Thursday, 11 August 2011

Why we are in a Bull Market

Edit: For the best written contrary view to mine read Mish:

As always, it takes more than one opinion to make a market. I can usually argue both ways, but on balance I think the fundamentals are favorable. Here is my opinion (just like a nose, everyone has one) … but fwiw …

1.       The US Government desperately needs to inflate away its liabilities
Total unfunded liabilities & other obligations of US exceed $50 tn. The current economy is $10 tn. It can’t and won’t grow enough in real terms to service this debt. Even if you cut entitlements to the bone, you won’t cut this below $35 tn. This problem can either be solved by austerity, default or inflation. A democratic country equipped with a printing press won’t default. Austerity will fail when faced with seniors dying of poverty. However, it can and will engineer a huge monetary debasement via monetization of government debts (QE continued). US corporations will hoover up this money and cause a secular rise in profits & dividends. In real terms the Dow may not go up much, but in nominal terms this will translate into a huge rally, which began at SPX 666.

2.       U.S. corporate strength is solid
Although the market re-pricing is brutal, it comes at a time when earnings over the last quarter were good, with far more positive surprises than negative. Moreover, earnings forecasts for the rest of the year depicted a degree of caution, not Armageddon. US companies have global earnings, and earnings from outside the US are increasingly rapidly. The US trade deficit guarantees an accumulation of dollars in asian central bank balance sheets. This will continue to generate a growth in local currency base money, and a rapidly expanding money supply. Stock market growth will be a global phenomenon.

3.       Funding and Liquidity are not an issue, as they were in 2008
The U.S. banking sector is in better shape now than it was in 2008. Although banks and other financial companies have been pummeled in the market downturn, there has been a considerable effort to reduce toxic assets, rebuild balance sheets and stockpile reserves. Creditsights (August 10, 2011) observed: "The takeaway message is that the large banks and brokers should have sufficient liquidity resources to manage through these market dislocations caused by S&P's sovereign downgrade." Significantly, Bank of America, one of the bank's most beaten up in the downturn, reported in Q2, 2011 that it has global excess liquidity sources totaling $402 billion, up $66 billion (+20%) from year-end 2010. The bank had reserve repo assets of $235 billion, versus repo liabilities of $240 billion, for net liabilities of $4 billion. This means that net liabilities were a manageable 1%.

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