You Say ‘Depression’, I Say ‘….’

No bells have been rung nor any fat ladies sung. Equity market rallies since Obama-day and it reflects both hope for his stimulus package and 1950's-style valuations between equities and bonds. Anything short of Armageddon for the corporate sector over the next twelve months is likely to be greeted with relief. Meanwhile, in an address to a banking group in Hawaii on Friday, San Francisco Fed President Janet Yellen didn’t mince her words, urging legislators to wrap up debate on a stimulus package and pass the legislation.

The IMF's MD Strauss Khan has described the advanced economies as being in depression. However, since the slump on Inauguration Day, the equity markets of the advanced economies have rallied: the S&P by 8%, DJ EURO STOXX by 6% and FTSE100 by 5%. The less advanced also: the Chinese CSI by 10% and Brazil by 15%.

I believe that the direction of travel is right; the timing will, as always, be a matter of finer judgment.

The Fed uses parity (of the forward PER) as a guide to fair value. On that measure, current values of equity markets would represent fair value if they were anticipating earnings declines over the next year of almost 40% on the S&P and around 70% on each of the FTSE100 and DJ EURO STOXX. If EPS declines prove less severe then, on this measure at least, further equity rallies could be justified. They would have to go a long way before Bernanke worried about "irrational exuberance"!

Governments now across the globe have provided funds to banks, taken shareholdings in them and appear to stand ready to provide greatly more funds including by way of quantitative easing (printing money). Otherwise, banks hold back, unemployment, corporate and personal bankruptcies all rise. As they rise, the banking sector is likely to become more, not less, risk averse. That's the vicious circle!

President Obama has taken a lead in setting a cap on packages to banking execs of $500k. We are seeing an extremely weak employment report, which portends very depressed levels of economic activity and consumer spending in particular in coming months, but from the market perspective, bonds were unable to forge significantly higher ground, instead capitulating to the downside as stocks got the upper hand.

Among some analysts that I know, there is a view that the worst is behind us now, as economic data has fallen off so rapidly in the last quarter that the pace is likely to slow or even flatten in the coming months though by the same token, that’s not likely to cause the Obama administration to take its foot off the pedal in terms of its efforts to rejuvenate the economy.