Saturday, August 1, 2009

Global bull market reflections

The market capitalization of global equity markets has recovered $14.3 trillion (with valuations up 56% from the March 9th low) of the $36 trillion that was lost last year and earlier this year. Not bad for less than 5 months' work! Mark Perry has some other charts and comments on this same subject.

I'm breathing easier these days, but there is a lot of work yet to be done before valuations—and the global economy—get back to something approaching normal. To understand what needs to be done, I keep thinking there are two parts to this drama, financial and political.

What got everything started was the unraveling of the housing boom, which then undermined the value of complex securities, when then undermined the capital structure of banks and cast great uncertainty on all financial counterparty risk, which then led to panic selling and collapsing prices which further undermined balance sheets, all the while the financial collapse led consumers and businesses to slash spending and build up precautionary balances.

The second part was the fear (beginning in late September last year when Obama started moving ahead in the polls, but reaching a peak with the passage of the stimulus bill last February) of the consequences of a massive shift in fiscal policy. It started with the trillions of dollars of bailout money thrown at the markets in October and November, not only in the U.S. but also overseas. Then it took the form of the Democrat's $800 billion stimulus bill which contained hardly any stimulus but lots of new spending, and then Obama's trillion-dollar-deficits budget projections. Anyone looking at the numbers quickly realized that government was poised to grow by 20-25%, and that would require an almost unthinkable increase in tax burdens. Then came the massive costs that would be inflicted on the economy by cap and trade legislation, as well as the likelihood that tariff barriers would be required to deal with China and India's refusal to self-inflict higher costs for carbon-based fuels. All of this would have been enough to leave markets reeling, but then Obama demanded that a compliant Congress pass legislation—before the August recess—that would result in a government takeover of the U.S. healthcare system.

The financial part of the drama is well on its way to being resolved. As the recent GDP figures show, the economy has experienced a massive readjustment in the past year and is now on the road to recovery, even though it will be licking its wounds (e.g., all the defaults and foreclosures yet to come) for another year or two. The resolution of the financial part of the drama has been evident for months now, as I've been pointing out, and can be seen in the dramatic narrowing of swap and credit spreads, and the decline in fear and the restoration of confidence, among other things. With financial health returning to the markets, the fears that drove money under mattresses all over the world are abating, and the money is being returned to the economy. Signs of growth show up in rising commodity prices, rising shipping rates, and higher-than-expected profits at many companies, among other things.

The political part of the drama may not be resolved, but it does appear that the U.S. is not going to blindly embrace a massive expansion of government and equally massive tax increases. The cap and trade bill is sidelined, and healthcare legislation is being attacked from all sides. Obama's approval ratings are headed straight down, and public discomfort with his agenda is growing daily. The roadblocks to Obama's legislative progress must have contributed substantially to the new bull market.

The economy may well be recovering, but there are still many uncertainties out there, plus the almost certain threat of higher taxes after 2010. So the recovery is not likely to be as robust as it otherwise could have been. Instead of the 6-8% growth that might have occurred had this been simply a financially-caused recession, perhaps we'll see only 3-4% growth. That will leave the economy in sub-par status for a number of years, and that means unemployment will remain stubbornly high for some time to come. And that takes us to the 2010 election season, when public dissatisfaction with Obama's agenda could result in big losses for the Democrats in the congressional elections, and that could be the best deja vu for the markets since the Democrats lost Congress in the 1994 elections.

In short, it could take another year or two before global equity markets recover all that was lost.


brodero said...

I am having a hard time reconciling the thought that the
economy is going to recover and
Obama will remain unpopular.You
must believe the recovery is going to be L shaped rather than U shaped. Now if you thought it was going to be W shaped then I could see your point.

Scott Grannis said...

That's a good point. But. For one, a 3-4% growth rate would be puny considering how deep the recession was. It would not get us back to "full employment" for many many years. To get unemployment down in time for next year's election would require a lot more growth than that. Two, recall that the recession of 1990-91 ended in in March of '91. 18 months later, as the 2002 elections approached, everyone was lamenting the miserable state of the economy, even though it had been growing at a 2-3% pace. Dissatisfaction with the economy was one reason Clinton won, in fact.

ronrasch said...

I enjoyed reading your summary Scott and I hope the danger to the economy emerging from dem health care reform can be minimized. The wild card might be Israel needing to take action to stop Iran's nukes.