2009-04-28

Andy Xie: Bulls, not Bears, May End in Tears

Andy Xie's latest still hits on the theme of a double dip, not just for the economy but for the stock market.
The bull case is built on three assumptions: (1) the market decline is already deep enough; (2) the global economy is either recovering or about to; and (3) more government stimulus money is coming, should there be more trouble. The bear case rests on: (1) this is a debt crisis, the debt levels are still too high, and the global economy can’t resume growth until debt levels recede to normal; (2) the world economy is still shrinking, though at a slower pace; and (3) government stimulus can’t start another growth cycle as the global economy must restructure itself first.

I am in the bear camp. The bull case is really based on comparing the current recession with other recessions in the past half-century. However, this is a once-a-century recession. The only comparable one was the 1930s Great Depression. For a new growth cycle to begin, two conditions must be met: (1) debt levels, relative to income, in consuming economies (U.S., U.K., Australia, Ireland, Spain, etc.) must return to levels prevailing two decades ago, and (2) the manufacturing export economies (China, Germany, and Japan, etc.) must become significantly less production-oriented.
He sums up the situation very well in those two paragraphs. Later, he makes this socionomic argument:
Bear rallies emanate from psychological leftovers of bubbles. When a bubble stays around too long, most begin to view it as the norm. When the bubble bursts and the pain becomes unbearable, most pine for the “good old days.” Their collective action causes a rally that creates the illusion that the bubble has returned. But a bubble, after bursting, can never be brought back.
One reason we still have bulls looking for bubbles is that the government continues to inflate the money supply in the hopes of levitating home prices. Andy sees the end of the government's interventions though:
Such confidence tricks are significantly impacting sentiment and financial markets, but they can’t reverse the trend. Property prices are falling and unemployment rates are rising across the world. Temporary euphoria in financial markets cannot reverse that. Reality will eventually extinguish the irrational euphoria. Once inflation rises, it will close the final door of hope – the government bailout. Interest rates can and will rise despite badly performing economies. Only then will asset prices truly bottom out.
This is the government's catch-22. If their policies succeed in sparking a recovery, interest rates will rise quickly and cause another crash in asset prices.

In the end, the government's actions have only prolonged the crisis. Had they allowed everything to collapse at once, we'd already be on the road to recovery. Instead, we're waiting for the next shoe to drop...commercial real estate.

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