Global stock markets surged over the past four days as investors adopted a more positive view of the prospects for the beleaguered financial sector and shrugged aside gloom about the economy. Citigroup (C) on Tuesday said it had turned a profit from operations for January and February (BUT did not mention credit losses, toxic paper, derivatives, etc.). JPMorgan (JPM) and Bank of America (BAC) later made similar comments.
A positive shift in investor sentiment, together with the possibility of the suspension of mark-to-market accounting and the reinstitution of the uptick rule, resulted in the best week for equities since November.
Arriving in time for my 54th birthday today, the reversal of fortune is illustrated by the strong gains of the MSCI World Index (+9.8%) and the MSCI Emerging Markets Index (+8.8%) since Tuesday. Although stashed (or "panic") cash was deployed, the top-performing stocks were the most pummeled ones of the past few months, indicating significant short-covering.
Extremely oversold markets bounced off levels last seen 12 years ago in the case of the S&P 500 Index and the FTSE Eurofirst 300 Index, and 26 years ago as far as the Nikkei 225 Average is concerned. Talking about being oversold, the Dow Jones Industrial Index has been down for 13 of the past 16 months.
As shown in the table below, the major US indices gained strongly during the week, recording only the second up-week out of ten in 2009.
The fact that government bonds had not been sold off during the equity rally indicates that some "side-lined" cash was deployed to fund the buy orders. The amount of cash hoarded over the past few months as a result of precautionary savings and deleveraging is enormous, as seen from the fact that money-market and savings accounts constitute more than 90% of the market capitalization of the Wilshire 5000 Index. (Hat tip: Todd Sullivan, Value Plays.)
UK government bond prices surged to record levels as the Bank of England launched its £75 billion program of buying securities to expand the money supply. The yield of the ten-year Gilt plunged by 40 basis points to close at 2.95% after having touched 2.91% earlier - its lowest level ever.
The US dollar lost ground as the rally in global equities kept the greenback in check and was further undermined by Wen Jiabao's comments about China's dollar reserves. However, the announcement by the Swiss National Bank to intervene by devaluing the Swiss franc dominated news in the currency markets. This step was a strong signal of the severity of the global recession and knocked the Swiss franc back by 2.5% against the US dollar and 4.7% against the euro (see chart below) on the week.
The SNB's move provided support for the gold price (although still down by 1.3% on the week) as more hedge funds are turning to the yellow metal. David Einhorn of hedge fund Greenlight Capital wrote in a recent letter to his investors (as quoted in the Financial Times): "Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself."
On the credit front, the TED spread (i.e. three-month dollar LIBOR less three-month Treasury Bills) is showing renewed stress as it has widened by 20 basis points since February 10 (also see "Credit market conditions - an update"). However, a graph of the US Depository Institutions Aggregate Excess Reserves (shown below) makes for interesting reading. Although the level of reserves is still far in excess of the amount banks need to keep on deposit to meet their requirements, the decline in this measure could be indicating a turning point in the recovery of banks. But the speed of the recovery, needless to say, remains unknown.
Next, a quick textual analysis of my week's reading. No surprises here as the picture is almost identical to that of last week with key words such as "bank", "financial" and "market" still featuring prominently. "Gold" seems to be on the ascent.
The stock market "internals", or market breadth, like the up/down volume spread, the advance/decline spread and new highs/lows have improved dramatically over the past few days and auger well for the nascent rally. Yet, the market still needs to do a considerable amount of work before evidence of a primary bear market low will be demonstrated. As a first step, the indices must clear their respective 50-day moving averages, i.e. the S&P 500 and Dow Industrials need to rise by 7.4% and 8.3% respectively.
"By the way, yesterday [Thursday] was a 90% up-day, the second of this week. This action strengthens the thesis that this advance has further to go.
"... are we now in a new-born bull market, or is this an upward correction in an oversold bear market? ... on the basis of duration and values, I believe we are experiencing a significant upward correction in an ongoing bear market.
"How far might this rally carry? Every movement in the stock market, minor, secondary or primary, is eventually corrected. Upward corrections in bear markets tend to recoup one-third to two-thirds of the ground lost in the preceding down-leg. The bear market will do whatever it has to relieve its oversold condition and at the same time lure the greatest number of investors back into its folds."
On the topic of rally "targets", Adam Hewitson of INO.com prepared a few slides dealing specifically with key levels. Click here to access the presentation.
The debate on whether stock markets are witnessing A bottom or THE bottom will take a while longer to resolve. Taking one step at a time, it is quite conceivable that the rally may last until the release of potentially ugly earnings and guidance announcements in April, by when a clearer picture should emerge on whether the bottom has been reached or yet lower levels are in store.
European Central Bank member Jürgen Stark said the world economy is in its deepest slump since the Second World War and that it was difficult to predict when it would end, as reported by CEP News.
Grim trade data from China also spooked economists. The country's trade surplus plunged to $4.8 billion in February, about an eighth of the amount in the previous month, as exports tumbled by 25.7% from a year earlier and imports fell by 24.1%. According to CEP News, Premier Wen Jiabao was quick to add that China remained firm in its commitment to deliver an annual 8% growth rate for 2009 and had "adequate ammunition" to "introduce new stimulus policies".
A snapshot of the week's US economic data is provided below. (Click on the dates to see Northern Trust's assessment of the various data releases.)
Commenting on the better-than-expected retail sales data and the issue of whether the US consumer could prove more resilient than feared, Asha Bangalore (Northern Trust) said: "The important question is if this pace of gains in retail sales will prevail in an environment where employment conditions are abysmal. The dire employment situation persuades us to forecast weakness in consumer spending in the near term."
Also jeopardizing the consumer's firepower is a sharp decline in household net worth, falling by $5.1 trillion in the fourth quarter of 2008 for an annual decline of $11.2 trillion - slightly below the mark seen in 2004. "Net worth of households has declined and their debt levels have grown noticeably slowly in 2008. But, the sharp drop in net worth has led to a debt-to-net worth ratio for households that is alarming," said Bangalore.
In addition to interest rate announcements by the Bank of Japan (Tuesday, March 17) and the Federal Open Market Committee (Wednesday, March 18), the US economic highlights for the week include the following:
That's the way it looks from Cape Town (where friends are arriving for my birthday celebrations).
"Empty houses in the US now number about 14 million or one in nine homes.
"At the forum in Davos, it was revealed the 40% of the world's wealth has been destroyed by the financial crisis so far.
"The International Labor Organization now estimates that global unemployment in 2009 could increase to 198 million or 230 million in the worst case scenario.
"In short, the biggest bubble of them all - that the US dollar is 'money' - is about to pop. The US dollar is on the path to the fiat currency graveyard, and will soon get there."