Global Markets in Review: Are Markets Discounting Bernanke's Scenario?

“Goodbye safe havens, hello risky assets” seemed to be the theme during the past week as investors placed their bets on a global economic recovery, propelling stocks and other risky assets higher amid better-than-expected earnings reports and tentative signs of stabilization in the U.S. job and housing markets.

Source: Jerry Holbert, Comics.com, July 23, 2009.

Not only did the Dow Jones Industrial Index on Thursday breach 9,000 for the first time since January and the Nasdaq Composite Index notch up a streak of 12 consecutive advancing days, but other global stock markets, commodities, oil, precious metals, high-yielding currencies and corporate bonds also put in a stellar performance as a bullish mood prevailed.

Bonds and other safe-haven assets such as the US dollar and Japanese yen were out of favor as investors sought higher returns elsewhere. Also, the CBOE Volatility Index (VIX), or “fear gauge” was at its lowest level (23.1) since before the Lehman collapse in September.

The past week’s performance of the major asset classes is summarized by the chart below - a set of numbers that indicates an increase in risk appetite.

Source: StockCharts.com

A summary of the movements of major stock markets for the past week, as well as various other measurement periods, is given below. As the second-quarter corporate results in the US rolled in, the American and most other markets closed the week in solid positive territory.

The MSCI World Index (+4.6%) and MSCI Emerging Markets Index (+5.2%) last week again added to the rally’s gains to take the year-to-date returns to +11.7% and a massive +45.3% respectively. Strikingly, the World Index advanced for ten straight sessions through Friday, whereas the Emerging Markets Index gained on nine of the past ten trading days.

The major U.S. indices are all back in the black for the year to date, with each index having fallen for only one day last week. Prior to a slight decline on Friday, the Nasdaq Composite Index experienced its best winning streak since 1992 as it rose for 12 sessions in a row.

Click here or on the table below for a larger image.

Stock market returns for the week ranged from top performers Romania (+11.1%), Russia (+9.5%), Egypt (+8.8%), Hong Kong (+7.9%) and Poland (+7.8%) to Greece (-3.6%), Bermuda (-2.5%), Jamaica (-2.0%), Côte d’Ivoire (-1.9%) and Bangladesh (-1.0%) at the other end of the scale.

Of the 97 stock markets I keep on my radar screen, a majority of 82% recorded gains, 15% showed losses and 3% unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

As an aside, the capitalization of China’s stock market is currently $3.2 trillion compared with $11.2 trillion for the U.S. market, according to data compiled by Bloomberg. Mark Mobius, head of emerging markets at Templeton Asset Management, said (via MoneyNews) China might surpass the U.S. as the world’s largest stock market in as little as three years, as China’s state-owned companies will sell new shares and the nation’s 1.4 billion people will put more of their money into the market.

Back to the corporate reporting season in the U.S. Of the 142 S&P 500 companies that have so far announced quarterly results, 111 came out ahead of earnings expectations, 10 in line and 21 below. While the earnings announcements thus far have been impressive at the headline level, the reports become less striking once one digs a bit deeper to discover that the earnings numbers often only beat estimates due to cost-cutting.

At the top line revenues are still deflating, indicating no pricing power. Specifically, 72 companies posted revenue that failed to live up to expectations. But the prospects are looking up as for the first time in quite a while many more companies are raising guidance versus lowering guidance.

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the winners for the week included Claymore/MAC Global Solar Energy (TAN) (+17.9%), PowerShares Biotech & Genome (PBE) (+17.4%) and Market Vectors Solar Energy (KWT) (+15.9%). Among the country ETFs, Market Vectors Russia (RSX) (+ 12.5%) performed splendidly.

On the losing side of the slate, ETFs included “all things short” such as ProShares Short MSCI Emerging Markets (EUM) (-6.2%), ProShares Short QQQ (PSQ) (-5.0%) and ProShares Short Russell 2000 (RWM) (-4.9%).

As far as credit is concerned, the cost of buying credit insurance for US and European companies eased sharply during last week’s trading, as shown by the narrower spreads for both the CDX (North American, investment-grade) Index (down from 131 to 118) and the Markit iTraxx Europe Index (down from 107 to 95).

