Tuesday, April 07, 2009
Dead Cat Bounce Or Something Livelier?
While many are optimistic over the present short spurt in equity prices, does it really have legs to carry on for at least a few months? The Dow rose nearly 23% in 19 trading days as of last Friday. That was the best performance over 19 days since the Great Depression. The S&P was even better, it rose nearly 25% over that period.
Now, before we get all optimistic, we should remember that there was a very similar rally just a few months back, November 2008 to be precise. In November the S&P 500 rose 21% in just 17 trading days, matching the current stretch closely. We all know what happened after that rally - the markets went to record NEW LOWS even faster.
So, is this another dead cat bounce (its called dead cat bounce, have you ever tried bouncing a dead cat, it does not come back up)? I think there is more credibility to this rally than the November rally.
The November rally was triggered by the wishy-washy announcement that Tim Geithner would be the new Treasury Secretary, and the markets had faith that he would be able to rework new plans to lift the banks of its toxic assets problem. Just as gung-ho in giving Geithner the thumbs-up, the market was even more devastating in selling down the markets when they heard Geithner's actual plans which lacked details and cohesiveness.
So, the November - January period can be characterised in the history book as The Swift Rise & Fall Of Geithner's Credibility.
Since then, Geithner has revealed a more concrete and winnable plan that include professional managers from outside to activate the sale and pricing of toxic assets. Now, the updated plan has more substance and is more convincing, and that was the cornerstone of the rally in March-April. The trigger for the current rally has to be Pandit's Pandora Box, which many thought could only be holding scary items every time he opens it. The surprising announcement that Citigroup made money even in January and February lifted the whole market. Maybe the troubled banks were not that troubled after all.
The feeling was that if these so called near-death banking giants were making money now, that means they are likely to survive, and if they will survive, the markets will NOT be getting another big-time crisis scare ala Bear Stearns / repeated bailouts of AIG / or total nationalisation of these banking giants. When you are able to take these "maybes" out of the equation, its silly not to rally.
Now that we know a bit more about AIG, we also know a bit better why the banks will probably be better off now than say six months ago. Many of the banks were huge beneficiaries when AIG kept taking bailout money. A lot of those funds went straight to the distressed banks which bought Credit Default Swaps on many of the CDOs (which got them into trouble in the first place). The sums owed by AIG to the banks probably was termed as "receivables" in the banks balance sheet, but in reality, the banks really did not know if they were going to get paid. IF AIG was allowed to fail, well, these so called "receivables" would be relegated to write downs. But Geithner and Bernanke knew what AIG was going to do with the money, and swiftly gave AIG the money, even though publicly both were blasting AIG for getting into so much trouble.
Both Geithner and Bernanke allowed AIG to keep scret as to where the bailout funds went, until recently. If they allowed AIG to reveal too soon, it could jeopardise the entire charade as too many could protest AIG's payments and may be stopped halfway, which will trigger a massive jump in counterparty risk. So, for all the hooting and hollering and charade, Geithner and Bernanke did a lot of things behind the curtains to save the global financial markets - and we didn't even write them a thank you note.
The November rally now looked as flimsy as paper as it was mainly riding on the appointment of Geithner, but this rally have more substance. Money went to the banks, CDS were paid out, banks made money, Geithner's new plan has more substance, future potential blind spots were averted smartly ... To add to the mix, we had a decent G-20 meeting which put in place major nations thinking and acting alike.
An even bigger factor was the tweaking of mark to market accounting rule by FASB. This has substantive repercussions, besides allowing the banks more leeway in treating these toxic assets, it will reduce their need to raise capital immediately. More importantly, the new rules will cause a lot more private equity and hedge funds to scramble to bid for these toxic assets as planned by Geithner. The new accounting treatment basically makes buying these assets more appealing.
So, how much legs does the current rally has? For one, I think we have lifted the market bottom to a new threshold. The market is unlikely to revisit 7,000 for the Dow, the new bottom should be 7,700-7,800 which will see many more willing to buy at those levels should it get there again. Looking at the current rally, the broader S&P 500 had a bigger rally than the Dow, which is to say its not a selective few which are moving the markets but a much broader class. This adds quality to the rally.
p/s photo: Deborah Priya Henry