The $7 Trillion Rally

The capitalization of global equity markets is up over $7 trillion from the lows of early March, but it's still down almost $30 trillion from the highs of late 2007. Is a new bull market underway? I see lots of bears warning that this is merely a bear-market rally, that stocks have yet to hit their lows, and there is no shortage pundits warning that the economy is in dreadful shape and a recovery is virtually impossible without more wealth destruction on a global scale.

In my view, the origins of this latest rally can be found in a variety of indicators: sharply lower swap and credit spreads; higher commodity prices; rising shipping rates; quantitative easing by the world's central banks; lower implied volatility in stock and bond options; a steep yield curve; surprisingly strong profits at banks and brokerage firms; a surge in home resale activity; historically low mortgage rates; a relaxation of mark-to-market rules; a decision by the Obama administration to back off from its headlong dash to implement cap-and-trade and universal healthcare; and push-back from the Senate on Obama's request to cut deductions on charitable contributions, to name just a few.

Note that I did not cite bailouts or TARP or PPIP or massive government spending stimulus or trillion-dollar deficits. I think the economy was always capable of recovering by itself, given time and some help from the Fed to accommodate a surge in the demand for money. If anything, I think the stimulus bill passed earlier this year will only retard the economy's recovery, since it boils down to government grabbing a huge amount of the private sector's money and spending it inefficiently; that money could have been put to use in a far more effective fashion by the private sector if policies had been geared to increasing the incentives to take risk (e.g., by lowering income taxes, and/or reducing or eliminating the corporate income tax) rather than redistributing income and force-feeding infrastructure projects.

Maybe we will see another selloff or two before equity prices march significantly higher, but that's probably irrelevant. What seems to be happening now is the beginnings of a virtuous cycle. Our dynamic economy has had plenty of time to adjust to new and painful realities; prices have adjusted massively so that markets are now clearing; confidence is slowly recovering; wealth is returning; cooler heads are prevailing. It all feeds on itself, resulting in a classic "melt-up" scenario.

In coming months we are likely to see a slowing in the pace of layoffs and a bottoming in inventories. Hiring should then resume, and by that time the recovery will be obvious to everyone and the equity market will be significantly higher, even if the outlook for growth isn't all that great and trillion-dollar-deficit storm clouds darken the economic horizon. In the meantime, expect to hear a steady drumbeat of pessimism.

Comments

[Dave Wrixon:]

Please define Dynamic Economy.

Apr 19 07:29 AM

[ArkansasAngie:]

I've got my fingers' crossed but I am not holding my breath.

Apr 19 07:41 AM

[User 241672:]

A reduction in the rate of decline of GDP is not a recovery.

How exactly is the consumer going to get out of this mountain of debt?

I wouldn't get too far ahead of things expecting a return to the good 'ol days of neg-am mortages and mailboxes filled with credit card applications.

People are going to have to figure out a new way forward that involves less imports and more exports, less financial engineering and more mechanical engineering. And I hope sooner than later wind down GM, CITI and AIG instead of throwing tax dollars at them.

Apr 19 08:03 AM

[ECONOMICS 101:]

How much more money can we through at this??? It's getting crazy!!!

Apr 19 08:29 AM

[bullpasture:]

What a joke! I didn't know that financial pundits smoked "funny stuff" so early in the morning...... Quick get your resume into CNBC. They need all the help they can get to "pump up" the the happy outlooks since Jim Cramer was so humiliated by the obvious truth.

By the way this statement of yours containing "...stimulus bill passed earlier this year will only retard the economy's recovery, since it boils down to government grabbing a huge amount of the private sector's money..." is inane and shows you are ideologically fixated as a "knee jerk" conservative. Haven't you grasped the fact that the "money" you worry about the government grabbing doesn't yet exist and won't be taken from the private sector in taxes and instead it is created with the Fed's "Quantitative Easing" after the treasury prints up some more treasury bills and notes to be purchased by them.

Good grief (says Charlie Brown). Get a life!

Apr 19 08:44 AM

[CautiousInv...:]

In my view, the origins of this latest rally can be found in a variety of indicators: sharply lower swap and credit spreads; higher commodity prices; rising shipping rates; quantitative easing by the world's central banks; lower implied volatility in stock and bond options; a steep yield curve; surprisingly strong profits at banks and brokerage firms; a surge in home resale activity; historically low mortgage rates; a relaxation of mark-to-market rules; a decision by the Obama administration to back off from its headlong dash to implement cap-and-trade and universal healthcare; and push-back from the Senate on Obama's request to cut deductions on charitable contributions, to name just a few. ______________________...
The Baltic Dry Index is up a little from its December lows but is still down 85% from its peak. New Home sales fell 12% in March and the latest Case Schiller housing price index indicates home prices are falling a rate of 19%. Copper is up a little because of China and a shortage of scrap; the VIX is down but a lot of Quant funds have been out of the market since the March lows; corporate bonds defaults are peaking as are corporate and personal bankruptcies; and the change in M2M allow Citigroup to report a profit when it is clearly unprofitable.Citigroup would have been operating substantially in the red were it not for the fact that it managed to book $2.5 billion of income from the fact that its debt securities plunged in value over the course of the quarter. Since the mark-to-market value of its liabilities is now lower, it’s allowed under US accounting rules to register a profit.

