Making a Case for the Bears

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

The bears have plenty of reasons to growl these days, and I’m not talking just about a severe case of post-hibernation irritation either. Although North American markets have posted unprecedented gains not seen in a generation from record recessionary lows, the bears believe such performance should be equated to that of an athlete on steroids — jacked up, but not realistic.

More precisely, the bears argue that all of those corporate profits and the rush to equities and commodities that have been hallmarks of 2009 are nothing more than knee-jerk reactions to interest rates that are low and globally orchestrated economic stimuli. Without these “steroids” in the early days of the Great Recession, the bears believe that the U.S. economy would have died a slow and painful death. However, if and when the government taps are finally shut off, world central banks will have little choice but to raise interest rates, which, in turn, are likely to curb any economic growth enthusiasm we are seeing the misleading preview of right now.

Why do the bears believe the current recovery is misleading? It is possible to experience a recovery while the credit market is still depressed or completely immobilized. However, such cyclical recovery is incredibly difficult to sustain. Economic theory and history teach that a financial and credit crisis triggered by housing market crashes tends to leave a long and wide trail of dysfunction. So, the bears argue, investors thinking that the return to any kind of pre-2008 normalcy is just around the corner are being unrealistic.

Additionally, the bears are very wary of the weak U.S. dollar, identifying it as the only reason for strong commodity prices and improving the U.S. competitive advantage in international trade markets. For months, the U.S. dollar has been at the end of the so-called one-way trades and the bears wonder if the greenback hasn’t been actually super oversold, having in mind interest rates rising in the near term and debt management issues resurfacing again with a vengeance. Yet again, the strength is only in the appearance, it is not fundamental strength.

The bears also believe that corporate profit expectations for 2010 are unrealistic, considering just how lethargic the U.S. economy still is. Sure, the bears agree that the first half of 2010 is likely to offer investors and economists plenty of reasons for joy. But that is only because economic stimulus is still flowing and inventories are still being rebuilt, while, in the background, something more sinister could be at work, such as weak consumer spending, dangerously high unemployment, and still tight credit conditions.

Finally, the bears are still wary of another black swan event that might still shock us and throw us backwards another decade or two. Perhaps the new economic tsunami would come from China. This emerging economy has been red hot for far too long and needs to cool off a bit. Perhaps we’re in for massive inflation once world governments’ balance sheets are brought back out of deficits. Perhaps the shock will come from within, as investors get impatient with the prolonged U-shaped recovery. Then again, perhaps we will become victims of our own complacency, having in mind low equity option volatility and almost normal spreads between corporate and government debt, all indicating a smooth ride ahead. But if the ride is not smooth, even the perception of a bubble could create unprecedented panic and a potentially unjustified crash in some segment of the market on the path to recovery, bringing us back to the brink of disaster where we found ourselves when Lehman Brothers collapsed in September 2008.