CDX (North America, investment-grade) Index

Source: Markit

The quote du jour this week comes from Bill King (The King Report) who said:

Sorry, Mr. President - you ‘wasted a good crisis’. You, Ben, Hank, W, Little Timmy and Democratic Congressional leaders told Americans that the world would end unless U.S. taxpayers mortgaged whatever little future remained in order to provide record stimulus now. You and your ilk said there was no time to delay. Remember you said ‘catastrophe’ would occur if there was no stimulus. You and your team boasted that millions of jobs would be created. No jobs yet. But Goldman Sachs and other insiders minted more money and numerous crony capitalists were able to salvage as much net worth as possible.

Americans have yet to express the appropriate and proportional opprobrium at the ruling class. But as night follows day, they will; and the longer the delay, the more intense the reaction will be.

As we keep asserting, the underlying structural problems in the U.S. economy and financial system have not even remotely been addressed. There will be no significant recovery until the necessary restructuring occurs. And there can be no necessary restructuring until the requisite hellacious purge occurs.

Other news is that President Obama’s healthcare reform got delayed as mounting concerns were voiced about costs. Elsewhere, CIT (CIT) - a company which provides finance to almost one million small and medium-sized companies in the U.S. - on Monday received a $3 billion private rescue package, enabling the troubled finance group to avoid bankruptcy. Also, the Federal Deposit Insurance Corp (FDIC) closed six more banks on Friday, bringing the tally of U.S. bank failures in 2009 to 64.

Next, a quick textual analysis of my week’s reading. No surprises here, with all the usual suspects such as “banks”, “economy”, “market” and “funds” featuring prominently.

The key moving-average levels for the major U.S. indices, the BRIC countries and South Africa (my home country) are given in the table below. All the indices trade above their respective 50- and 200-day moving averages.

Importantly, the 50-day lines are in all instances also above the 200-day lines and therefore not threatening the bullish “golden crosses” established when the 50-day averages broke upwards through the 200-day averages.

The June highs and July lows are also given in the table as these levels define a support area for a number of the indices.

Click here or on the table below for a larger image.

For more on key levels and the most likely short-term direction of the S&P 500 Index, Adam Hewison’s (INO.com) short technical analysis provides valuable insight. Click here to access the presentation. (Adam also covered the outlook for crude oil, gold and the dollar/yen exchange rate in recent analyses. Click the links to view these.)

Interestingly, sentiment is still showing plenty of skepticism. “If twelve straight days of gains in the Nasdaq won’t bring out the bulls, what will?” asked Bespoke. According to the most recent survey by the American Association of Individual Investors (AAII), bears (42.4%) among individual investors still outnumber bulls (37.6%). As far as newsletters are concerned, bullish writers outnumber bearish writers by a slim margin (36.7% versus 35.6%), as surveyed by Investors Intelligence.

Source: Bespoke, July 23, 2009.

The 10-day average of daily advancers minus decliners is a useful indicator of stock market breadth and helps to identify inflection points. The chart below, courtesy of Bespoke, shows the 10-day advance/decline line for the S&P 500 Index. Said Bespoke:

… The recent rally has put the A/D line well into overbought territory and at a level that has indeed marked a peak during prior rallies in the past year. After 12 up days for the Nasdaq and an average gain of 13% for S&P 500 stocks since July 10, it’s time for a breather.

Source: Bespoke, July 23, 2009.

The long-awaited Dow Theory bull signal finally arrived on Thursday. This came about as a result of the Dow Jones Industrial Average and the Dow Jones Transportation Average both breaking through their previous rally peaks (registered on 12 and 11 June respectively).

Richard Russell, “Mr Dow Theory” and author of the Dow Theory Letters, forthwith replaced the bear on the first page of his daily newsletter with a long-horned Texas bull. The long-timer said: “I believe we are now dealing with an extended bear market rally (some will call it a cyclical bull market). But I’m operating on the thesis that a primary (secular) bear market is still in force (although it has been suspended for a while). In my opinion, the true final bottom for this secular bear market lies somewhere ahead.

“Remember, on March 9 very few of the items characteristic of a true bear market bottom were seen. There was no extreme pessimism, there were no huge bargains in stocks, and the public continued to be hopeful. On this evidence, I concluded that the final and true bottom of the bear market had not been seen.”

