Tuesday, 22 December 2009

Back to normal?

2009 has truly been a remarkable year. Pitch-black pessimism in the stock markets was replaced by a powerful rally. The banks were rescued by governments without much demanded in return, and now everybody is surprised that nothing has changed in the banks' behaviour. Or rather in the behaviour of the bankers...

Among all this there have been a couple of changes in the underlying dynamics that just may give some pointers to the events in 2010. The rally that took place from early March is likely to be remembered as a relief rally, triggered by the fact that it became clear that the world economy would not collapse, that the banks would not evaporate, that the truckloads of taxpayer money thrown at avoiding a recession actually did work.

At the end of the day, the entire operation amounted to a massive move of bad assets from the banks' balances to the public sector balances without the taxpayers getting much in return. Apart from the ignominy of seeing the very same bankers walk away with huge bonuses, this time largely owing to public money.

Since October it has been clear that the stock markets moved away from the relief rally kind of thinking and back to a more "normal" focus on growth and earnings. It is no big surprise that the market participants have been rather bad at getting estimates and expectations right, a lot of economic forecasts and sales forecasts have gone out the window and have to be replaced by new ones. However, the fact that the stock markets are turning back to poring over company earnings reports represent a big step back towards the normal state of things.

I believe that "returning to normal" will be a highly important factor in 2010. It does not in any way guarantee a return to stability, though. The next big "normalisation" will be that of the monetary policy and bond markets. While the monetary policy provides explosive levels of liquidity, the excesses are slowly being reined in. Through 2010 or early 2011 we will return to a neutral monetary policy. Central banks may then move on to actually putting the foot on the brake, however lightly. Somewhere along the line the bond markets will have to deal with the fact that massive amounts of new government issues are flooding into the market in order to finance the budget deficits.

Whether that will lead to a major readjustment of bond yields (upwards, that is) will depend on whether the global private sector has increased it savings rate sufficiently to absorb the many new issues. That depends on a lot of factors ranging from the Chinese private sector savings to the spending habits of the American home owners. Having been sidelined by the stock market since the heyday of the dotcom bubble, bond markets are likely to return to take centre stage sometime in 2010. Back to normal, maybe, but without any guarantee of less volatile markets.

No comments: