Will Bear Market End with Disgust for Capitalism?

By Prieur du Plessis  AUG 31, 2009 8:30 AM

Deficits -- and the interest on them -- could destroy America's economy.


Stock markets, in general, again logged gains last week as pundits perceived economic data to be better than expected. But the recovery path isn't home and dry yet, as shown by declines in crude oil, a number of emerging stock market indices, small cap indices, and high-yield corporate bonds. All said, risky assets displayed some fatigue despite positive economic reports.

Caution remained over the robustness of any economic upswing, as reflected by the solid performance of government bonds, with safe-haven currencies such as the US greenback and the Japanese yen also edging up.

As expected, Federal Reserve Chairman Ben Bernanke was appointed by President Barack Obama on Tuesday to serve a second term. “Mr Obama is said to credit Mr Bernanke with a leading role in helping to avert economic catastrophe. By reappointing Mr Bernanke -- who worked in the Bush White House -- Mr Obama can also emphasize his bipartisan credentials at a time when he is embroiled in a fiercely partisan battle over healthcare reform,” commented the Financial Times.

However, critics of Obama’s decision were plentiful and Morgan Stanley’s Stephen Roach, blaming Bernanke for his pre-crisis actions, said (via the Financial Times): “It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor.” Bill King (The King Report) ascribed the stock market rising subsequent to Obama’s announcement to a “thank God it’s not Larry Summers” rally.

The past week’s performance of the major asset classes is summarized by the chart below -- a set of numbers showing both the S&P 500 Index and government bonds rising, indicating an expectation of a subdued economic recovery and that the Fed’s monetary policy will stay easy for an extended period of time.

A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below.

The MSCI World Index (+1.3%) and MSCI Emerging Markets Index (-0.2%) again followed separate paths last week as China, Hong Kong, and Brazil underperformed. Mature stock markets have recorded gains for a straight seven weeks, whereas emerging markets have seen two back-to-back weeks of declines. The end result is that emerging markets have now underperformed developed markets for four weeks running. Could this be a sign of a retrenchment in risk appetite?

The major US indices extended their gains to two consecutive weeks, including eight straight up-days in the case of the Dow Jones Industrial Index, before getting snapped by a decline on Friday. The year-to-date gains are as follows: the Dow Jones Industrial Index +8.7%, the S&P 500 Index +13.9% and the NASDAQ Composite Index +28.6%. With declines on three days, the Russell 2000 Index was the odd index out last week, but still boasts a respectable +16.1% gain since the beginning of 2009.

Top performers in the stock markets this week were Lithuania (+28.2%), Estonia (+17.3%), Latvia (+12.6%), Egypt (+9.6%), and Iceland (+9.1%). The top three positions were all occupied by eastern European countries where worries over the risk of some economies collapsing have receded. At the bottom end of the performance rankings, countries included Nepal (-4.0%), China (-3.4%), Kenya (-2.7%), Uganda (-2.6%), and Bangladesh (-1.8%)

The Chinese Shanghai Composite Index recorded its fourth consecutive down-week as investors remained concerned about how long China’s exceptionally loose monetary policy will continue. The banking regulator has already instructed lenders to raise reserves to 150% of their non-performing loans by the end of this year -- up from 134.8% at the end of June, and the central bank has increased money-market rates to drain liquidity.

However, US Global Investors opines that historically sustainable market rallies out of a cyclical trough usually start with an expansion in valuation multiples followed by a recovery in earnings. “China may be poised to enter this second stage against a favorable macro backdrop. With surging money supply and significantly lower commodity prices from a year earlier, corporate earnings in China could produce upside surprises going forward,” said the report.

Of the 96 stock markets I keep on my radar screen, 77% (last week 47%) recorded gains, 18% (47%) showed losses, and 5% (4%) remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the winners for the week included CurrencyShares Russian Ruble (XRU) (+5.0%), First Trust Amex Biotechnology (FBT) (+4.8%), iShares MSCI Australia (EWA) (+4.5%), and iShares Silver Trust (SLV) (+4.2%).

