The stock market has been in bull market mode for the past three weeks. Many are saying that we have seen the bottom are now in a bull market. I think this is all hogwash. Here are some reasons why this is not the bottom:
The economy is not improving nor is it likely to improve soon. We may be nearing the low in home sales and also auto sales. But that doesn't mean we will have a quick rebound in either. Sales of homes or autos require financing. While financing for either is available and at reasonable interest rates, it is only available for those with good credit and money for a down payment. That means that most Americans and businesses are excluded from more credit.
Nobody with good credit wants to borrow anyway. In an economy like this, there are few places to invest so why borrow money? Why would anyone borrow money to open a restaurant when so many are failing and closing down? Businesses are being penalized for having lots of debt so why would any business add more debt right now? House prices are falling so fast that it makes sense to wait to get a lower price in the future.
The key thing to note here is that you can only lever up once. Once you have turned the balance sheet of a country into a heavily indebted one, you can't add any further credit. The Fed and Treasury are desperate trying to find someone else capable of levering up and continuing the spending. Who is available? The government of course is one. The government can borrow and spend and offset the retrenchment in spending to some degree. But there are limits there. If they add much more Federal debt, the Fed will have to purchase it. This is obviously just printing money and eventually our foreign creditors will say enough is enough and stop buying dollar denominated debt.
The other party is private capital: hedge funds and private equity who will always borrow if they can be assured at getting a good return on the borrowed money. Geithner's plan is to lever up these groups in order to offload some of the toxic assets on bank balance sheets. This plan will face some obvious political problems. There is some serious danger that taxpayers will get stuck with some major losses which will make Geithner and Obama's chance of keeping their jobs quite slim. This plan can only work if private capital ends up making a profit. But if the profit is too large, this will stoke populist outrage and for good reason. It is already looking like a massive wealth transfer from the taxpayer to banks and private capital. Some have called this the biggest wealth transfer since the government gave away land to the railroads in the 19th century, the beginning of the last gilded age.
Even if this dicey plan works, they are really just ways of inflating out of the debt problem. Will the rest of the world who holds dollars as reserve currency put up with us debasing the currency to avoid paying the price of our profligacy? We will find out this week at the G-20 meeting. My guess is that this week will coincide with a loss of faith in the current rally. The market will realize that the rest of the world is not on board with the US plan of printing our way out of trouble. You just have to look ahead a little further. What is the Bernanke/Geithner plan really? What is the endgame? Is there really any reasonable way for this to turn out OK? I think not. I am using this really as a chance to sell stocks that are turning up due to the hope of economic recovery although I hold very few of them anyway. Gold is looking more and more attractive as is resource stocks like Uranium miners. Recession resistant, low debt, multinationals that have a high fraction of sales in other currencies also look good, like my long-held core position in Johnson & Johnson. Eventually I think China will get tired of buying treasuries and will start buying up our multinational companies in addition to commodities.
