Bears ready for an Ice Age

US share markets again pushed higher overnight as investors continued to reassure themselves that the US economy is finally on track for recovery, while other analysts warned that this is yet another false dawn.

Certainly, the bulls seem to have some justification for their optimism, which again pushed the Dow Jones index close to the 13,000 level overnight.

US interest rates are extremely low, and corporate balance sheets are in great shape. The dire outlook for US unemployment appears to be improving somewhat, with figures released overnight showing that initial claims for unemployment benefits totalled 351,000 in the week ended February 18, which was better than the 355,000 that the market has expected. Even the housing market appears as if it might have bottomed out, with sales of previously owned homes rising to the highest level in nearly two years in January, while the inventory of unsold homes shrunk.

True, consumers have only been able to keep spending because they have pushed their savings down to dangerously low levels, but the bulls are hopeful that the improving jobs outlook might boost income levels and allow consumers to keep spending.

But other analysts argue that the recovery we've seen to date is largely the result of the $US2 trillion that global central banks have pumped into the economy in the past six months. They argue that 2012 is proving to be a carbon copy of 2011, which saw an initial rise in equity markets on hopes of a global recovery. But markets subsequently slumped as those hopes were dashed.

Albert Edwards, the extremely bearish Socit Gnrale global strategist, warns that investors are being deluded by false optimism.

"The market is once again in a hope phase – hoping that the US is now in a self-sustaining recovery; hoping that China might be soft-landing; hoping that the Greece bailout and the ECB liquidity polices have settled things down in the eurozone.”

But Edwards warns against believing that we are at the cusp of a new dawn. He believes that the global economy has entered an 'Ice Age', similar to what the Japanese economy experienced in the 1990s, and the US economy went through in the 1930s. An Ice Age follows a major credit collapse where there is still an excessive overhang of debt, and the private sector is intent on deleveraging.

Edwards has isolated some key features of Ice Age post-bubble economies. One is that sharemarkets become much more vulnerable to weaker economic conditions. Another is that the recovery in sharemarkets only begins when investors abandon all optimism.

"One key lesson from Japan is that an essential ingredient to the end of a long valuation bear market is revulsion. It is when 'buyers-on-dips' become 'sellers-on-rallies'. It is when volume dries up to almost nothing. It is the loss of hope.”

In Japan, he says, "we saw huge rallies in the Nikkei on the back of short-lived cyclical recoveries. Each cyclical failure and further new lows in the equity market saw hope being progressively crushed.”

Edwards notes that we've still got a fair way to go before markets finally reach their lows. "Previously US valuation bear markets typically take four to five recessions to fully play out. We have only had two.”