On the losing side of the slate, ETFs included Claymore/AlphaShares China Real Estate (TAO) (-4.2%), Market Vectors Coal (KOL) (-3.1%), SPDR KBW Regional Banking (KRE) (-3.1%), and iShares MSCI Brazil (EWZ) (-3.0%).

As far as credit markets are concerned, Bloomberg reported that banks were increasing lending to buyers of high-yield company loans and mortgage bonds at what might be the fastest pace since the credit-market debacle began in 2007.

“Federal Reserve data show the 18 primary dealers required to bid at Treasury auctions held $27.6 billion of securities as collateral for financings lasting more than one day as of August 12, up 75% from May 6. The increase over that 14-week stretch is the biggest since the period that ended April 2007, three months before two Bear Stearns Cos. hedge funds failed because of leveraged investments.”

This is a sign of credit markets moving towards normalization.

Referring to the mind-boggling US budget deficit, the quote du jour this week comes from 85-year old Richard Russell, author of the Dow Theory Letters. He said:

“Comes the dawn -- and the penalty. There’s a price to be paid for Bernanke's all-out battle to thwart the bear market. And now it’s being told. Yesterday the White House itself admitted that the budget deficit over the next 10 years would be $2 trillion above their original outrageous estimate of $7 trillion dollars.

“As I said all along, it would have been better to have allowed the bear market to run its course to conclusion. That would have been extremely painful, but the US would have recovered. However, deficits in the trillions could ultimately ‘break’ this nation. I can't imagine how Bernanke-Obama plan to handle the coming mind-blowing deficits, plus the interest on those deficits.

“The pressure will be on the reserve status of the dollar, the level of the dollar compared to other international currencies, interest rates, and the standard of living of all of us living in the new ‘banana republic,' the United States of ‘bankrupt’ America.

“When you take all this in, you can begin to see how this bear market could end with stocks selling below known values and people despising the stock market and capitalism."

Other news is that the Fed must, for the first time, identify the companies in its emergency lending programs -- created to address the financial crisis -- after losing a Freedom of Information Act lawsuit against Bloomberg. The Fed is likely to appeal against the order on the grounds that such disclosure would threaten the companies and the economy.

Also, the Federal Deposit Insurance Corporation (FDIC) on Thursday said (via the Financial Times) the number of “problem banks” had grown from 305 to 416 during the second quarter, representing total assets of $299.8 billion. In the meantime, the FDIC’s deposit insurance fund, which insures up to $250,000 per depositor in each bank, had fallen to just $10.4 billion -- the lowest level since March 1993 -- as a result of all the bank failures, tallying 84 so far in 2009.

The key moving-average levels for the major US indices, the BRIC countries, and South Africa (from where I'm writing this post) are given in the table below. With the exception of the Chinese Shanghai Composite Index, which fell below its 50-day moving average about two weeks ago, all the indices are trading above their respective 50- and 200-day moving averages. The 50-day lines are also in all instances 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 August 17 lows that represent short-term support levels for the major US markets and are as follows: Dow Jones Industrial Index (9,135), S&P 500 Index (980) and NASDAQ Composite Index (1,931).

For more on key levels and some ideas regarding the 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.

The chart below, courtesy of Bespoke, shows that the average short interest as a percentage of float for stocks in the S&P 1500 is currently at 6.9% -- the lowest level since February 2007 when the average was 6.6%. “In 2008, it was the bulls who argued that high levels of short interest were a reason the market should rally. With the recent data, however, it is now the bears who will argue that low levels of short interest suggest that investors are now too bullish,” remarked Bespoke.

Doug Kass (The Street.com) said:

“The authorities have created a sugar high for speculation, with a Federal Reserve that has maintained interest rates so low that there is no return on savings and with an Administration that promises to provide stimulus until it manufactures economic growth. My view is that investors will shortly see through the current sugar high and the better-than-expected earnings cycle and will begin to look over the valley at the chronic and secular issues that have emerged from the past cycle and from policy decisions aimed at returning the domestic economy toward self-sustaining growth."

