Between a Bull and a Bear

Similar conditions exist today, with the effects of the stimulus expected to be the strongest in the third and fourth quarters of this year. Growth in China, too, is showing strong signs of reviving. The market upswing is likely more substantive than a short-lived bear-market rally.

If that is the case, the S&P 500 could rise to 1000 sometime later this year. The rally could begin to fade by the end of 2009, once the impact of the stimulus begins to wear off. Any further headroom could be then limited by a general wariness about enacting any new spending plans, with government debt piling up and the binged-out consumer remaining in a funk.

The current rally could be cut even shorter if the bond markets begin to panic about the size of mounting government deficits that would crimp their ability to borrow, or if the financial sector and the consumer just want to get rid of the excessive debt at a pace faster than the government can spend the new stimulus funds.

The real wild card is the China-led emerging-markets growth story. It's possible that we could see a brand-new global bull market in stocks if China takes over America's place as the world's major economic growth engine. But the Chinese domestic market doesn't yet possess the scale or the size to play the same role in the global economy as the United States has so often done. China's share in the global economic output is 10 percent, compared with 25 percent for the United States.

Furthermore, domestic consumption in China constitutes an extremely low 40 percent of GDP, and while it is bound to increase in the coming years, such changes are gradual. For the time being, any revival in China is being led largely by public investment—even as its economy suffers from an overinvestment problem. China, too, will end this year with a high fiscal deficit of 6 percent of GDP, and while its situation is hardly as worrisome as that of its Western counterparts, there's a limit to how much it can spend to shore up the economy.

The conditions are not in place for a major new bull market to begin. But a bear market is not the only other alternative. There is a middle path, like Japan in the mid-1990s.

© 2009