While Dow Theorists delight in the bull signal, it is appropriate not to lose sight of the economic picture, as aptly summarized by David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates:

Well, the S&P 500 surged 15% in the second quarter and what we did was go back in the history books to see what happens to the economy the very next quarter typically after such a big bounce and the answer is … just over 3% real GDP growth. So consider that de facto what is being discounted at this time for current quarter growth - it better be a humdinger of an inventory build.

Now, for the market to build on such a rapid advance in the current quarter, history again suggests that we would need to see 5.5% real GDP growth, which we give near-zero odds of occurring. Hence our call for a sputtering stock market through year end. Too much growth - and hope - are priced in at this point.”

Although I maintain that stock markets are in a broad bottoming-out phase, I am concerned that prices have moved too far ahead of economic reality. I am therefore adopting a cautious approach in anticipation of the market working off the overbought condition and fundamentals reasserting themselves.

For more discussion on the direction of financial markets, see my recent posts “Video-o-rama: Dow back above 9,000“, “Earnings - not what they seem?“, “Dow Theory calls a bull market“, “Coppock shows bottom in Treasuries“, “Is the yield curve indicating better tidings?“, and “US dollar about to pop?“. (And do make a point of listening to Donald Coxe’s webcast of July 24, which can be accessed from the sidebar of the Investment Postcards site.)

Economy
The latest Survey of Business Confidence of the World conducted by Moody’s Economy.com:

Global business confidence continues to make steady gains. There was a substantive improvement last week in businesses’ broad assessments of current conditions to its strongest level since just after the start of the current financial crisis nearly two years ago. Sentiment in the US also improved notably last week.

Despite the steady improvement in confidence it remains consistent with ongoing global recession.

Source: Moody’s Economy.com

Ifo reported that its Business Climate Index for industry and trade in Germany rose again in July.

The firms are no longer quite as dissatisfied with their current business situation as in the previous month. They are again less skeptical regarding business developments in the coming half year. It seems that the economy is gaining traction.

Source: Ifo, July 24, 2009.

However, Rebecca Wilder (News N Economics) warns:

… A compilation of indicators shows that the recovery is tentative at best - more likely, a global bottom has not yet been found. The leading indicators are stronger in some countries; exports are still declining at an annual pace of 20%+ but stabilizing; and volatile retail sales growth rates are, well, quirky.

Stephen Roach, chairman of Morgan Stanley Asia, is also downbeat about the global economic outlook, saying (via MoneyNews):

Sorry to break the news, but the financial crisis is not over. You’ve got plenty more write-offs of bad paper to come. Developed economies haven’t broken out of recession yet. Seventy-five percent of the world’s economies today are still contracting, and the biggest piece on the demand side of the global economy is the American consumer, who is dead in the water.

A snapshot of the week’s small number of U.S. economic reports is provided below. (Click on the dates to see Northern Trust’s assessment of the various data releases.)

July 24
•Tracking a few of the Fed’s extraordinary programs

July 23
•June Existing Home Sales report - sales, inventories and prices moving in the desired direction
•Initial jobless claims increase; decline in continuing claims is misleading

July 22
•Housing market update - mortgage applications and FHFA House Price Index

July 21
•Fed’s exit strategy - a deft and fortunate Fed?

July 20
•Leading Economic Indicators - history suggests economic recovery is around the corner

The Conference Board’s Index of Leading Economic Indicators came in above expectations in June, gaining 0.7% against May and rising for the third consecutive month. However, David Rosenberg (Gluskin Sheff & Associates), cautioned not to get all excited about this green shoot.

… The ‘here and now’ indicator (the coincident index) is still showing declines (now down eight months in a row) and the level, at 100.3, is the lowest since September 2004. As the chart below shows, recessions do not end until this metric carves out a bottom (irrespective of the coincident/lagging ratio).

Source: David Rosenberg, Gluskin Sheff - Breakfast with Dave, July 23, 2009.

In his semiannual Monetary Policy Report to Congress on Tuesday, Fed chairman Ben Bernanke said:

The FOMC anticipates that economic conditions are likely to warrant maintaining the Federal funds rate at exceptionally low levels for an extended period. I want to be clear that we have a very long haul here because, even if the economy begins to turn up in terms of production, unemployment is going to stay high for quite a while, so it’s not going to feel like a really strong economy.

