Something strange happened yesterday. As you know, some economists are now drawing parallels with 1929, and predicting the worst slow-down since the 1930s. Yesterday the Independent plastered the headline USA 2008: the Great Depression, all over its front page. Tuesday’s news was pretty grim, but what did the markets do? They went out and celebrated, with the Dow surging by 391 points, for example. The index is now 914 points, or 8 per cent, up on the year-low set on March 10. But the rises were not just restricted to the US, indices across the world were up yesterday, and in the Far East this morning.
And as if to confirm the new mood of optimism, gold fell, dropping below $900 an ounce, more than $100 lower than the records set in March.
Why were the markets so jubilant?
The logic went like this. The results revealed by UBS were so bad, that they can’t possibly get any worse.
The feeling is that in attempting to come clean, and getting all the bad news out of the way, the bank had gone too far. With its new management team – all of the senior directors who were at the helm before the credit crunch have gone – there was a sense that the bank was trying to wipe the slate clean, and in the process made bigger write-downs than was absolutely necessary, and that as result it would be, as it were, writing-up the write-down later this year.
The Swiss bank also announced a $15bn rights issue – which had financiers chomping at the bit. Once this fund-raising is complete, they reasoned, UBS’s balance sheet will be strong enough to handle all kinds of woe.
But the markets had other reasons to celebrate too – Deutsche Bank also revealed $4 billion of write-downs in the quarter – and the markets loved that, with shares in the bank rising by 3 per cent.
As for Lehman Brothers, it successfully managed to raise $4bn in cash. In fact the investment bank, which just last week was subject to rumours it could be going the way of Bear Stearns, initially planned to raise $3bn, but so great was the demand that it upped the scale of fund-raising.
Markets already knew big write-downs were on the cards, and were relieved to get so much bad news out of the way. At the same time, they were impressed by the strength of demand for Lehman’s new shares.
But sentiment is the real factor that moves markets at times like this. And over the last week or so, sentiment has been good.
Yesterday also saw the unveiling of the latest Purchasing Managers Index from the Institute of Supply Management. The index rose ever so slightly over last month’s awful score. Furthermore, it appears the main reason for the rise in the index was a change in the way the data that makes up the index is weighted. According to Capital Economics, “If the old weighting system used up until the start of this year was still in place, the headline index would actually have dropped quite sharply.”
Markets weren’t bothered by that. Spring was in the air, and traders were convinced they could smell the green shoots of a recovery.
Yet, the US housing market is still experiencing the biggest falls ever recorded – and inventory levels are now so high that even if there was a sudden and inexplicable surge in demand for housing, it seems prices would continue to fall for some time. Bill Gross, the famous bond investor from Pimco, warned earlier this week that the new tighter regulations will reduce the level of lending that leading “US banks will be able to undertake,” and as result profitability will be lower in the longer-term. Also this week, Morgan Stanley London-based analysts said that, “The industry is facing the most severe investment banking crisis in 30 years.”
There are no reasons to assume an economic recovery in the US any time soon – plenty of reasons to believe things will get worse.
It is true that the history of recessions and markets tells us that when an economic downturn is underway, markets tend to hit bottom and then start recovering while the economy is still getting worse.
True, it seems unlikely that the economic slowdown will be as bad as the 1930s – that is surely hype, but equally it seems the slow-down will be nasty.
So far the markets have not adequately allowed for this. At it’s lowest point this year, the Dow had fallen to around 17 per cent below last year’s all-time record.
If you believe economic conditions are set to worsen, than that fall was nowhere near far enough. They say that in bear markets, stocks keep falling to levels where investors give up virtually all hope, only then do they start to rise. But, as yesterday’s rallies show, world markets are far from ready to give up hope. Somehow it seems fitting that the markets chose April 1 for such backwards logic.
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