Last month’s stock slump and a sluggish US recovery are raising fears of an ‘Armageddon scenario’.

The vital question is: what to do about this unpleasant little Armageddon scenario? Photo: Jim Rice

A SHAREMARKET dabbler would have done well this year to adhere to the adage ”sell in May and go away”, provided they sold at the beginning of the month.

Like clockwork, there was the traditional sharemarket rally through Christmas and the New Year. Then came May, a shocker, down 7.5 per cent, erasing the year’s gains and $100 billion in market value.

And now there is fear. The bond market – usually a harbinger of what is in store for equities – is warning things will turn ugly.

In a flight to safety which eclipsed even the depths of the financial crisis, government debt yields touched 60-year lows this week: three-year bonds fetched 2.09 per cent – incidentally, a full 4 per cent below the banks’ three-year fixed rates.

Credit markets are forewarning a good chance the Reserve Bank will lop a full 50 points cut from its official 3.75 per cent cash rate when its board meets next week; and at least another 1 per cent down the track, to boot.

For the latter to occur, as Goldman Sachs noted this week, ”China will have to blow up, Europe disintegrates and the US double-dips”.

”Then we’d also be gone – Aussie house prices down 20 per cent.” This was unlikely, said the broker, an ”Armageddon scenario”, but nevertheless an outcome borne out by this week’s market action around the world.

The vital question is: what to do about this unpleasant little Armageddon scenario? In Washington and Brussels the policymakers are hapless. They have fired their shots. Three years of zero interest rates and incessant money printing.

Wall Street is baying for the Federal Reserve to crank up the printing presses again and deliver QE3 (a third quantitative easing program where the US buys its own debt).

THEY don’t care for David Einhorn much on Wall Street. The 43-year-old hedge fund manager hit the spotlights in 2008 when he cleaned up by short-selling Lehman Brothers.

Einhorn is a well-known critic of the investment banks. His thesis is they pay out 50 per cent of their revenues in staff pay and so have an incentive to take unacceptable risks, operating with high leverage to tart up their returns.

Since they are too big to fail, though, that risk is effectively carried by the system. It is risk for everyone but rewards for a few.

Einhorn didn’t ingratiate himself with the Fed much either when he penned a long comment piece in the Huffington Post a couple of months ago lambasting its easy money routine.

”A Jelly Donut is a yummy mid-afternoon energy boost. Two Jelly Donuts are an indulgent breakfast. Three Jelly Donuts may induce a tummy ache. Six Jelly Donuts – that’s an eating disorder.

”My point is that you can have too much of a good thing and overdoses are destructive. Chairman Bernanke is presently force-feeding us what seems like the 36th Jelly Donut of easy money and wondering why it isn’t giving us energy or making us feel better.

”Instead of a robust recovery, the economy continues to be sluggish. Last year, when asked why his measures weren’t working, he suggested it was ‘bad luck’.”

Although things look bleak, and will likely get worse before they get better, there are still a few things going for the stock market.

One is valuation. It is 10 per cent cheaper than it was just a few weeks ago. And it has a yield, in contrast to bonds, where the 10-year Commonwealth variety is yielding just 2.84 per cent.

And it is simply not in market psychology or human nature for things to stay down for too long. That said, this bear market is a real doozy and one whose end may only come when every last punter has written off the prospect of recovery for years.