By Dan Denning
Here's an interesting pair trade to begin your day with: sell China and buy Goldman Sachs. Okay, okay. It sounds ludicrous. But let's consider some facts.

Both the S&P 500 and the Dow Jones Industrials closed up about 2.5% overnight. Analysts upgraded estimates for Goldman's earnings. That sparked a buying frenzy in bank and financial stocks, which took markets higher. Presto, change-o, everything is bull again.

Or is it? We'd suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America. However, that doesn't mean the pair trade doesn't have legs. In fact, an analysis show you might be convinced it's time to buy the S&P!

Thanks to massive stimulus from China beginning in November, there's been an explosion in consumer and business lending. That's translated, we'd suggest, into asset inflation. Exhibit "A" is the nearly 75% year-to-date climb in Shanghai's benchmark CSI 300 index. It has, as you can see, trounced the return in U.S. stocks.


Is this the market's verdict on U.S. growth prospects and Obama's trillion dollar deficit plans? Is it vindication that China's stimulus has been a lot more successful and promoting real economic growth than the $787 billion pile of junk passed by the U.S. Congress?

Or how about a third theory? Is it evidence that China is in the accelerating phase of its own massive credit bubble? And could the collapse of this credit bubble lead to a Chinese Day of Reckoning?

If that's the case, then it would be time to sell commodities and buy Goldman, or at least time to sell commodities. A collapsing Chinese credit bubble would remove a lot of the demand and price support for Australian commodities (especially coking coal and iron ore). We covered the story while filling in for Kris Sayce at Money Morning today.

While we're on the subject of stimuli, a New York Times story from yesterday suggest that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble. But the evasion is like hiding under the bed from the bogeyman. He's still going to get you. Sucking your thumb and pretending otherwise won't help.

"The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value," says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. "It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing."

This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now. The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they'd got a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent). Yet many banks are under the absurd illusion that if they hold certain assets to maturity, they won't suffer any losses.

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