As the first half of another remarkable year in the markets wends its way to the finish line, the reedy voices of optimism are increasingly making themselves heard above the bearish din.
It takes a sunny optimist to plow money into equities in the midst of a nasty recession. And until running out of steam recently, the global rally has been nothing short of impressive. Index averages jumped by up to 40 per cent in less than four months.
Those of a bullish bent believe we'll be seeing more of this in the second half, as the landscape that seemed so desolate mere months ago is dotted with little green shoots. The economists' latest choices for the recovery-is-at-hand prize: U.S. durable goods orders climbed in May for the third time in four months; the U.S. Conference Board's Leading Economic Index rose smartly for the second month in a row; and even those famously glum German consumers are feeling better about things.
On top of that, the credit markets have been thawing nicely. And the global banking system - whose stunning transformation at the hands of government was the biggest story of the first half - is slowly digging itself out of the rubble, thanks to the billions pumped into the system. Just this week, the European Central Bank announced a record infusion of €442-billion ($715-billion) to needy banks for the next year at a mere 1-per-cent interest rate.
The connection between the unprecedented bailouts and the first-half equity resurgence is not to be underestimated. Investors had been pricing financial Armageddon into stocks since the infamous collapse of Lehman Bros. last fall. Once that possibility came off the table and banks of many stripes began reporting better-than-expected results, the bargain-hunters rushed back to the bazaar. The leading global financial index nearly doubled in three months.
But anyone expecting the financials to take up their historic role and lead the way to recovery is in for a rude shock, as more than one perceptive bank watcher has repeatedly reminded us in recent weeks.
Leaving out Canadian banks, which occupy their own little oasis in the financial desert, we should be thinking of the global players as patients still on the mend from a massive heart attack, one of those astute analysts, Satyajit Das, was saying the other day.
"They have been stabilized. They're pretty full of adrenalin and all sorts of other things. Perhaps they're being moved from the intensive care ward, but nobody is taking any of the monitors off them yet," Mr. Das says.
Even with about $900-billion (U.S.) in new capital, he estimates the global banking system remains short by a trillion or two. That means available credit will have to be slashed by as much as 30 per cent.
So investors, who have been lured back to banks in the expectation the worst is over, should proceed with extreme caution.
Even those with cleaned-up balance sheets face the usual recessionary woes of rising loan losses, corporate retrenchment and deteriorating real estate assets.
Also, their role in the broader economy is shrinking. So forget the heady days of growth. With fewer sources of income and lower returns, most will resemble utilities.
"For a shareholder to translate survival into upside on stock prices and higher dividends is a big jump," says Mr. Das, one of the world's foremost derivatives experts, a former banker and globetrotting adviser to serious money. "Saying that they'll survive is not the same thing as saying they'll prosper."
It should come as no surprise that banks have been able to turn a profit so far this year. What's worrisome is that they haven't earned more.
Banks are paying next to nothing for their money. The yield curve is sharply in their favour; governments are ensuring their solvency; accounting changes have boosted the value of their securities; trading revenues from bonds have soared; and competition has been dramatically reduced.
"If they can't make money in this environment, when are they going to make it?" Mr. Das asks.
He leaves vacation-bound investors with a sobering message for the second half: We need to lower our expectations, because the new normal isn't going to be anything like the old normal.