Thursday, April 2, 2009

Can the Bull Market Continue?

From Marketwatch:

To me, the recent rally looks dangerously similar to each of the previous bear-market rallies that have failed over the past year. At the beginning of March, few people believed a rally was possible. It seemed everyone was convinced the S&P 500 was headed for 600 or worse. With stocks 20% higher and economic data that is "less bad," the media seems dominated by those expecting a new bull market driven by a second-half recovery.

Perhaps the market has seen the lows and a cyclical bull market can continue. Yet to endorse this view, investors must make the aggressive assumption that actions by the country's leadership have solved the financial and economic crisis such that this heavily indebted economy can return to growth later this year.

For example, the Treasury's public-private investment plan to buy up to $1 trillion in bad assets leaves critical questions unanswered, including what price will be offered for the assets and whether the banks will be willing to sell at that price.

Most disturbing, the plan relies on more debt to solve a debt-induced problem, akin to solving a drinking problem by ordering another round. Fundamental problems remain, including weak bank balance sheets, too much debt, and too little capital.

The bull case lies in the growing confidence that trillions of monetary and fiscal stimulus dollars will gain traction. The Fed and other central banks around the world are pulling out all the stops, keeping interest rates low and buying mortgage-backed and Treasury securities.

This is an interesting article that gets to the heart of the current rally: can the plans of the government as envisioned and implemented work? Ultimately the plans boil down to standard Keynsian economics; when the economy slows the government can provide the missing demand stimulus through macro-level spending. However, this will probably involved the issuing of more government debt, which seems counter-intuitive in a recession.

I should note that I endorsed the stimulus plan in an article back in January. My logic was straightforward. GDP is comprised of 4 elements: personal consumption expenditures, gross investment, exports and government spending. Three of these numbers -- PCEs, investment and exports are in negative territory. From a practical standpoint that leaves government spending to make-up the slack. It's that simple.

However, there are big problems associated with that idea as well -- namely, the issuance of a mammoth amount of debt to pay for the increased spending. Consider the following debt totals from the Bureau of Public Debt:

09/30/2008 $10,024,724,896,912.49
09/30/2007 $9,007,653,372,262.48
09/30/2006 $8,506,973,899,215.23
09/30/2005 $7,932,709,661,723.50
09/30/2004 $7,379,052,696,330.32
09/30/2003 $6,783,231,062,743.62
09/30/2002 $6,228,235,965,597.16
09/30/2001 $5,807,463,412,200.06
09/30/2000 $5,674,178,209,886.86

The current total is over $11.1 trillion.

All of this debt has to go somewhere -- it can't simply exist in a vacuum. Therefore, asking the question of "where will all this debt go" is the key to the current rally. Assuming there are buyers we're fine. When people stop buying, we've got problems.