Maybe it's the sunshine but I'm coming round to the view that thanks to all the government money being printed we are going to miss a huge 1930's style explosive depression.
I've been talking to my old friends who are still hands on in the frontline of the investment banking industry about this rally and more importantly my singular absence from it. One, who is now head of research at one of NY's remaining ultra blue chips says that mutual funds, insurance companies and long only houses, after a disastrous 2008, are back in the market and learning the value of trading derivatives as part of portfolio insurance . It sounds a good line even if I'm note exactly 100% sure what it means in practice. Another, who is head of trading for a v.large firm in NY informs me that he has been let loose with his prop and back books and is playing as if there has been no crisis ( and doing rather well at it). Margins on his desk are up 50% y-o-y if I understand him correctly - and I think I do if his comments on the conjectured 2009 bonus were anything to go by. A third who heads an emerging market trading desk at a former bulge bracket, now owned by a culturally alien retail bank , has been given the green light to start playing again. He says he is finding willing takers for his financial esoterica in the more aggressive hedge funds who are willing to marry liquidity and risk. Even the worst managed of 'perpetual growth' Russian stocks are back in fashion. So, it would seem that we have a rally driven by trading desks that believe that we have missed global armageddon. This relatively benign outlook has in turn brought in some of the more conservative value driven players together with the specialist emerging market and sectorial players - hence the indices recent surge. The only missing part of the bull story is the relative lack of volume at this stage of the rebound which indicates that the perfect recovery story is not yet fully believed.
If you buy into this post-armageddon view then the recent equity market rally has some logic to it - risk brings its own rewards particularly if you're an institution taking a three to five year view. Reduce real GDP by the say 6% to 8% hit it could take from this downturn . Then go back in recent economic history to see which year corresponds to this lower level of output and corporate profits. In the case of the UK after strong national growth in 2006 and 2007 that would return us to output levels last seen in 2004/2005. The FTSE then traded in the low 4000 to mid 5000 level making the current 4240 number look reasonable.
The problem with all of this is that I can quite understand why institutions and their 'star' portfolio managers that have had a terrible 18 months are biting at the bit to get back in the market and do some trading. I can also understand at face value a reworking of valuations back to levels of 3 or 4 years ago when GDP was comparable to the likely 2010 rate. I can also understand that there are signs that the economy is stabilizing or at least moderating after some pretty hairy falls in Q4 2008 and Q1 2009 . Certainly, despite this now being one of the worst downturns since 1947 we are only about 2/3rds of the way to a full depression (as defined by a 10% fall) .
What worries me is the political and economic aftermath of the crisis and what it means for equities. In the UK ahead of an election next year neither party wishes to upset the electorate by talking of the bitter choices ahead. A reasonable analysis would indicate that taxes will have to rise, government spending will need to be cut and whole swathes of public services that are taken for granted will need to be cancelled in order to pay for the latest government unfunded spending spree. At the personal level savings are growing and personal expenitures are falling and housing ( that great national store of wealth ) is far from reaching a bottom. Taken together these factors hardly represent a recipe for the return to levels of credit elevated growth seen over the last half decade.
Politically, governments will be torn between wanting to raise taxes on a smaller revenue base in order to maintain services and on the other side those who call for draconian reductions of 20% in outlays in order to balance the books. In the UK even the Trident nuclear deterrent, the hallowed sacrosanct last symbol of post -empire status, is now being revisited and is likely to be cancelled and replaced with air breathing cruise missiles. What a blow to national pride that would be with the French remaining the European Unions only premier nuclear power.What then of the UK's seat on the UN Security Council, or its voice in Europe , or its special relationship with Washington? The economic and political implications of this downturn are only now emerging and markets haven't even begun to pay credence to the new, possibly sharply lower growth, but certainly very different world that awaits.
So I come back to my original view and happiness to stick with cash and bonds. There are some signs of stablization but a long U shaped recovery lies ahead or possibly (30% chance ) an L . Toyota US April sales down 42% don't point to an upturn yet. The ISM numbers for April show the 15th fall in a row and indicate that exports and industrial production will remain weak for the balance of this year as banks suck money back out of the general economy depressing earnings. Bank deleveraging and the reversal of financial innovation is now increasingly holding back lending activity leading to aggressive consolidation across the service and manufacturing sectors. In other words we're back to the world of 2004 and staying there. History might not repeat the experience of the 30's but we'll be left with something painful that rhymes a long slow period of deflation and stagnation.