Sucker's Rally, Not Green Shoots

The rally has been based on the rise in bank stocks. To understand the rise in bank stocks, you must understand the stress test. Saturday Night Live understands this quite well. View it now.

David Rosenberg, the chief economist at Merrill Lynch, retired last week. He may still be bullish on America, as the old Merrill slogan went. He is not bullish on the present U.S. stock market. He calls the rally a sucker’s rally.

From the beginning of this rally, he has maintained that it will not be sustained. He has not changed his mind.

He staked out his position early. He is not abandoning it now. To the extent that he will be remembered, this parting shot is appropriate, but only if he turns out to be correct.

He said that the stock market was likely to peak last week. That prediction was confirmed for at least one day. Friday’s Dow closed at 8575. It lost 155 points on Monday.

Is this a new bull market? Has optimism returned? He doesn’t think so. Risk is higher now. The market is close to where it was last January.

While it may be the case that the pace of economic decline is no longer as negative as it was at the peak of the post-Lehman credit contraction, the reality is that employment, output, organic personal income and retail sales are still in a fundamental downtrend.

As I have written over and over, Keynesian economics insists that the economy is driven by consumption. So far, we have not seen this. Consumers are still on the sidelines. Rosenberg understands this reluctance to spend.

Supply-side economics and Austrian School economics both teach that increased productivity is the key to economic growth. We are not seeing this, either. Business spending remains catatonic.

Rosenberg noted that the stock-buying public is still on the sidelines. The fund managers have driven this rally, he says.

While it is likely that headline GDP will improve as inventory withdrawal subsides and fiscal policy stimulus kicks in, our view is that whatever growth pickup we will see will prove to be as transitory as it was in 2002, when under similar conditions the market ultimately succumbed to a very disappointing limping post-recession recovery.

The increase in GDP, if any, will be transitory, he predicts. Falling residential real estate prices have not ceased falling. Commercial real estate will decline.

Balance sheet compression in the household sector will continue to pressure the personal savings rate higher at the expense of discretionary consumer spending. This is a secular development, meaning that we expect it will last several more years.

Let us hope that he is correct. Until households begin to save, and save like maniacs, the balance sheets of American households will remain insufficient to cover retirement. The recovery from the “negative savings” rate — increased net household debt — has been mild. Savings may today be 4% to 5% of discretionary income. This is not the stuff of a new economic boom.

Rosenberg dismissed the bank stress tests having been designed to produce less-than-dire results. That was also the goal of the Financial Accounting Standards Board’s revision of mark-to-market accounting in early April.

Commercial banks are not lending yet. Rosenberg observed: “In fact, the weekly Fed data are now flagging the most intense declines in bank lending to households and businesses ever recorded.”

May 13, 2009

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2009 Gary North