>Phase Two - Credit cycle begins (CLSA)

SOLID GROUND

Global Outlook
Investors have mistakenly attributed the rebound in equity prices to an upbeat economic future, rather than simply the survival of equity itself. Phase One was driven by a falling deflation-risk premium. In postdeflation equity rallies, Phase Two occurs when the credit cycle begins. Most investors, still fearing deflation, have failed to note that US credit is now larger than 2H08. In particular, they ignore the likelihood of a strong rebound in bank credit as banks seek to repair balance sheets through lending growth. This report seeks to show where supply and demand for credit will come from and why US equity prices have much further to go.

Equity price rises always follow the trough in the credit cycle
■ Since WWII, only one credit rebound did not produce an immediate equity rebound.
■ A rebound is more likely than ever, as the government both supplies credit and demands up to one-third of all credit.
■ Banks may not be growing credit, but 73% of US credit comes from outside the banking sector.

Credit in the USA is growing and about to accelerate
■ Government demand for credit is keeping credit growing.
■ Private-sector credit will emerge to buy current record-high corporate cashflows.
■ Banks now use record-high reserves to buy government debt and recapitalise.
■ Bank loans for property will create a reflexive rise in their own capital ratios.

Banks’ credit growth will result in money growth
■ When the banks start to create money, quantitative easing (QE) can end.
■ An end to QE will be good for the US dollar as ‘printing’ ends and assets reflate.
■ A rising US dollar is a short-term negative for emerging-market equities.

US banks can support the US bond market, but not forever
■ US bond yields will probably rise only slowly, due to massive buying by US banks.
■ Bond prices will fall as inflation rises, and then fall sharply when China revalues the renminbi.
■ The US government stopped creative destruction in 2008-09, but the longer-term price is the creative destruction of US government credit.

To see full report: GLOBAL OUTLOOK