Pricing in recovery

April 1, 2009 — Mitul Kotecha

As was pointed out to me in one of the comments following my last article there are some signs that the market has become increasingly resistant to bad news. Indeed, it is encouraging that a host of weak economic data, more bad news on the banking sector front, bickering by leaders ahead of the G20 meeting, and the likely bankruptcy of a couple of US automakers has not prompted a more negative reaction.

Is the market tired of selling? It’s highly possible. Having faced an onslaught of bad news over recent months perhaps market players are simply exhausted. Adding weight to this is the fact that any pullback in equities has been relatively small compared to the gains over recent weeks whilst technical indicators are suggesting a more positive picture emerging.

I am not convinced. I will grudgingly admit that the market looks in better shape than it has done for months but this is far from a sustainable rally. Retail investors have yet to get in on this rally and like past equity crashes such as that following the Nasdaq bull burst, it took a long time for many investors to get back into the market having been burned so badly on the way down.

As I write this the US ISM manufacturing and pending home sales data have been released and both have come in on the positive side of expectations. The caveat is that the ISM is still in contractionary territory, consistent with falling GDP. Even if the data coming out now is less negative economic stabilisation is unlikely to take place until at least the end of the year. Based on past trends equity markets begin pricing in recovery around 6 months ahead of actual economic recovery, suggesting that we may only be a few months away from a more sustained turnaround in equity markets.

My only concern with this theory is that this is unlike any previous recession and so the equity market signal may be false. The current US recession has already lasted around 16 months, which is already a few months longer than the average for past recessions. It will need banks to be healthy before the economic outlook improves. If banks continue to remain in bad shape then past history will be a poor guide to the current path of the US economy.

Posted in bank rescue, Economics, equity markets, Financial crisis, US. Tags: , . 1 Comment »

Tough week ahead

March 30, 2009 — Mitul Kotecha

It looked as though it all went wrong today as the bad news just kept on coming. Following reports on Friday that JP Morgan and BoA had a more difficult month in March following a stronger start to the year, reports that UBS would be shedding thousands of staff and would announce billions more in writedowns as well as news of the takeover of a Spanish regional bank by the Bank of Spain hit market sentiment hard. Topping all of this were comments by the US administration that some banks would need more capital in addition to that already provided. The administration also said that bankruptcy may be the best option GM and Chrysler.

This sets up a difficult week ahead, with risk aversion set to rise further and the news unlikely to get any better. Economic news is likely to add to the market’s gloom as US releases such as the ISM manufacturing survey for March and the jobs report will likely reveal further deterioration. Expectations for another hefty drop in payrolls in March could see a total of over 5 million jobs lost so far in the current cycle with many more to go.

The news in Europe will not be much better and as today’s Eurozone sentiment indicators have shown the outlook for the economy remains gloomy. The ECB is likely to cut interest rates but will refrain from embarking on the quantitative easing policies followed by other central banks such as the Fed or BoE. As risk aversion rises the USD is set to continue to strengthen against most currencies this week.

Posted in bank rescue, central banks, Currencies, Economics, equity markets, Europe, Financial crisis, UK, US, US administration. Tags: , , . 6 Comments »

Is the bad news priced in?

March 28, 2009 — Mitul Kotecha

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.

Posted in bank rescue, Economics, equity markets, Financial crisis. Tags: , . Leave a Comment »

Even Geithner would like a global currency

March 26, 2009 — Mitul Kotecha

Around the same time as I was writing about the end of the US dollar US Treas Sec Geithner was telling us how he actually liked the idea of a global currency as purported by China’s central bank governor. Of course the news didn’t go down too well in the FX markets, with the dollar dropping like a stone before Mr Geithner realised the error of his ways and clarified his comments. He went on to say the dollar is still the best reserve currency in the world but added a caveat that this would only continue if the economy and markets got back on their feet. The pros and cons of a new reserve currency have now been much debated and as noted in my previous post it will provide great fodder for markets at the G20 meeting in London next week.

As usual we are all in for disappointment, however. There will be no great change in perspective on the dollar or any other currency as UK PM Brown hinted today. Instead G20 officials will do their best to show an act of unity whilst sniping at each other’s stimulus plans in the background. Do not expect conrete policy measures emerge either. It has been a rare occassion when such get togethers yield more than a nice photo shoot of world leader.

On a completely different note it is intriguing to see how deep the loss in wealth has become when the likes of the comedian John Cleese are renegotiating their divorce settlements. A local free Hong Kong newspaper put it as the “battered rich want divorce terms slashed”.  Battered indeed.

Posted in Currencies, Economics, US administration. Tags: , . Leave a Comment »

Fed throwing everything but the kitchen sink at the crisis

March 20, 2009 — Mitul Kotecha

The aftermath of the Fed’s surprise decision to buy US Treasuries was dramatic across markets, with Treasury yields dropping, equities rallying and the dollar sliding. The Fed has now moved from what was initially credit easing to full blown quantitative easing. Effectively the Fed is throwing everything but the kitchen sink at the problem and is arguably the most aggressive central bank at present.

What are the implications:

1) Equities like the news and it helped extend a rally that had been in effect for a couple of weeks. But the momentum is likely to run out quickly as the bad news starts to filter back into the market once again.

2) Commodity prices rallied, especially gold. Why? Inflation concerns intensified following the Fed move due to the risk that the Fed will not be able to end it’s programme of “printing money” quickly once the economy starts to turn around. Commodities are set to rally further.

3) The dollar dropped like a stone, and although it is difficult to see it regaining much ground in the wake of a central bank that flushing the market with dollars, its falls looks overdone. For now, the dollar looks like it has entered new weaker currencies and may even benefit if the market appetite for risk declines again.

4) Other central banks in particular the European central bank will be under huge pressure to follow the Fed. The Bank of England, Bank of Japan and Swiss National Bank have already moved but not as aggressively as the Fed. So far the ECB has been reluctant to act and technical issues mean that it can’t act in the same way as the Fed. Nonetheless, the rise in the euro means that something may need to be done and quickly.

5) The move by the Fed shows that policy makers are doing all they can to turn things around, but this is merely a reflection of the severity of the crisis. Economic recovery is still some months away

Posted in Bond markets, central banks, Commodities, Currencies, Economics, equity markets. Tags: , , . Leave a Comment »
« Older posts
Newer posts »