The last words on equities go to Jeff Saut, investment strategist of Raymond James, who said:

“'Breakout or fake out?' is the question du jour. Yet as market maven Arthur Zeikel wrote decades ago, 'Despite what theoreticians tell us, investing -- particularly at the margin -- is not the product of rational and objective analysis, but an emotional relative analysis -- anxiety about the future.' My colleague Bob Ferrell put it this way: 'Emotions are simply stronger than reason; people do not change and people make markets!’ Indeed, fear, hope and greed are only loosely connected to the business cycle. And, at session 30 in the ‘buying stampede,' we are clearly in the ‘greed phase.' We continue to invest, and trade accordingly.”


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

“Global business confidence remained positive last week for the third straight week. The last time confidence was consistently positive was nearly a year ago. Businesses are responding most positively to broad assessments of the current economic environment and the outlook into early 2010; they are as strong as they have been since the financial crisis first hit in the summer of 2007.”

The Survey results suggest that the global recession is coming to an end, but isn't quite over yet.

The German economy expanded in the second quarter of 2009 with real GDP rising by 0.3% on a seasonally adjusted basis from the previous quarter. Also, the Ifo Business Survey reported that German business confidence improved to an 11-month high in August, indicating a further improvement in GDP in the second half of 2009.

Heading home from Jackson Hole a week ago, the world’s central bankers seemed in no hurry to start increasing interest rates -- intent on not repeating the monetary policy tightening mistakes of the Great Depression. As reported by the Financial Times, Martin Feldstein, a Harvard professor, thought it would be possible to have “two years or more of very low interest rates” without risk of excess inflation, given the labor and factory capacity in the economy.

Meanwhile, after keeping the interest rate at a record low of 0.5% from April to July 2009, the Bank of Israel (BoI) became the first central bank to raise interest rates in this cycle, increasing the benchmark rate to 0.75%. Analysts believe Australia and Norway will tighten first among the G-10 central banks in 2010, as reported by RGE Monitor.

A snapshot of the week’s US economic reports is provided below.

August 28

Cash for Clunkers lifts consumer spending in July

August 27

Jobless claims decline, but continuing claims including special programs advance

Second-quarter real GDP unchanged at -1.0%

August 26

Sales of new homes advanced, inventories are shrinking

Defense and aircraft orders lift durable goods in July

August 25

Case-Shiller Home Price Index and FHFA House Price Index -- noteworthy recovery

Gain in consumer confidence during August nearly erases losses of prior two months

August 24

Chicago Fed National Activity Index -- confirms positive signals of other report

The S&P/Case-Shiller Home Price Index for June showed its second straight monthly increase. According to Bespoke, the last time home prices increased two months in a row was back in the summer of 2006 at the end of the last housing boom. “June's 1.4% monthly gain was also the largest monthly increase since June 2005. There’s no denying that these numbers are showing considerable improvement.”

The White House confirmed on Tuesday that the US deficit would be wider than they'd previously estimated. The graph below, courtesy of Clusterstock - Business Insider, shows that although the budget deficit as a percentage of GDP has been revised down for 2009 -- due to less bailout spending -- it's been increased for every year through 2019.

“The longest and deepest recession of the postwar era has ended,” said IHS Global Insight chief economist Nariman Behravesh (via MarketWatch). However, he expressed concern that the recovery could lose steam in a few quarters, warning: “A sustained, robust global recovery depends on renewed growth in consumer spending and capital investment. The coming expansion will be restrained by cautious consumers in the United States and Europe, who are saving to rebuild depleted assets and reduce debt burdens.”

Week’s Economic Reports

Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data. Click here for an economic calendar from Yahoo.

The European Central Bank (ECB) will make an interest rate announcement on Thursday (September 3). US economic data reports for the week include the following:

August 31

Chicago PMI

September 1

Construction spending

ISM Index

Auto sales

September 2

ADP employment


Factory orders

FOMC minutes

September 3

Initial jobless claims

ISM services

September 4

Nonfarm payrolls

Unemployment rate


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

That’s the way it looks from Cape Town (from where I'm leaving on a business trip to Slovenia in five days’ time -- let me know if you are in Ljubljana at the time and would like to meet).
No positions in stocks mentioned.

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