April 7, 2009
A bull market requires three things – attractive valuations, excess liquidity, and strong economic growth. Two of those three appear to be in hand, and the third, economic growth, may soon follow, Louis-Vincent Gave said recently.
Gave is CEO of GaveKal, a Hong Kong-based economic consulting and fund management firm. His remarks were delivered at the Altegris Strategic Investment Conference on April 3.
Based on common metrics such as P/E ratios and market capitalization as a percentage of GDP, Gave says US equity markets are “at least close to historically low levels.” Gave was similarly confident that sufficient liquidity is present to fuel a bull market, a judgment he based on money market and cash balances.
But economic growth is the key impediment to a sustained market rally, Gave said. GDP historically has grown at approximately 3% annually, and growth was basically at this normal rate over the last four to five years. GDP growth rates advancing significantly above the 3% trend line are a reliable leading indicator of an impending recession.
The current recession, however, is the exception to that rule, and this distinctive characteristic creates the critical challenges to recovery.
The big problem is that lending is still at a standstill, principally because banks cannot securitize their loans. In the current environment, banks can buy loans at 80 cents on the dollar in the open market, leaving them with no incentive to originate loans.
The government’s response, through the TALF program, is an attempt to increase the values of loans in the secondary market from 80 to at least 95 cents on the dollar, which will indirectly stimulate lending. “It may work,” said Gave, “but you also need consumers willing to borrow.”
Consumer interest payments currently represent approximately 15% of income, which Gave says is near record levels, and he believes this, combined with a bottoming out in the real estate market, can restart lending and consumer spending.
“If lending gets going, auto sales will follow,” Gave said. A lot of the loans being repackaged and sold through the TALF program are auto loans, he noted, consistent with the Obama administration’s policy of stimulating auto sales.
“We will know whether the US is mending from the credit markets, and the credit markets right now are not buying into current equity market rally,” Gave said. Spreads have not tightened. BAA corporate bond spreads below 5% are critical for an equity market, and they remain near the 6% level. “The credit markets are saying that debt can’t be rolled over, and that debt will eventually become equity,” he said.
While the TALF program represents one way out of the current crisis, Gave said another path offers similar potential – growth from China.
“In 1949, people said Communism would save China, then in 1960s they said the Cultural Revolution would save China, and a decade ago the mantra became ‘capitalism will save China,’” Gave said. “Now the question is whether China can save capitalism.”
China’s problems do not stem from a collapse in its exports. “For China, exports are the cherry on the cake – most of China’s growth is from domestic capital expenditures and domestic consumption,” he said. Only 2% of Chinese growth comes from exports, whereas 10% comes from those domestic sources. “Those two percentage points are gone,” Gave said, and its absence is forcing a massive inventory cycle adjustment.Display article as PDF for printing.
Would you like to send this article to a friend?
Remember, if you have a question or comment, send it to .
