you are paying off the loan with cheaper dollars as inflation rears its ugly head. But if you are seeking investment grade properties, they will probably not appear in another 2-3 years time.
Because of the liquidity being pumped into the financial system by the Federal Reserve, nobody in his right mind will sit fully on cash and let inflation eat into their wealth. It is difficult to know how much further this rally will last. Is it exhausted already or the start of another massive bull run?
The bulls feel that “prosperity is around the corner” and that this recession, like others since World War II, will end as soon as the stock market, as a leading indicator, recovers and people start spending again.
I am inclined towards the view that things are picking up but the possiblity of another major correction is never far from my mind. On the technical side, there is room for huge rallies, but there is also room for plenty of misery.
The key is not to be overexposed to the stock market and stay nimble as the opportunities that present themselves may not follow traditional recovery patterns. Stocks could be depressed further or languish for years, so if you see the need to take profits off the table, then just do it.
While there will be quarters of positive economic growth ahead and the recession could even be declared officially over in the coming months, the radical economic reorganization that is slated by policy makers or will be forced upon by circumstances will change the macro economic landscape as we know it.