Is Bernanke’s scenario the one the stock market is discounting?

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Date	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
Jul 20	10:00 AM	Leading Indicators	Jun	0.7%	0.5%	0.5%	1.3%
Jul 22	10:30 AM	Crude Inventories	07/17	-1.80M	NA	NA	-2.81M
Jul 23	8:30 AM	Initial Claims	07/18	554K	540K	557K	524K
Jul 23	10:00 AM	Existing Home Sales	Jun	4.89M	4.85M	4.84M	4.72M
Jul 24	9:55 AM	Michigan Sentiment -Revised	Jul	66.0	64.5	65.0	64.6

Source: Yahoo Finance, July 24, 2009.

The U.S. economic highlights for the coming week include the following:

Source: Northern Trust

Click here for a summary of Wells Fargo Securities’ weekly economic and financial commentary.

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

Source: Wall Street Journal Online, July 24, 2009.

“As a general rule, the most successful man in life is the man who has the best information,” said Benjamin Disraeli, British Prime Minister and novelist in the 19^th century. Let’s hope that the news items and quotes from market commentators included in the “Words from the Wise” review will assist Investment Postcards readers to assimilate appropriate information for taking correct investment decisions.

Comments

[basehitz:]

As your article concludes “As a general rule, the most successful man in life is the man who has the best information”.

Thanks for your contribution toward that end.

Jul 26 06:55 AM

[Dave Wrixon:]

The risky asset as you put it is the dollar. They are not going to be saying hello to that for much longer!

Jul 26 07:10 AM

[Old Rick:]

Great article Prieur! On the aside on the Chinese market perhaps surpassing the US market in a few years; why does it sound like the Chinese government is trying to create 1999-2000 again?

Jul 26 10:54 AM

[markfl:]

"Although I maintain that stock markets are in a broad bottoming-out phase, I am concerned that prices have moved too far ahead of economic reality. I am therefore adopting a cautious approach in anticipation of the market working off the overbought condition and fundamentals reasserting themselves." I agree with this remark. After reading several news reports from trucking companies about their earnings, I don't see the kind of increase in goods shipments you'd expect from a robust recovery. I also don't hear much optimism.

"The less-than-truckload (LTL) market -- which refers to truckers who consolidate smaller loads into a single truck -- has been battered by weak freight volumes."
www.reuters.com/articl...

"Looking ahead, the company [Ryder] said it anticipates 'the weak overall economic environment and protracted freight recession to continue throughout the remainder of 2009.' "

Jul 26 11:03 AM

[Hugo O'Neill:]

It is hard to understand how can investors’ be so optimistic in such a shaky global economic environment. The growth model for advanced economies' is still based in private consumption, which depends on real income and consequently on employment. Increasing unemployment and the current propensity to save rather than to consume, the still limited availability of credit, the yet unresolved crisis of the real estate market and the risk of major countries like the USA and UK running into a debt trap, debase the assurance for economic recovery in a near future. The only highly probable trend is the loss in USD trade weighted value due to the growth in US monetary base and the contraction of GDP.
On the other hand the decoupling theory may only work on the long run as the weight of the highly populated emerging economies (China, India Brazil and Indonesia) in the global GDP is around 15% versus 48% of the advanced economies (USA, EU, Japan) and the emerging countries are facing serious difficulties in switching the main growth drive from export demand to domestic demand, hampering the achievement of the growth rates that have been forecasted.
On top of this unfriendly macroeconomic scenario, in the past 100 years company valuations, as calculated by Prof. Shiller of Yale at the end of a bear market and at the beginning of a bull market were between 5 and 10 whereas they are now at around 16.
Although there is a first time for everything making it possible for the current market trend to persist, I am very doubtful that we are in a real bull market.

Jul 26 01:48 PM

[Alphameister:]

Many of us believe that November '08 and March '09 together formed a double bottom for the cyclical portion of the preceding bear market. The conventional sentiment and oversold indications of a bottom were present at one or both of those lows. That double bottom shows up very nicely in the survey of business confidence presented above. Nothing in the available evidence suggests either a powerful or a durable ecomomic recovery and bull market in the US, but successful traders and investors learn to play the hands they're dealt.

