Published June 10, 2009

Pessimists, optimists have plenty to chew on

By R SIVANITHY

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IN market parlance, stocks appear delicately poised at an important inflexion point now, with the Straits Times Index having gained around 60 per cent in a little less than three months but displaying significant wobbles over the past two sessions. Going forward, optimists and pessimists will undoubtedly debate their respective cases vociferously and to be sure, there is enough data out there for either side to sink their teeth into. The key, however, as always, is how Wall Street behaves.

The massive bounce in stocks here and all over the world since early March was largely because of hopes of a V-shaped economic recovery in the US which if it materialises, should filter its way around the globe. Such a recovery, it is said by optimists, will surely unfold in the months ahead while manifesting itself in the economic numbers and, with interest rates hovering around zero, it makes good financial sense to buy stocks.

While this rosy view of the 'green shoots' theory has some merit, the nagging feeling remains that with such a large bounce in such a short space of time and with little substantial improvement in the economic numbers yet, a) prices may have overshot themselves on the upside as they probably did on the downside earlier this year, and b) what if the recovery is not as benign or V-shaped as buyers are hoping for?

Optimists will point to recent US economic numbers as suggesting the American economy is gaining traction and therefore this justifies continued buying. For example, the April new durable goods orders suggested the manufacturing sector is recovering while the latest employment figures suggest that the US labour market is stabilising. Both, combined with benign inflation figures, flickering signs of stability in banks and real estate, and increasing savings, indicate the worst may be over for the economy.

Maybe so, but investors might be interested to read in US newspaper Barron's June 1 issue that some of the numbers simply don't stand up to closer scrutiny. In that issue, columnist Alan Abelson pointed out that April's surprise 1.9 per cent jump in new durable goods orders which led to hopes of a manufacturing turnaround only came about because March's figures were quietly revised downward from -0.8 to -2.1 per cent. Also, the writer points out that the same downward revision in earlier months' data is apparently occurring in recent employment reports but the stock market has either missed it amidst all the jubilation or simply chosen to look the other way - for now.

If this is accurate - and there's no reason to doubt Barron's veracity - then it must only be a matter of time before Wall Street decides to stop looking the other way and instead scrutinises the supporting numbers. If it does, it may not like what it sees.

In the US banking sector too, optimists and pessimists can find plenty to debate. The fact that most of the larger banks passed what were admittedly lax stress tests has combined with news this week that some of the money borrowed by the banks under the Toxic Assets Rescue Programme (TARP) is to be returned to the Treasury to reinforce hopes that the banking sector is on the mend.

However, as consulting firm McKinsey & Co correctly pointed out in a US bank sector report this month, even the most adequately capitalised banks will find it difficult to cover loan-loss provisions over the next two years, even with cheap funding provided by the central bank. And the result of this would be weak profitability, which in turn could impair future capital raising exercises. 'The entire industry is now dependent on government support of all kinds, ranging from low-cost funding to debt guarantees...there is no clear path to restoring the industry to independence from the US government,' said McKinsey.

Pessimists would also surely highlight the first quarter US mortgage delinquency figures provided by the Mortgage Bankers Association, which show the overall mortgage delinquency rate rising to a new high of 9.12 per cent from 7.88 per cent the previous quarter. Sub-prime delinquencies in the meantime were up to 24.95 per cent from 21.88 per cent in Q408, while prime delinquencies rose to 6.06 per cent from 5.06 per cent in Q408. All in all, not very confidence-inspiring numbers that Wall St has again chosen to ignore, maybe because of explicit government guarantees or maybe because momentum and liquidity encourage everyone to look the other way. How much longer this can continue is anybody's guess but one thing's for sure - going forward, optimists probably won't be having it all their own way.