Stock markets have roared back since their early March lows: by April 17, the S&P 500 was up 23.7 percent, FTSE 100 16.5 percent, HSI 37.5 percent, Shanghai A 20.8 percent and Nikkei 26.3 percent.  Even American banks, the epicenter of the financial crisis, are reporting good earnings. The U.S. president is talking about silver linings. Fed Chairman Bernanke is seeing “green shoots.” Japan just announced another fiscal stimulus package.  The market is expecting a second Chinese stimulus. Suddenly, it feels like you must get in now or it will be too late.

But this is a bear market bounce that will end in tears. What will bring it down will be the likely torrent of new issues.  Banks that report good earnings and speak about recovery will probably try to raise massive amounts of capital, taking advantage of the market rally, to weather the long winter ahead.  IPOs will swamp emerging markets.  Money flowing from bullish investors will become the winter clothing for distressed banks and companies.

Indeed, the placement torrent may have already begun, and this bear rally may end within a month or two.  There could be another bear rally in the fall due to the encouraging economic news.  That rally will end when (1) the economic recovery proves unsustainable and economic indicators dip a second time, and (2) inflationary pressures tick up, forcing central banks to tighten despite weak economic conditions. Asset prices will hit their final bottom, probably in the second half of 2010, when fiscal stimulus funds are exhausted and central banks are unable to print more money.

In the beginning of 2009, I predicted a bear market rally in the second and third quarters.  Revising that prediction, I now see two bear rallies in 2009.  We are in the middle of the first. Private placements and IPOs will bring it down. Improved indicative economic news in the third quarter may spark another rally. In my previous article, I expanded my economic outlook to predict the second dip in 2010.

Fear has dominated financial markets since the sub-prime crisis began in the summer of 2007.  Rallies were brief, mere backdrops to deeper market plunges.  The latest rally, in the past five weeks, has been the longest.  As it went on, it pulled in more and more skeptics.  But I sense desperation among the bulls. The other day a CNBC host in the U.S. nearly kicked out a bearish guest who expected “waves of financial crises to come.”  When I told an acquaintance that Hong Kong property prices will drop substantially, he furrowed his eyebrows and said emphatically that Hong Kong people had holding power.  Faith rather than evidence is what’s keeping the bulls going.

But the big test for the market will come when companies begin to issue stocks for cash.  It began with Goldman Sach’s US$5 billion offer of common stocks right after its ‘good’ earnings announcement. The odds are that other global financial institutions would do the same, all in the good name of repaying the government.  (But if they are in good shape, why would they need to raise money to repay the government?)  In emerging markets too, IPOs will begin soon, ending nearly two years of drought.  IPOs are what emerging markets are all about, as their underlying economies are hungry for capital.

When the IPOs hit the markets, investors should think about why businesses want to raise money.  The global economy is unlikely to be strong in the foreseeable future.  Businesses shouldn’t need capital to expand.  The likely answer is that they are preparing for lean times ahead.  I suspect businesses making optimistic noises in public are, in fact, still bearish about the future.  As long as the market remains buoyant, they will take advantage of the opportunity to raise money.  The supply of stocks will eventually overwhelm the market.

The bull case is built on three assumptions: (1) the market decline is already deep enough; (2) the global economy is either recovering or about to; and (3) more government stimulus money is coming, should there be more trouble.  The bear case rests on: (1) this is a debt crisis, the debt levels are still too high, and the global economy can’t resume growth until debt levels recede to normal; (2) the world economy is still shrinking, though at a slower pace; and (3) government stimulus can’t start another growth cycle as the global economy must restructure itself first.

I am in the bear camp.  The bull case is really based on comparing the current recession with other recessions in the past half-century.  However, this is a once-a-century recession.  The only comparable one was the 1930s Great Depression. For a new growth cycle to begin, two conditions must be met: (1) debt levels, relative to income, in consuming economies (U.S., U.K., Australia, Ireland, Spain, etc.) must return to levels prevailing two decades ago, and (2) the manufacturing export economies (China, Germany, and Japan, etc.) must become significantly less production-oriented.

The debt crisis is far from over.  Just look at the U.S. financial sector debt – the source of all problems in this crisis. It has not come down, despite all the talk about deleveraging. It stood at $17.2 trillion at the end of 2008, higher than $15.8 trillion in September 2007, when the crisis began. Even though it can’t borrow from the market like before, it is borrowing from the Fed and the government.  How could we say that the crisis is over when the U.S. financial sector’s leverage hasn’t declined?

The economic fallout of the debt bubble bursting is just beginning.  By the end of 2008, households’ net wealth in the U.S. had declined by $13 trillion or 20 percent from its peak in 2007.  U.S. property prices are still declining.  The odds are that the value of all residential properties in the U.S. would decline by another $5 trillion or more before stabilizing. On the other hand, U.S. household debt has not fallen. It stood at $13.8 trillion at the end of 2008.  For the first time since the 1930s, aggregate household debt would exceed the value of the property that households own in the U.S.  Obviously, borrowing against property to fund consumption is no longer possible.

Income prospects look very poor.  Unemployment is rising rapidly in the U.S., Europe and Japan. As the credit-funded portion of global demand vanishes, the labor force behind it loses their jobs. As the unemployed curtail their consumption, the multiplier effect pushes unemployment even higher.  This vicious cycle is yet to reach its natural peak. The impact of rising unemployment on demand may last through 2010.

Many who argue for a bull case are actually hoping for another bubble. The thinking is that if enough people believe in the bull case, their money keeps it going, rising asset prices support demand growth, corporate earnings improve, and the bull case is validated.  The hope for another bubble is widespread in the world today.  Even policymakers are secretly hoping for another bubble.  They all remember how good life was during the bubble.  The crisis has weighed down on everyone’s spirits.  It seems that “doing the right thing” is just too hard.