Jul 26 01:59 PM

[Kinsman Red...:]

Very well researched and presented--your hard work is much appreciated!

Jul 26 02:20 PM

[untrusting ...:]

Good observations. Saw a Nightly Business Report commentary on China. They interviewed a production line worker in China who worked on the auto assemby line in China. The female worker commented that it was impossible for workers like her to buy a Chinese made automobile. She worked 9 hours/day, 6 days/week for something like a few hundred dollars a month (don't remember the exact monthly wage but when I calulated it at the time it was less than $1/hour if I remember correctly). So it just seems inconceivable to me that the BRIC countries and emerging markets, even with their hugh populations, can replace the demand/wealth destruction in the US and the developed countries anytime in the near future. Maybe over the next decade(s) but not anytime soon. Of course the elites and connected will prosper greatly in these markets, but it seems unlikely that will be enough to balance the declines in the developed markets.

On Jul 26 01:48 PM Hugo O'Neill wrote:

> It is hard to understand how can investors’ be so optimistic in such
> a shaky global economic environment. The growth model for advanced
> economies' is still based in private consumption, which depends on
> real income and consequently on employment. Increasing unemployment
> and the current propensity to save rather than to consume, the still
> limited availability of credit, the yet unresolved crisis of the
> real estate market and the risk of major countries like the USA and
> UK running into a debt trap, debase the assurance for economic recovery
> in a near future. The only highly probable trend is the loss in USD
> trade weighted value due to the growth in US monetary base and the
> contraction of GDP.
> On the other hand the decoupling theory may only work on the long
> run as the weight of the highly populated emerging economies (China,
> India Brazil and Indonesia) in the global GDP is around 15% versus
> 48% of the advanced economies (USA, EU, Japan) and the emerging countries
> are facing serious difficulties in switching the main growth drive
> from export demand to domestic demand, hampering the achievement
> of the growth rates that have been forecasted.
> On top of this unfriendly macroeconomic scenario, in the past 100
> years company valuations, as calculated by Prof. Shiller of Yale
> at the end of a bear market and at the beginning of a bull market
> were between 5 and 10 whereas they are now at around 16.
> Although there is a first time for everything making it possible
> for the current market trend to persist, I am very doubtful that
> we are in a real bull market.

Jul 26 03:57 PM

[untrusting ...:]

Good point and information. Supports much of the author's information in the article. If the A/D line has any predictive value, one would expect a pretty significant downward correction in the market sometime pretty soon. The question is will GS and the HFT traders who dominate an estimated 50-70% of trading volumes now let it happen? Who knows, but a some point it only makes sense that they can make a lot more money going short and driving the market down as opposed to supporting it and managing it up. Guess we will find out over the traditional Aug-Oct market weakness phase. Seems like the most realistic commentators are calling this a "traders market", which probably a lot more accurate than either the bulls or the bears.


On Jul 26 11:03 AM markfl wrote:

> "Although I maintain that stock markets are in a broad bottoming-out
> phase, I am concerned that prices have moved too far ahead of economic
> reality. I am therefore adopting a cautious approach in anticipation
> of the market working off the overbought condition and fundamentals
> reasserting themselves." I agree with this remark. After reading
> several news reports from trucking companies about their earnings,
> I don't see the kind of increase in goods shipments you'd expect
> from a robust recovery. I also don't hear much optimism.
>
> "The less-than-truckload (seekingalpha.com/symbo...) market
> -- which refers to truckers who consolidate smaller loads into a
> single truck -- has been battered by weak freight volumes."
> www.reuters.com/articl...
>
> "Looking ahead, the company [Ryder] said it anticipates 'the weak
> overall economic environment and protracted freight recession to
> continue throughout the remainder of 2009.' "

Jul 26 04:15 PM

[SeekingTruth:]

If we get thru this mess without total carnage and ruination, the power elites will just say " Ha - ha -ha - We lied our way thru another mess, and if the public only knew the 'real' disastrous shape we were in, they would have croaked, if they hadn't revolted first."
And if things turn out totally calamitous, they will just say, "Well, all the signs were there for everyone to see if they just looked and took notice."
Suggest we all take a good look --- and prepare.

