Friday, 3 April 2009

Ready to adjust your portfolio

Are you ready for the next piece of chocking news? The financial crisis is over. Well, maybe not quite, but I am pretty confident that the financial markets will beat this drum roll over the next weeks. The result is likely to be that the stock markets will run up further and that there will be significant moves in selected commodities. Oil has started and it will likely continue. Government bonds should technically suffer significantly, but probably will not, as they are subject to central bank manipulation at a historical scale.

All of this sums up to a change in the market sentiment. Governments and financial institutions across the world will latch on to it for reasons easy to understand. But the underlying situation has in fact not changed a lot since, say, the beginning of March.

True, over the past weeks we have seen the first signs of a slowing of the downwards momentum in the US economy. The rest of the world still has not yet seen such signs, but some good news could be in the offing in the coming weeks. Look out for the New Orders component in the ISM statistics and for rebounds in the property market as early indicators.

True, the US has more or less put a banking rescue plan in place. It is a terrible, expensive muddle, but it will eventually work. Yesterday's partial suspension of the Mark-to-Market rule by the FASB is another element in propping up the banks' balance sheets. It has now been replaced by a Mark-to-Whatever-You-Like rule for toxic assets which greatly helps the banks annointed as winners. European governments and banking regulators have also put in place a series of packages that will secure the survival of the banks. None of the plans have attacked the issue of expelling the boards and the CEO's responsible for the mess, so the same people will maintain their influence, once the party gets going again.

Quite significant stimulus packages have been introduced, USA, Germany and China are leading the pack, and some more may come from Europe. Over the past weeks, virtually all economic institutions with OECD in the lead have been revising downward their growth estimates for 2009 but expressed more optimism for 2010.

Last but not least, the stock market rally that began on March 9 has pushed past some important levels. At the beginning of March, the market rallied on a significant short squeeze, and optimism that the US plan to rescue banks would actually work. Since then the rally has been fed by investors who wanted to bring up their equity holdings, and now we are on the cusp of breaking out of the downtrend that has set the tone for the past many months. On top of that, remember the magical 9 months. That is the time the market is supposed to lead the real economy. It just forgot that in early 2007, but it surely has learnt from its own mistakes.

Of course we will now be persuaded to cheer up, things are not that bad. Most people still have their jobs, most houses will not be repossessed: Above all your country wants you! It wants you to start spending so demand for goods and services can grow. Your pension plan will recover.

I believe this rally still has some legs. Unfortunately there is no doubt that the foundation for the rally is not that strong – to say the least. Consumers still need to reduce their debts across the world. The CDS bubble is still out there. So are resets on the US mortgage loans. France, Italy, Spain have not done a lot for their national economies. Eastern Europe is still a mess. Long term interest rates will have to go up worldwide and the Euro-zone will have to come to grips with the fact that the Euro has been the victim of "competitive depreciations" and will eventually have to weaken. Government deficits will have to be curtailed. Banks are still not lending.

In other words, not a lot has changed, except for the subjective perception of risk. But for now, that is not really important. It will be important later.

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