The best thing I’ve read all day is a column from last Friday by the Financial Times John Plender, “A Dash For Trash May Yet Become A Flight To Quality”. I rarely read a piece of financial journalism that is this balanced and nuanced. Here is an excerpt:
A mere six months ago investors were contemplating the wreck of the global financial system, the collapse of world trade and an imminent threat of deflation comparable to that of the 1930s. Today the headlines trumpet a surge in equities redolent of the euphoric upswing after the economic catastrophe of 1929-32.
For many, the unsettling feature of the post-March bounce is that it was driven by a dash for trash. Undercapitalised banks and companies with overstretched balance sheets have been in the vanguard. Still more worrying is that the S&P 500 index is once again way above fair value as measured by the cyclically adjusted price earnings ratio, which is a multiple of average earnings over 10 years.
As Jeremy Grantham of Boston-based fund manager GMO recently remarked, after 20 years of more or less permanent overpricing of the S&P 500, we saw just five months of underpricing after the March trough. In which case, has the transition from fear to greed run away with itself? Could the rally prove as evanescent as the great bull market of 1932, which was followed by one of the longest bear markets in history?
On this occasion investors have not completely parted company with their wits. Fears of global financial collapse and, at least in the short term, deflation have been put to rest by the huge policy response. The effectiveness of the various initiatives – Tarps, Talfs, quantitative easing and the rest – may have been mixed. But the outcome is clear. These and similar moves around the world have prompted an incipient economic recovery.
Leading economic indicators have turned. The economies of Japan and Germany are on the mend. The Chinese economy has responded, like the half-command economy it is, to reflationary instructions from Beijing. Residential house prices in the US and UK have stabilised. The US corporate sector has retrenched to the point where it is generating a positive cash flow. The prospect of a Japanese-style lost decade in the world’s largest economy has thus retreated.
The pattern of the stock market upturn is likewise perfectly logical. Since the collapse of Lehman Brothers last year, it has become clear that governments have no appetite for further systemic shocks. So big banks are in clover because their capital position continues to be subsidised by the state. Loose monetary policy delivers easy profits by cutting their borrowing costs and increasing their interest spreads. Increased concentration resulting from bail-outs means that pricing power is strengthened.
And yet. There remains a real question about the robustness of the recovery. Fiscal expansionism, which shifts the burden of indebtedness from the household to the public sector, is a jump-start remedy that cannot be sustained because indefinite increases in borrowing threaten sovereign debt ratings. Other policy measures, such as “cash for clunkers” car scrapping schemes, bring expenditure forward, leaving a hole later on.
I highly recommend the entire piece……