… UBS is also gearing for a big rebound, convinced that the Fed’s move to shoulder $30bn of Bear Stearns liabilities has changed the game.
In its latest report -“Ready for a Rally” – it said financial shares rose 448pc in the 12 months after the Swedish rescue in 1992, 88pc after Japan’s Revitalisation Law in 1998; and 82pc after Roosevelt’s Emergency Banking Act in 1933.
The pessimists at Société Générale remain sceptical, even though the Fed has gone nuclear. “We expect global equity prices to fall by up to 75pc from their peaks as a deep global economic downturn unfolds over the next few years,” said Albert Edwards, their global strategist. He fears a 50pc collapse in earnings, compounded by an “Ice Age derating of equities”.
It may echo the Lost Decade in Japan, where stocks fell 80pc. The yields on state bonds kept falling as debt deflation engulfed the banks, thwarting efforts to nurse lenders back to health by the usual device: “steepening yield curve”. The authorities were left chasing their own tails. Having lived through this, Japan’s chief regulator Yoshimi Watanabe has advised Washington to go for a quick taxpayer rescue, rather than trying “to fix the hole in the bathtub”.
Whatever happens, there will always be tactical rallies. Mr Edwards cites four Wall Street bounces above 25pc in the 2001-2003 bust. The buying cue is when investor gloom nears black despair. The put/call ratio on options is now at a bearish extreme of 0.90.
“That would historically suggest that a joyous 25pc spring rally is close at hand,” he said. Yet Mr Edwards remains wary as long as analysts cling to their belief that earnings will rise 11pc in 2008. This is not the sort of “washout” level of gloom required to clear the air.
Still, the oldest adage on Wall Street is “never fight the Fed”. In short order, Ben Bernanke has slashed interest rates by 300 basis points to 2.25pc, and invoked the emergency clauses of Article 13 (3) of the Federal Reserve Act for the first time since the Great Depression to take on direct credit risk.
The Bush administration has told the housing agencies Fannie Mae and Freddie Mac to absorb $200bn of extra mortgage debt. It has implicitly nationalised them in the process. The network of Federal Home Loan Banks has mopped up $900bn of mortgage securities. Congress has rushed through a $170bn fiscal blitz.
This is not to be sniffed at. It is worth a good spring rally, until the inexorable logic of a 25pc house price crash prevails once again.
Bernard Connolly at Banque AIG, who foresaw this crisis with uncanny accuracy, believes central banks will resort to full-throttle reflation, setting off a fresh boom in shares and gold. But this will occur only after the economic slump has spread to Europe and beyond.
The authorities will wait too long to act, believing their own decoupling myth. Unemployment will ratchet up. Civil unrest may rock Latin Europe.
In the end, the whole industrial world will stoke a fresh credit bubble to put off the day of reckoning, for another cycle.
The capitalist system is now so deformed by debt that it requires ever lower interest rates to keep going. It survives on perma-bubbles. Monetary rigour at this late stage would endanger democracy. …
Volcker and Thatcher proved that democracies can weather more pain than conventional wisdom will ever expect. Other than that I have nothing to add …