Thanks for a masterful compendium of timely and relevant information.

Jul 26 05:13 PM

[Market Sniper:]

Great article! Personally I believe we are now in the eye of the hurricane. The worst is yet to come. No growth engines to be found anywhere and there is no such thing as a "jobless" recovery. Highly reminiscent of 1930..recovery is just around the corner-Herbert Hoover.

Jul 26 05:17 PM

[bricki:]

Bear market rally vs. bull market is no

Jul 26 06:03 PM

[Northstar10000:]

It's all about money flow. Next move sharp down into September /Oct
big Oct fake out no crash. Move up into year end and early 2010. give the washington nut jobs hope as Dow goes thru 10,000. spring/summer watch the market stick it to the politicians for trying to mess up their markets. Also great time to take money out of the pockets of the little fools who will be starting to listen to the nonsense coming out of the government. Should be about the same time as the second round of money shredding comes out of Californina. Nothing solved there except kicking the can down to 2010. Might add New York and New Jersey to the mix by then. short now long August. Like gold/silver stocks after August Sept.
after the dip. they should roar with the rally.

Jul 26 06:48 PM

[Northstar10000:]

Sorry should have proofed it. short now long OCT. NOT August as previously stated. My bad.

Jul 26 06:50 PM

[User 461189:]

Excellent presentation of invaluable economic data plus smart conclusions!!!
GAP

Jul 26 07:17 PM

[MSimon:]

"China might surpass the U.S. as the world’s largest stock market in as little as three years, as China’s state-owned companies will sell new shares and the nation’s 1.4 billion people will put more of their money into the market."

I remember that song. People were singing it just before the Japanese bubble burst.

Jul 26 07:24 PM

[MSimon:]

Let me add that China has "stimulated" its economy to the tune of $600 billion. And you know what? A much smaller stimulus (relative to the economy) in America was considered (it is) ruinous.

What does it mean for China? Revolution.

Jul 26 07:29 PM

[derryl:]

I'm interested in your comparison of China's market cap to the US. I doubt that Mark Mobius' prediction of China's cap exceeding the US in 3 years will come true, but I think it's clear that China is trying to generate a wealth effect among its people to kickstart a domestic consumption market.

China told its banks to LEND! and they did, far surpassing their quotas for new loans. A lot of this money found its way into the stock markets and pumped them up (I don't know the numbers for real estate so I won't comment). This money did not go primarily into IPOs or additional stock offerings. That is, the money did not go into funding new productive ventures or expansions. It went into buying stocks at rising prices from people who already owned those stocks.

This puts lots of cash in those sellers' hands. They are "wealthy", and newly wealthy people tend to want to upgrade their consumption lifestyle to reflect that, as we saw with Americans who used their rising house values as ATMs to live rich. Even Chinese who didn't sell their stocks feel wealthy at current and rising valuations, so the wealth effect is present in China.

When I first heard about China ordering its banks to lend and the resultant stock market rise or inflation or bubble I was mystified. I don't think Chinese are stupid. Had they learned nothing from the US experience? Now I see that they did learn from the US. They learned how to use the wealth effect of rising asset valuations to accelerate domestic consumption. They may be deliberately inflating asset bubbles toward this end.

The lever is credit creation, and they are pulling it hard. They are pumping money into their economy. Both the M and V of Friedman's formula are at high levels, so we can expect either or both Q and P to rise with them.

That is, China's economy will be seeing some combination of output increases and price inflation as a consequence of this MV acceleration. With all the slack production capacity that opened up due to the collapsing export markets I don't think CPI inflation will be a big Chinese problem just now, so they should see significant output increases to meet rising domestic demand.

Considering individual bankruptcies as a macro economic factor, when highfliers come crashing down due to overleveraged ambitions, the result is that banks write off the debt and recover some fraction of the debt amount by selling the collateral asset. So (using US$ terms instead of yuan) if a bankrupt owes his bank $500k and the bank sells the foreclosed collateral for $300k, there is now $200k of 'owned money' in the economy.

