Investors tend to be a very optimistic bunch — even during the most significant economic downturn in more than seventy years, the slightest piece of good news is pounced upon, with “experts” happily proclaiming that the market has “bottomed”. Since touching 3,125 on 4 March, the All Ordinaries closed yesterday at 3,693 — a rise of 18%. In the United States, the broader S&P500 index has risen from 682 on 5 March 2009 to close this morning at 865 points — an increase of almost 27% in less than six weeks.
Much of the good news which has spurred the rally is not really good news at all. Rather, it is bad news, camouflaged as better news. For example, earlier this week, financial stocks received a boost after Goldman Sachs reported that it had made a US$1.8 billion profit for the quarter ending November 2008. Goldman shares rose as high as $131.27 on Monday (having languished at only $58.88 back on 20 January 2009). It was later revealed that Goldman’s profit figure conveniently ignored its December results (in which the bank lost US$1.3 billion).
Goldman was able to exclude the poor December figure as a result of its conversion to a bank holding company (and the subsequent change of financial year). More disturbingly, as The Daily Reckoning noted, the vast majority of Goldman’s income was generated due to its fixed income, commodities, and currency trading division — the more stable investment banking business generated a far more somber US$823 million.
But Goldman wasn’t the only bank to present a Wizard of Oz style update. Well regarded Californian-based bank Wells Fargo announced last week that it had earned (a record) US$3 billion in its last quarter. The news led to Wells Fargo shares leaping 32%. However, all was not as it seemed, as Bloomberg’s Jonathan Weil pointed out. Weil noted that following Wells Fargo’s acquisition of Wachovia last year, the bank was able to carry over a US$7.5 billion ‘loan loss allowance’ — that allowance allowed it to reduce its reported ‘loan losses’ (last quarter Wells reported loan write-offs of only $US3.3 billion — well down from US$6.1 billion in the previous quarter for the merged entity). Wells also made several other mysterious disclosures, including a US$44.2 billion “other assets” entry in its balance sheet and also benefited from changes to the mark-to-market accounting rules.
The performance of US financial institutions is however, of less relevance to Australia investors than the happenings at our second-largest trading partner, China. China announced yesterday that GDP growth had slumped to 6.1% — down from 10.6% in the corresponding period in 2007. Given the levels of urban migration in China, is widely believed that a growth rate of less than 5% is equivalent to the economy being in recession. Further, the growth figures would have been boosted by the Chinese Government’s US$585 billion in stimulus spending.
The possibility of a soft Chinese landing in asset price also appears unlikely. The Financial Times reported today that “an apparent rebound in the property market was unsustainable over the medium term and being driven by a flood of liquidity and fraudulent activity rather than real demand. [With Cao Jianhai, professor at the Chinese Academy of Social Sciences, a leading government think tank claiming that] he expected average urban residential property prices to fall by 40 to 50% over the next two years from their levels at the end of 2008.”
The FT also noted that “preliminary [Chinese] government investigations had turned up numerous examples of real estate developers using fake mortgages to offload apartments on to the books of state-run banks facing enormous pressure from Beijing to rapidly increase lending to boost the economy.”
Property prices may not be the only asset in China to readjust. The Shanghai composite stock exchange could be in for a similar fall, with the bourse having risen from a low of 1,728 on 27 October 2008 to close yesterday at 2,536 — an increase of 47% despite the country encountering its lowest economic growth since 1999 and its major markets (the United States and Europe) encountering significant recessions.
The beauty of a bear market bounce is its ability to alter reality — the US sharemarket bounced significantly after the 1929 crash (rising from 236 on 4 November 1929 to 293 on 7 April 1930 before eventually bottoming at 44 in June 1932. it took until 1954 for the Dow Jones to return to its April 1930 levels.
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Investors’ willingness to accept what appears to be good news could again result in widespread losses. It’s not called a bear market trap for nothing.