Market Rally Taking Lambs to the Slaughter

I’m as ready as anybody to see the market rally that becomes the leading indicator of economic recovery… but this one isn’t it.  This is a fool’s rally that is going to take retail investors to the cleaners.

This rally began with Citibank’s statement that their core banking business was profitable in the last quarter if you discount write-downs of toxic assets, the fact that they are earning money on tens of billions of “free” dollars injected by the government, etc.  Retail investors have focused on “profitable” and ignored “if you discount”.

The government’s stress tests are still a month away from completion and when they wrap up they are going to show that core business profitability or not, several of the largest US banks, probably including Citi, are insolvent and will need to be nationalized in deed if not in name.  When the results of the stress tests re-assert reality, this boomlet is going to fall like a house of cards.

The real rally will not occur until the banks are fixed with no “if you discount”‘s.   That could be as soon as June or July if

  1. the results of the stress tests come back dire enough that
  2. the administration is forced to face reality, nationalize the zombie banks, and take over the damaged assets on their balance sheets and
  3. sell clean, chopped up, smaller banks back to the public
  4. with new regulations in place reinstating the firewalls between commercial banks, investment banks and insurance companies; forcing limits on the size of financial institutions, and putting concrete limits on the overuse of leverage anywhere and everywhere in the economy.

If these things do not happen, the real rally will be delayed months or years more until banks slowly work through the realization of their asset losses.

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