Bank loans are money creation and repayment of bank loans is money destruction, so if borrowers put their $500k into the economy by buying a house from someone then take $500k out of the economy to repay their loan, the net 'owned' money they add to the economy is zero. But if a borrower defaults then the $500k is already in the economy, and the important thing is that the money is owned by someone other than the bankrupt borrower and the bank cannot get it back from its present owner. The bank takes the writeoff and the money stays in the economy.

My point is that the Chinese leadership may be well aware that they are blowing bubbles that will collapse, and that collapsing bubbles leave lots of 'owned' money in the economy even as borrowers go broke and banks take loan losses. Some win, some lose, but in macro you end up with much more money circulating in your economy that is not owed to your banks as repayment for loans. The banks wrote off the debts but the people who sold stuff to the borrowers still get to keep the money.

Basel II notwithstanding, bank solvency and how you deal with it is an issue for national regulators. Bankruptcy is a political decision, not an arithmetic necessity. Large US banks were not dissolved recently just because massive asset devaluations rendered them technically insolvent. China can support its insolvent banks if its purpose is to increase the amount of money circulating in the Chinese economy in order to build up a domestic consumer market.

This is a longer term process, of course. The same process the US followed since 1913, with all those 'business cycles' of booms, busts, bankruptcies and debt writedowns by banks. The Chinese may have learned the US lesson very well.

Jul 26 07:36 PM

[MSimon:]

"The firms are no longer quite as dissatisfied with their current business situation as in the previous month. They are again less skeptical regarding business developments in the coming half year. It seems that the economy is gaining traction."

But that is absolutely normal at the beginning of an inflationary period. All that new "cash" looks like real demand. The heartbreak comes in mid or late 2010.

Jul 26 07:40 PM

[BKLee:]

I have been in the tech reck of 1999, and had lost quite a bit in that crash. I was new to investing then, but looking back, I see how the media twist info around to prop up the market. (Remember, CNBC is sponsored by banks, an investment firms, Financial Magazines also have these sponsors, and thus they have a bias not to report news that would not fair well to these sponsors). Just as it happened in 1999, I believe when these sponsors have had their share of gains, they will pull the rug out, and short the market to make huge gains heading up, and down at our expense. It usually happens when optimism is at it's peak. BEWARE!

Jul 27 04:02 AM

[shanec:]

Comparisons with 1930's are a bit tricky. In 1930's the Smoot Hawley Tarrifs caused enormous ruptures in international trade. It is unlikey anything like that will happen this time around. Also most currencies are floated now so they react and stabilise with market changes. On the other hand debt levels are higher, and small rises in interest rates, particular real interest rates, will cause enormous damage. It seems to me commodity prices are heading too high, much like a repeat of last year. This will squeeze the cosumer and business by raising their input costs. Commodity prices are generally much higher than in 2003-2004 and while some of this is related to demand in the developing world much of it is speculation. Most of the developing world is too poor to afford overpriced commodities. Once again we are seeing imbalances driven by large hedge funds. Governments of the world must regulate against speculative stock trading (e.g. only one trade of a stock within a three day period) and stockpiling of commodities. As always another crash is in the making. Please read more about the Long Depression of the 1890s and you will see comparisons with real estate bubbles etc.


On Jul 26 05:17 PM Market Sniper wrote:

> Great article! Personally I believe we are now in the eye of the
> hurricane. The worst is yet to come. No growth engines to be found
> anywhere and there is no such thing as a "jobless" recovery. Highly
> reminiscent of 1930..recovery is just around the corner-Herbert Hoover.

Jul 27 05:10 AM

[Perry B:]

Good article. Twelve days up is a good rally up cycle. But I agree with Northstar, The fall is coming and it is not a calender event. Du Plessis made really good points and good insights like where is the GDP in this rally? This rally is fueled in my opinion by institutions testing the market to feel the strength and sentiment of retail traders. Infusing the market through opening up gaps. Then pulling a portion of thier money out during the trading day taking profits on the fake bull rally. Institutions then re entering at previous days lows Lightening many retail traders wallet further confusing the rally. The light daily volume suggests the retail traders are not convinced it is bullish. Without the uptick rule; betting on an unsustainable hedge fund, and institution based rally is a tough call.

Jul 27 09:28 AM