First published: Financial Times, 20/05/2009
The rally in equity markets has spread a little optimism around a global economy that is still in deep funk. Some argue this is precisely how new bull markets begin. Others, including your scribe, assert it is an impressive bear market rally. The latter case has been made consistently since it began, and maybe that is a reason why it may continue for a while. It is certainly the pain trade par excellence, that is, the risk of not being involved is becoming increasingly painful. However, this rally will stall eventually and then reverse for three important reasons.
First, the structural credit system dysfunction in advanced economies hasn’t been fixed yet. Some previously blocked credit arteries have been opened up a little, and credit risk in the banking system has receded thankfully, but we are still a long way from a viable, solvent banking system that intermediates credit independently. Surveys suggest banks have become a little more willing to make loans, but they lack creditworthy borrowers. The biggest hurdle of all, as David Roche highlighted in this column yesterday, is that the great debt restructuring, especially of mortgages, has barely begun. The collapse in asset values has left household and aggregate economy debt ratios (in relation to GDP, net worth, income and cash flows) at record highs as of March 2009. These ratios will all decline markedly over the next 2-3 years as debt …more