Tuesday, April 28, 2009

Bulls, not Bears, May End in Tears

A good article by Andy Xie. Some interesting points are:
  • But this is a bear market bounce that will end in tears. What will bring it down will be the likely torrent of new issues. Banks that report good earnings and speak about recovery will probably try to raise massive amounts of capital, taking advantage of the market rally, to weather the long winter ahead. IPOs will swamp emerging markets. Money flowing from bullish investors will become the winter clothing for distressed banks and companies.
  • The bull case is built on three assumptions: (1) the market decline is already deep enough; (2) the global economy is either recovering or about to; and (3) more government stimulus money is coming, should there be more trouble. The bear case rests on: (1) this is a debt crisis, the debt levels are still too high, and the global economy can’t resume growth until debt levels recede to normal; (2) the world economy is still shrinking, though at a slower pace; and (3) government stimulus can’t start another growth cycle as the global economy must restructure itself first.
  • Some argue, why can’t we revive the old bubble or start a new one? The problem is that after a bubble has lasted several years, its bust leaves so much rubbish around that a new bubble cannot take root. For example, high levels of existing debt make further debt growth difficult. Without debt, a new bubble would have no legs. The economy needs time to recover before it can support another bubble. If you are waiting for another bubble to bail you out, I am afraid it’s going to be a long wait.
  • For example, the U.S. government is conducting a stress test on the banks. The test is a scenario analysis, i.e. whether banks can survive the downturn under different possible scenarios. I am sure most banks would ‘pass’ the test with flying colors, but this is self-deception. The U.S. financial system is technically bankrupt. The strength of a banking system reflects the strength of the economy it serves. Just look at the balance sheet of the U.S. household sector. How could U.S. banks survive when so many of their customers have negative equity?

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