Amid rate-cut glee, a word of caution
NEW YORK - Alan Greenspan and his fellow central bankers are going to save the world. There's not much doubt about it in the stock market.
The Dow Jones industrials picked up another 50 points Monday in the third up day since Greenspan stepped forward Thursday and lowered overnight lending rates. Total gain for the three days: 6.2%.
The burst of enthusiasm was even endorsed by a change in outlook by one of Wall Street's most widely consulted strategists, Byron Wien of Morgan Stanley. Wien, in Hong Kong when Greenspan cut rates, said he has dropped his prediction that the Dow will dip to 7000 this year. Wien said Greenspan's move, which came between regular Fed meetings, foretells coordinated cuts by central bankers that should keep the U.S. economy out of recession and support the market.
You may suspect there is another point of view to be considered. Indeed, there is, courtesy of William Kaye, a Hong Kong-based American hedge fund manager with The Pacific Group. Kaye was speaking in New York at a Grant's Asia Observer conference Thursday afternoon when someone in the audience of institutional investors interrupted with news of Greenspan's cut. Fortunately for Kaye, he had anticipated easier money when he prepared his chilling talk: "The Approaching Nuclear Winter for U.S. and Global Equities."
His advice: sell into any rally sparked by easing. Cheaper money doesn't mean stocks won't be ripped by a bear market, Kaye says. The proof is as near as Japan's market, still bleeding around 1985 levels even though the Bank of Japan cut its discount rate from 6% in 1990 to 0.5% now.
The reason behind his argument: Commercial banks have lost so much money in emerging-market debt that they have no choice but to cut back on their outstanding loans. "The banks have to tighten the screws to deal with their own problems," he says. The banks will turn away borrowers who normally would have their loans renewed. Kaye estimates that banks from rich countries will need about $485 billion, 2.3 years of recent profits, to rebuild their capital to 10% of loans outstanding. They would need even more to reach the 12% capital ratio reported before the crisis.
Rate cuts only will nourish the commercial banks back toward health. But the banks will eliminate loans for two years in the meantime. "The banks will be solvent" before they resume new lending, he says. The same process happened in the USA in 1991 and 1992 after banks had been crippled by the late-1980s bust in real estate. Now it is happening simultaneously around the world. The tight lending will wash out stock prices that Kaye says are still too high.
"There is an enormous amount of pain in global equity markets that is going to have to be experienced before we're done with this," says Kaye. A bull might counter that there is little evidence of banks pulling loans. At least, not yet. Credit crunches don't hit hard overnight.
Maybe the central banks will find unusual strength acting together forcefully as never before. But then again, they've never had these compelling reasons to team up.
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