East Coast Economics

What I Missed, And What I Make Of It

with one comment

After having been blissfully unaware of any economic and market news since the end of March I am back in Boston, and it’s time  for me to get back into the game.  I’m still in the process of catching up, but here’s what I think the key developments over the last few months were:

1.  The market hit a (temporary) bottom in early March.  The Dow Jones is back at around 9,550, roughly 45% above its March 9 low of 6,547.05.  Similarly, the S&P500 is somewhere north of 50% above its March low.  At the same time, 30 year  Treasury yields are back in the neighborhood of 4.35% after having hit a bottom at 2.55% in late December 2008.

2.  Both Chrysler and GM declared bankruptcy; the two firms emerged from bankruptcy after no more than a few weeks each.  In addition to the troubled automakers there were 84 bank failures in 2009 through August, a full 63 of which occurred in between the end of April and now. 24 of those bankruptcies occurred in July, another 15 in August.

3. The US economy seems to recover, albeit slowly.  Unemployment stands at 9.4% but negative GDP growth slowed to -1.0% over the second quarter and durable goods orders were up.  Re-appointed Fed Chairman Ben Bernanke suggested in his speech last week that we have the worst behind us in this “most severe financial crisis since the Great Depression.”

But do we really?  Is the rally in the stock markets actually sustainable, especially without analogous interest rate increases?  What happens if the dollar crashes?  What if inflation picks up?  The futures markets do not seem particularly worried at the moment:  implied probability has the Fed Funds rate steady at 0.25% through the end of 2009 and then suggests and increase to 1.0% towards the end of the first quarter of 2010, suggesting steady progress on the course towards economic recovery.

My own conclusion at this point is simple: I’m at a loss.  I don’t see what should justify a stock market rally of the magnitude that we have seen.  I do see optimism that isn’t based on any real data (if you disagree please let us know!), and I believe that there’s a systemic problem lurking in the financial system that we prefer to ignore:  all the money that has been printed over the course of the last year.  When you look at the US monetary base and the level of excess reserves of depository institutions, the picture doesn’t look much different from seven months ago when I first wrote about it.

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Bernanke suggested last week that “the continuing provision of liquidity and a tightening of the regulatory framework are key” to keep financial markets functioning properly.  It’s blatantly obvious that the provision of liquidity remains a top priority of the Fed at the moment, and our monetary base and excess reserves are still at levels that are barely different from the end of 2008 when the crisis was in full swing.  Looking at these charts doesn’t make me confident that we have the worst behind us. Or maybe we do, and what we are looking at is a systemic change in the financial system.  What do you think?

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Written by eastcoasteconomics

August 31, 2009 at 12:52 am

One Response

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  1. Welcome back!

    I agree it is not a rally that is based on fundamentals. I don’t think consumption will really come back to justify current stock prices. We now have a high level optimism amongst investors. The solution for too much debt and consumption cannot be more debt and consumption.

    The reasons I think stocks have rallied are: (generally speaking)

    Relief that a total financial meltdown has been averted.

    Investors have been cashed up and with cash yields so low, investors have been thinking dividend yields on equities don’t look so bad.

    The weak dollar & inflation outlook – your charts say it all and equities can be a benefactor of this in the short term. The fact that the stock market and gold are going up simultaneously signals something is wrong.

    Foreign markets have had a tremendous rally it is the strength in overseas markets that is dragging U.S. stocks along for the ride.

    Money that is being printed is going into the stock market.

    There has been a pick-up in consumption as people buy things they need, following 2008’s dramatic fall in consumption.

    Firms have surprised on earnings but not sales. Cost cutting and free govt money has temporarily boosted earnings but is not sustainable.

    A stronger stock market is self-fulfilling to a degree, as higher stock prices increase consumer net worth and improve earnings for firms managing stocks for example.

    trick

    September 14, 2009 at 9:51 pm


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