Is the bad news priced in?

I have been harping on about the fact that the market rally is losing its legs, that the market is too optimistic about the bank rescue plans, that there is a lot pain ahead on the economic front. This has been a view that is generally not a consensus one.

There is a good article in the FT today about the divergence between the equity market reaction to the US administration’s plans and the fixed income market reaction. The article sums up quite well the thoughts I have been having and why I believe the rally does not have legs. The article describes how “broken finance” has become since the onset of the crisis and how the US Treasury is relying on leverage and securitsation when this was exactly what got banks into the mess in the first place. The difference in the price that banks are willing to sell toxic assets (realising losses at the same time) and the price private investors are willing to pay could be a major stumbling block to the plan working. In addition, another question revolves around the type of toxic assets banks will be willing to offload with the worst quality likely to be sold off first.

If the the process results in better disclosure of such debt then it may finally reveal that some institutions are technically insolvent. If so, will the administration do the right thing and temporary nationalise “zombies” or even allow them to go bust? My view is that in the end a quick end to the pain, with a lethal injection may be better than the slow tortourous debt that is happening now.

I was asked on CNBC this week why I believe the rally won’t last and I said that there was a lot of bad news still out there. The presenter replied that is this not priced in to markets? I replied that perhaps some of the bad news is priced in, but there is still a lot more to come. I would add to this, does this pricing in of bad news also justify the magnitude of the rally seen over recent weeks. I don’t think so.

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