George Bush’s US$700 billion bazooka gun has been fired, but it doesn’t come free. The penalty will be felt here in the UK and across the globe for years to come.
Wow!
The shocks just don’t stop coming.
The FTSE 100’s 8.84% rise on Friday was its best one-day performance since its introduction in 1984.
Royal Bank of Scotland (LSE: RBS) was the biggest winner, jumping an astonishing 32% on the day, with Barclays (LSE: BARC) not far behind, up 29%. Beleaguered HBOS (LSE: HBOS) also soared 29% higher.
The party continued over on Wall Street Friday evening as the Dow Jones soared another 369 points or 3.4%. It completed the biggest 2-day rise since the sharemarket crash of 1987.
Big George Fires The Bazooka
By now you probably know all about George Bush’s bazooka – the plan for a US$700 billion emergency fund set up to enable the US Government to buy troubled mortgage debt from banks. It’s a last ditch attempt to once and for all ensure some stability for the global banking system.
On top of that, the US and UK and other world markets have banned or severely curbed the practice of short-selling. [Read The Motley Fool’s Idiot Guide to short-selling.]
Clearly world markets believe the US emergency plan will be passed by Congress, hence the huge market rallies. In fact, given the quotes by the two men charged with dealing with this mess, there is absolutely no other option.
“If we don’t get this, it will be nothing short of a disaster for our markets” – US Federal reserve chairman Ben Bernanke.
“If it doesn’t pass, then heaven help us all” – US Treasury Secretary Henry Paulson.
A Pricked Bubble Has No Mercy
Given those comments, I am absolutely sure the emergency rescue package will be passed. But what does it all mean?
Hopefully it will free up credit markets so that they work in a ‘normal’ fashion again. You remember the way banking used to work? A bank takes deposits from savers and then lends out that money, and a little bit more, to companies and individuals. It’s called borrowing short and lending long. The bank makes its money on the difference between the interest rate it pays the savers and the interest rate it charges the lenders.
But there is a penalty to be paid. The giant house-price bubble has well and truly been pricked, and is deflating rapidly.
Many highly indebted home owners still have huge mortgage bills to pay. They can’t sell and trade-down, because the house will likely be worth considerably less than the value of their mortgage. Heaven help them if they lost their job.
The Heavy Price All Of Us Must Pay
US residents have a heavy price to pay, one which will reverberate around the globe, including here in the UK.
In the ensuing years, US citizens will have to contend with a combination of the following…
• Higher inflation, as the government effectively prints more money to pay for all the mortgages it is soon to take onto its books.
• Because the US has a huge and growing debt, any responsible government will surely scale back its budget spending plans and/or increase taxes. That means less money to spend on infrastructure upgrades, education, welfare and health, to name a few. Depending on which party gets into power, it may mean higher taxes for higher earners. Good luck to Barack Obama or John McCain – I think they’ll need it.
• There will just be a lower growth rate altogether. For too long we’ve been spoilt by the goldilocks economy of low inflation and steady growth. It was all part of the housing bubble and financial engineering which is quickly unravelling before our very eyes. We’ve now got to look forward to the much less palatable scenario of low growth and high inflation.
Kiss Goodbye To The Plasma TV
In a nutshell, for consumers around the globe, it’s a time for hunkering down and just getting through the next couple of years without any major hiccups. In a world of higher unemployment, it will mean lower wage growth and less opportunity for promotion. Jobs will become even less secure.
People will have to cut back on discretionary expenditure – and that means saying no to the plasma TVs, new cars, luxury holiday and the like. It means saving any spare money you can, and cutting down on things like energy bills and mobile phone bills. It means shopping around for a better mortgage, lower insurance premiums and a higher savings rate.
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Where Next For The Stock Market?
As for the stock market, it’s still virtually impossible to predict the direction of the market in the short-term. Banking and financial stocks in general will remain very volatile. It remains to be seen whether the huge gains of last week can be held.
Sentiment may be helped by the news overnight that Wall Street’s last two remaining independent investment banks, Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS), will become banks regulated by the Federal Reserve. It will allow the firms to access direct loans from the central bank, providing them with increased liquidity. The upshot will likely be that the banks no longer will have to consider being forced to sell to retail banks, as did Merrill Lynch (NYSE: MER) , Bear Stearns, and to some extent, Lehman Brothers.
Just by looking at the share price movements on Friday, I get the feeling there were some knee jerk over-reactions, some of which I expect will be somewhat reversed in the ensuing days and weeks. Friday was a combination of a relief-rally, a scramble by hedge funds to close out short positions, and some panic buying combined with pure gambling.
Give Me A Boring Market Any Day
The best strategy remains to sleep through it all. The second best strategy, which is similar to the first, is not to panic sell or panic buy. Sometime relatively soon, markets will stabilise and a base will be formed.
Personally, I’m looking forward to a boring day on the markets, a day when they neither flying higher nor plunge lower. Bring back the days when share prices move in a reaction to normal things, like a trading statement, interim or final results, or some economic data.
But don’t hold your breath. Despite last week’s huge rises, fear and pessimism remain the over-riding forces driving this market, notwithstanding the firing of Ben Bernanke, Henry Paulson and George Bush’s US$700 billion bazooka.
These remain interesting and unpredictable times.
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> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in HBOS and Barclays.
