All That Glitters / Pitfalls in an Economic Rebound

Is the recession ending? No? Maybe? Admit it: There aren't many investment managers out there, or businessmen, who'd bet the house that the worst economic crisis to hit the planet in 70 years is starting to peter out.

True, there is quite a bit of evidence in that direction. The breakneck pace at which American property values have been shrinking eased in March. The housing value bubble has been a key element in the crisis this time around. Corporate statements for the first quarter of 2009 do show a sharp drop in profits, but the slide isn't as bad as had been expected. Every week another pundit stands up and states that we've bottomed out, and that the long-term market trend will be upward from here.

One of the latest gurus to sound the all-clear is Anthony Bolton, investments manager at the American mutual fund giant Fidelity.

Bolton's opinion matters. He manages $157 billion worth of assets. When he decides to increase the proportion of Fidelity's assets in stocks, at the expense of other types of assets, it impacts the market.

It isn't that the optimists have forgotten the problems. The global economy and global trade remain weak. America's banks have plenty of problems, and the big auto manufacturers are in trouble. All the latest evidence shows that the speed of the downtrend is slowing, but putting the behavior of stocks aside, we see no solid evidence that the downturn is stopping altogether. Certainly, we see no evidence of reversal.

But even diehard pessimists can't ignore the signs of spring. Something in the air has changed for the better. Despair has been replaced by cautious optimism.

Yet in the markets, what looks toothsome at first sight can be nauseating for investors, at least in the short run. Take the market for government bonds.

Last Thursday, as stocks soared, government bond prices dropped worldwide. Why? If the appetite for risk is returning, millions of investors will be abandoning their safe haven in government bonds over time, which will depress their price.

If the global economy is starting to thaw, investment in government bonds isn't good. At first, investors will abandon them in favor of other assets. Later, the bonds will hurt from rising interest rates and inflation, both of which have to happen at some point.

Also, governments everywhere will be issuing floods of bonds to cover their bailouts and mounting deficits. Heavy issuance combined with a flood of newly printed money will, under the laws of economics, result in rising interest rates and inflation, both of which will drag down bond prices.

Prepare for double-digit inflation

Overseas economists predict that at the height of the next stage of the crisis, inflation in the dollar bloc will reach double-digit levels. They foresee yields on 10-year T-bills reaching 10%. That compares with no inflation and yields of 3.15% currently. If they're right, anybody holding T-bills today is in for a painful loss. And because markets today are interrelated, that hurt will reach Tel Aviv.

Logic dictates that if money seeps out of the bond market as the appetite for risk revives, at least, stocks should gain. Right? But that isn't assured. The TA-100 index has risen 44% from its low last November, and corporate bonds are back to their level from before Lehman Brothers collapsed in September. The great recovery may be over.

"Oops, You Missed Your Chance, Stocks Back At Fair Value Again" ran the headline of a piece by Henry Blodget, an analyst of repute. From now on, stocks will only gain ground slowly, he predicts, and only if the companies show real recovery in their reports.

In October and November 2008, hundreds of thousands of Israeli savers fled to safer shelter by selling their holdings in provident and mutual funds and putting the money into conservative assets. Since then, the price of Shahar government bonds has risen by 10%. But if the economy does recover, the bonds will return to their level before the crisis and these profits will evaporate.

Yet again the financial markets show how hard it is to ride them: When the economy collapses, everybody loses money, but when it's in recovery, there are no free lunches either.