The rally of stock prices, in practically all the bourses of the world, that started in early March and still goes on - but with less dynamism - has created a heated discussion about its nature. Obviously, the main question the participants in this debate are called to answer concerns the time horizon of the stock bonanza. Distinguished financiers are taking part in the discussion, like George Soros and Warren Buffet, either supporting the bull or the bear character of what is happening in the world stock exchanges. Over the past weeks however, the discussion on this matter has lead to two well-shaped answers, one optimistic and another, pessimistic. The two sides are searching in the same economic space to find their contradicting arguments. The first, the optimistic option, says that the gains in the bourses do not form a rally in a bear market, but constitute a totally brand new trend, while the pessimistic option insists that the stock price rally will soon end and give its place to a strong downward correction.
The crucial point for both though lies in the financial market and deals with the sub-prime credits and their derivatives. In short, the optimistic side believes that those “paper” values, which today are worth almost nothing, will soon start gaining value, mainly because the crisis in the real economy will soon end. Using this logic, no economic crisis lasted more than three or four quarters of a year in the post-WW II period, and we are already now in the third quarter of the recession. So the bourses, which traditionally see first the resumption of economic activities, are now performing this role and announce that the worst is over. Undoubtedly, the banks will be the first to gain from this new turn on both accounts. First because their sub-prime loans and derivatives will gain in value, and secondly because their stocks have already and will continue in the future to gain more and more value.
To the contrary, the pessimistic side says that the credit crisis and the sub-prime credits have not yet shown all their ugly face, and the real economy has not faced a normal crisis but a new kind, which still has a long way to go, approximately another two years. All that means of course is that the present gains of stocks are simply a rally in a bear market and soon there will be a downturn of prices. This analysis says that the crucial question lies with what is happening in the credit markets, and what are the banks still hiding in their balance sheets - or off them. In short, how many more toxic assets are still lurking in the banking sector? For the reader to get an idea of what range of values we are talking about, it suffices to report that the International Monetary Fund, in an announcement last week, revealed that according to its estimates the banks need another USD 1.7 trillion to write off the remaining toxic assets in their portfolios. Up to today, they have received something more than USD two trillion. In a few words, things are as follows: led by the large American banks, the present bonanza in stock markets is directly financed by public money, coming either from central banks or the governments. The question is if these monies will keep flowing and take care of the toxic assets hidden in the banks’ portfolios until the first signs of resumption in the real economy appear. Then the reader can answer the question of the nature of the rise in bourses.