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 »

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 »

Running out of steam

March 25, 2009 — Mitul Kotecha

The euphoria in markets over recent days appears to be fading but only after a fairly solid rally in equities amounting to around 20% in some stock indices from their lows. Financials have led the gains over recent weeks helped more recently by a warm reception to US Treasury Secretary Geithner’s plans to fix banks.

Although I am doubtful about the staying power of the recent improvement in market sentiment I have to admit that there are clearly positive steps in action in the US both from the Fed and the US Treasury.  In fact the US authorites have gone all out to get things turned round.  This appears to have put a floor under risk appetite for now. 

Ok there are still a lot of questions to be asked such as how quickly the Geithner’s bank plan will work or whether banks will be unwilling to offload toxic debt at a significant loss or whether the deal is a raw one for US tax payers who seem to be bearing most of the downside and not too much upside if things go well.  All of that aside something is better than nothing even with its faults.

As for equity markets this still smells like a bear market rally or put another way a dead cat bounce.   I could be wrong and will be happily eat my words but I can’t see how the rally can be justified given the struggle ahead for both banks and the economy.   At best, what to expect is a period of high volatility before a real recovery arrives. 

Posted in equity markets, Financial crisis, US, US administration. Tags: , , , , . Leave a Comment »

Dead cat bounce or real recovery?

March 14, 2009 — Mitul Kotecha

Over recent days the market has been acting as if a bottom has finally been reached. Data releases such as the surge in US housing starts and other less negative economic numbers have helped. More importantly, some banks have noted that they have had a strong start to the year, which will come as a relief to many bank shareholders who have seen their holdings disintegrate over recent months. Along with the improvement in risk appetite the US dollar has weakened as the repatriation of US money from overseas has slowed and the safe haven bid for Treasuries has pulled back.

How long will it last? Not long in my view. Markets have been heavily sold and some form of recovery had to happen but it will not be sustained and is more like a dead cat bounce than a market turnaround. The economic news will remain bad and if anything will get a lot worse in the weeks and months to come whilst banks remain heavily burdened with toxic debt. Moreover, the issue of how to value this debt remains a problem in that it is a key obstacle to removing such debt. Indeed, the US and global economy for that matter will not stabilise until the end of this year. The next problem for banks will be consumer debt and credit card defaults etc even if other toxic debt is removed.

So, I would suggest not getting too excited by this market as the potential for disappointment is very high. As for the dollar, it is getting hit but not dramatically and as risk aversion picks up once again, the dollar will find itself back in command.

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