All That Glitters / The Return of Pessimism

Last week brought bad news to the markets, quashing any ebullience among traders, investors and economists alike. Barring surprises, the mood in Israeli market circles is likely to sour, too.

The snowball started with the jobs data in America. After an astonishing first half for capital market investors, the U.S. economy growled, reminding all and sundry that the recession is not yet over, and there's no proof to the sentiment making the rounds right now, to the effect that the worst is behind us.

The figures were, simply, hideous. In May the pace of job losses had slowed to 322,000, half the pace posted in January to March. Experts had predicted further improvement in June. Wrong: that month, 467,000 people lost their jobs, lifting unemployment to 9.5% of the workforce.

In-depth analysis of the figures brought more bad news. When you examine the number of working hours lost per week, a figure that factors in not only job losses but truncation from full-time work to part-time - we find that the slowdown worsened. And note that these figures don't include jobless people who have despaired of finding work: they encompass only those actively seeking work.

In conclusion, unemployment in America is clearly running well beyond 10%.

The markets reacted immediately. American stocks fell by about 3%. The index tracking volatility, otherwise known as the "fear index" - the VIX - jumped by 7%. European stocks wrapped up their third week of losses, having retreated by more than 5%. The dollar, which apparently remains the most finely-tuned and accurate yardstick of investor self-confidence, soared: "The appetite for risk suddenly vanished," one trader said.

They really are going broke

The trouble doesn't end there. In June, we learn, there was a significant increase in the number of companies whose bonds were classified as junk - that actually did go bankrupt. According to rating agency Standard and Poor's, the rate of bankruptcies in that category of high-risk companies jumped to 9.2% in June, from 8.1% in May.

Moreover, the list of companies in Chapter 11 includes the likes of General Motors, the U.S. outdoor-clothing chain Eddie Bauer Holdings, Fontainebleau Las Vegas, and Lear, the main supplier of seating and electrical systems to carmakers GM and Ford.

Nor does S&P foresee an upswing. It thinks the rate of bankruptcies among companies like these will rise to 14.3% in 2010. If the state of the economy continues to deteriorate, says S&P, that proportion could climb to 18.5%.

During the preceding three months, the markets proved sublimely indifferent to bad news, of whatever ilk. Share prices continued to roar, even the highest-risk bonds forged ahead. No less than 109 issues of new bonds took place, an increase of 38% against the same period of 2008. That is quite an astonishing figure, indicating a craving for risk. While on the subject, that figure also explains why American investment banks posted such handsome profit figures for the second quarter of 2009, and how they could pay creamy bonuses to their top people.

But the million-dollar question is whether anything fundamental will change in the public's appetite for risk. Quite a few leading analysts think it will.

Let's start with Nouriel Roubini, fondly known as "Dr. Doom", who scorns theories of imminent rebound. The figures on jobs show that the "green shoots" everybody's talking about "are mostly yellow weeds that may eventually turn into brown manure."

One wouldn't think it possible, yet Roubini managed to take his pessimism to a whole new level, predicting that America will simply slither into another recession, and that stock and bond prices will drop in waves.

"Bond king" Bill Gross, who manages Pimco, the world's biggest mutual funds company, paints a rather more balanced picture, but it's no less depressing. With 15 million Americans unemployed next year, and tens of millions more working part-time and with caps on their credit, who exactly is going to maintain the American consumer economy, he wonders.

Gross sees chastened Americans shifting from putting aside none of their money to saving about 10%. That, too, will hamper the rebound: American growth won't pass more than 2% a year for a whole generation, he predicts.

Washington won't have a choice but to offer a whole new package of incentives, Gross and his fellow economists conclude.

And what about investors? They won't like the new reality, says Gross, unless they're incurable optimists or have an IQ of less than 100. A lot less. Investment in stocks, says Gross, or in junk bonds or property, is intensely risky. Investors would be better off in government bonds, or stocks that pay dividends, in his view.

Are Gross and his peers correct?

History shows that even the most popular pundits have agendas. Nouriel Roubini is sought after for his speeches pouring fire and brimstone on the system. He gets as much as $100,000 per lecture, not including his travel costs by executive jet. The second he adopts the consensus, the public's interest in him will vanish. They want him as a prophet of doom, not a pussycat. Bill Gross is the world's biggest investor in bonds, and he doesn't hesitate to recommend that the government make moves that would do well by his positions in the marketplace.

Yet with the demise of easy credit and American unemployment nearing 10%, after $15 trillion of the American people's wealth vanished since 2007 - no obvious driver for American or Israeli stocks leaps to the eye, one that would lift them higher than the levels reached in the second quarter of 2009. True, low interest rates can inflate stocks beyond their natural level. But we all know how financial bubbles end.