March 2009 Lows Will Be Tested: Strategist

The stock markets’ March 2009 lows could be tested and even broken as sovereign debt continues to grow in Europe and stimulus measures wane, Philippe Gijsels, head of research at BNP Paribas Fortis global markets, told Tuesday.

"The situation on the old continent is indeed very difficult," Gijsels said. "Like everywhere in the world a massive amount of debt has built up. In the previous banking crises the debt moved up the chain to the sovereign level and the weakest links are now being attacked."

There are two ways to pay down these huge debts and policymakers in Europe are about to embark on the wrong path, he said.

“If you find yourself with a mountain of debt, there are eventually two ways to get rid of it,” Gijsels said. “You can save your way out off it. This means tax increases, spending reductions, a strong decline in economic growth and possibly/probably a recession. This is the course Germany is pushing for.”

“The other solution is inflating the debt away,” he said. “This is not in the DNA of the ECB and previously the Bundesbank, who are scared to death of inflation. Therefore, we and the markets were quite surprised last Monday that the ECB is buying government debt, a process that is potentially inflationary.”

Investors need to watch the ECB very closely, and deflation and a severe economic slowdown in the second half and 2011 are now on the cards, Gijsels added.

”It is true that earnings and data have come in strong,” he said. “Corporate balance sheets look quite good. This is clearly the bright spot in the economy. However, most people fail to understand that these strong figures are merely the mirror image of the fiscal and monetary stimulus that was created by governments and central banks.”

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“It is basic economic theory really,” he added. “If the government runs a deficit of 14 percent it is quite logical that the other agents do well. If you put € 2 trillion into a €12 trillion economy it should help right?”

When this stimulus is taken out of the system, we will see the emperor has no clothes, Gijsels said.

“As stimulus is gradually taken off and replaced by higher taxes the economy will slow and economic and corporate figures will start to disappoint.” he said. “This means that the mother of all bear-market rallies is over and bears now have a good shot at the March 2009 lows which will possibly even be broken.”