Is the optimism justified? - Why current optimism may be premature

You would have watched the small attempts of bulls to ignite a rally across the global markets. While analysts (the sell side variety!)are back and urging investors to buy, some signals and unresolved questions suggest that these attempts are unlikely to succeed this time round as I show in this posting -

1. Low volumes on Exchanges - While equities have posted rallies of about 10-15 percentage points during the post October phase volumes have been low. Any chartist will tell you that volume is an important indicator.

2. We are in a sidewise pattern on equities - To me this is an indicator of uncertainty especially when I add volume to the price indicators. Of course this need not be bearish always and can well represent consolidation before a leg up though I doubt that enough logic exists for this logic at this stage.

3. Most estimates speak of a recession (or depression in whatever form)that is likely to stay till well into the year 2010 - i.e., in US that would be a 30 month recession which would rank as one of the longest one. Some months ago people had hoped that 2009 would bring in a reversal to the recessionary trend. The huge job losses of about 2 million plus last year in the US alone(revisions to the payroll numbers however suggest much higher job losses) have pushed unemployment to 7.2 pct with possibly more damage due in 2009. The Obama administration has steadily ratcheted up the employment target of its (now) trillion dollar plus intervention plan to bring about a reversal to the ongoing recession. Obama now talks of creating 4 million jobs compared to 2 million plus a few weeks ago.

4. Along with the trillions worth of interventions by Central Banks, Governments are bringing in their share of trillions. Meanwhile, the velocity of money is slowing significantly across the recession hit ecnomies. So banks continue to hold huge quantities of funds but the multiplier effect is being weakened. To my mind this is a stark reflection of the insufficient demand and overwhelming fear of the unknown.

5. The steps by Central Banks and Treasuries are overtly inflationary which is a big reversal in stance in a few months. This brings out the truth - that Central Banks sense a depression is already in or is round the corner. In monetary policy terms that is turning while to black and you cannot accomplish that in a few months nor can you reverse the effect in a few months. I am saying that an inflationary policy will take months to take effect and you dont make such a policy if you intend to reverse it in months.

Given the above, why should equity markets rally now? I dont see a logical reason. On the other hand the fall in yields has begun to reverse - a result of unreasonable panic in some countries but clearly rational in the US and some other places. But, again I am unable to say yet whether this reversal can be sustained; after all, the buying up of various debt instruments by the Treasury in the US and similar steps in other economies should pull yields down and new issuance is yet to hit the roof. A second fall in yields thus seems in order and therefore, a reversal should wait for another 3-6 months.

Then we have the corporate results that are likely to throw up bad vibes. The success of the measures taken by Treasuries and Central Banks so far has been little - yes, we have seen a thaw in credit and money markets and some initial signs of lending. But, how will GDP grow so soon in the face of further weakness in employment and demand. With GDP of emerging markets worsening and employment being hit how is trade to expand? And as I said earlier, the juggernaut cannot be haulted so soon from sliding down and its climb up is likely to take time.

I guess I have enough arguments that point to the threat that the budding optimism may die soon. A bottom is yet to be completed.