Friday saw yet more confounding action on the US market. In case you missed the numbers, the US economy 533,000 jobs in November, with large downward revisions for September and October. The unemployment rate jumped to 6.7%. By any measure, these numbers were awful. What is worse was that the pace of declines is actually accelerating.
Why on Earth then would anyone buy stocks against such a backdrop?!
I have spent a lot of the weekend pondering this question, but the ticker provides its own, crystal-clear story. 8,000 on the Dow is clearly a significant base.
Not only was Friday’s rally extremely surprising, it even appeared to have some significant weight behind it, based on the day’s volume data. A clear pattern has been forming over the last few months, in which the Dow has vacillated between 8,000 and 9,500. Friday’s rally was more evidence of a market finding its feet. I am still extremely bearish, but markets do rally in bear markets and we are due some positive moves after 6 months of carnage. I know talking about Obama’s inauguration is a tired topic, but it is extremely significant and is only 8 weeks away now.
I have stayed out of the market since September, but I think I will be tempted in again if the Dow hits 8,000. It just seems that no matter how negative the newsflow is at the moment, it is not able to sink US equities below their recent lows.
In the UK the situation looks a lot bleaker. Thursday’s “shock” 1% drop in Interest Rates was not at all surprising, nor was the reaction of retail banks.
A major row is now brewing, as politicians and journalists round on the banks, demanding that they pass on the full reduction to consumers. I generally have very little sympathy for banks, especially in light of the huge bailouts they have required from taxpayers.
However in this instance I am on their side and think they are actually doing the right thing.
When Japanese Rates hit 0% in the early 1990′s this proved to be the catalyst for economic stagnation, which the country only recently seemed to be breaking out of. Much has been made recently of the dangers of the “Japanese example”, but very few seem to have grasped what the fundamental problem was.
Taken at face value, 0% rates appear to de-risk the lending system. The thinking goes that the overhead of lending money is removed so this should encourage more risk taking, increase lending and stimulate more economic activity. This was certainly behind Greenspan’s aggressive rate policies in the late 1990′s and early 2000′s.
I think a lot of confusion in the media has been an inability to square the apparently contrasting results of similar policies in Japan and the US. Why did Japanese rate cuts in the early 1990′s fail, whereas Greenspan’s “worked”?
The first part of this answer is that the US rate cuts at the turn of the Century clearly didn’t work. All they succeeded in doing was to fuel a massive credit-driven boom, which we are now all facing the consequences of.
The second part of the answer is less clear, but I think (and hope) is behind UK banks not passing on the full cuts.
0% rates actually do not de-risk lending. Banks have substantial fixed overheads to cover to enable them to lend money as well as to carry the risk of borrowers’ failing to repay loans. If banks were required to pass on all base rate cuts then the further rates fall, the less viable it is for banks to function as businesses. In a traditionally conservative country, such as Japan, this proved to be a killer blow as the incentives for risk taking were inadvertently removed and capital markets dried up, starving entrepreneurs and corporations of the lifeblood they needed for growth.
Moving back to the present day, the outlook is so bleak that the likelihood is the next wave of losses to hit the banking industry will be those traditionally associated with recession. Traditional banking prudence, the likes of which has been absent in the past decade, is now being forced on senior management. I do hope that they remain steadfast in not passing on all rate cuts to consumers. By staying strong, they will be doing what is in our best interests in the long run, albeit painful in the short term.
If we are to claw our way out of a recession then a strong banking sector is going to be a necessity. A strong banking sector requires strong balance sheets and the ability to operate sustainable, profitable business models. Although this is galling to most of us, after the years’ of excess that have precipitated the worst economic conditions in three generations, but we really have to support measures, which are going to help us out of this mess faster.