Apr 19 08:48 AM

[madmilker:]

today....American has dug it a $57 trillion dollar hole and the nincompoops in D. C. are still holding the shovel. They jus put 2 more trillion of dirt on tat pile which puts the US within spittin' distance of all them people tat are buried standing up in China.

45% of our economy today is dependent on government spending & control which puts American at 45% socialistic, leaving only 55% FREE....is this what them few fat farmers had in mind when with the penmanship of poets they wrote down on tat piece of paper back in 1776.........the American dream.

If anyone thinks a $7 trillion dollar rally is coming....they be one sandwich short of a picnic. Your not gonna hear a steady drumbeat of pessimism from the American people cause they be looking at a $57 trillion hole tat the Federal Government, State Government, County Government, City Government and "we the people" living above their means put there.

Apr 19 08:50 AM

[Steven Hansen:]

what is not well understood is that the economy will only fall a certain amount. there is a resistance to further economic contraction which grows as the economy contracts. even though negative pressures exist for further contraction, they are opposed by this resistance. this is why the economy simply does not continue to fall when faced with negative pressures.

on the other hand, the the origins of this latest rally are not economic - except if the market believed the economy was going to continue to fall at its current rate through 2009.

Apr 19 09:22 AM

[KCN:]

On the spot. The money Govt. put in never existed in private economy. Yes, the conservatives distort facts and they fundamentally believe in two class system. The major headache for Conservatives under Clinton was that lower classes were able to go to nice places impinging on their style. When Clinton left, we had surpluses coming out of ----. Republicans, after stealing two elections, made sure that there was none. The game for conservatives is simple: mine is mine and you have none, so I am rich beyond your imagination.


On Apr 19 08:44 AM bullpasture wrote:

> What a joke! I didn't know that financial pundits smoked "funny stuff"
> so early in the morning...... Quick get your resume into CNBC. They
> need all the help they can get to "pump up" the the happy outlooks
> since Jim Cramer was so humiliated by the obvious truth.
>
> By the way this statement of yours containing "...stimulus bill passed
> earlier this year will only retard the economy's recovery, since
> it boils down to government grabbing a huge amount of the private
> sector's money..." is inane and shows you are ideologically fixated
> as a "knee jerk" conservative. Haven't you grasped the fact that
> the "money" you worry about the government grabbing doesn't yet exist
> and won't be taken from the private sector in taxes and instead it
> is created with the Fed's "Quantitative Easing" after the treasury
> prints up some more treasury bills and notes to be purchased by them.
>
>
> Good grief (says Charlie Brown). Get a life!

Apr 19 09:27 AM

[ArkansasAngie:]

There are different types of recoveries.

I am not for a return of the status quo.

For example, you hear that Goldman, CITI etc. are really chaffing at bonus restrictions. It is at least in part why they want to return the money.

Personally I think that kind of compensation is ridiculous in good times and bad.

Apr 19 09:35 AM

[pokernut:]

04 August 2007

Scott Grannis (Chief Economist at Western Asset Management) writes privately to say (and share)...
- David M Gordon / The Deipnosophist
======================...
"It's clear to me that the economy is not going to be very strong, but at the same time it's hard to find signs of impending disaster. There's a decent mix of weakness and strength out there."
-- Scott Grannis

This guy is not credible. A decent mix of weakness and strength? How can anyone be so clueless?.

Apr 19 09:48 AM

[morph366:]

Your headline highlights the fallacy of marking the whole market to value based on the value at the margin.

Apr 19 11:16 AM

[Alphameister:]

Probably a bit too optimistic with the "melt up" scenario for the US economy and market (though I've certainly enjoyed this melt-up first phase), but otherwise a very good article. For me, the melt-up scenario is much more plausible for the Chinese stock market where superior growth prospects are combined with deep undervaluations.

Apr 19 02:32 PM

[Allan Frain:]

As long as there are enough of those who can convince themselves that printing money can solve the resource misallocations that arose out a debt-bubble--we will get more and more money creation.

Dollars are not capital. They are claims on capital per Legal Tender Laws. Their efficacy decreases proportionally with their proliferation.

Apr 20 08:44 AM

[Responsibility:]

There are so many viewpoints and they all have good reasons. We have excessives in the financial market, we need to correct that. We have Republican and Democrates working against each other beyond good intentions, we need to correct that. We spend too much and labor too little, we need to correct that. We are too greedy and living beyond our means, we need to correct that. We - - - -

Apr 21 12:16 PM