It was the best of times, it was the worst of times...

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us..."

Dickens' opening line to "A Tale of Two Cities" is a wonderful piece of literary craftsmanship, and as he described the European backdrop leading up to the French Revolution in the late 18th Century, he could easily have been describing world sentiment at this current point in time. The to-ing and fro-ing of perspective between complete despair and unmitigated hope has taken a recent turn towards the latter within the financial world over the past fortnight. This last week has seen world stock markets continue to rise, risk aversion drop significantly, and a clear emphasis amongst analysts that "green shoots" are definitely taking root.

The "stress tests" carried out on the major US banks categorically told us that these banks are in serious trouble, but not completely insolvent - they need close to $75bn worth of capital of which Morgan Stanley and Wells Fargo raised $11.5bn between them in a single day on Friday. The continuing capacity to plug capital shortfalls from willing global investors is hugely impressive, given the various rounds of pain these same investors have felt in the not-too-distant past.

Good news it appears, but with a context of ever extending unemployment in the US (which hit a 25-year high on Friday) and more significant long-term structural issues with the finances of the major world economies, the current exuberance albeit pleasant, is overdone. We are still somewhere between the "winter of despair" and the "spring of hope".

Barack Obama recently passed his first 100 days in the White House, and answering reporters questions for nearly an hour in the East Room, he showed what has become his trademark cool and calm no matter whether the question was about torture, the auto industry, Pakistan, Iraq, abortion, black unemployment, the financial crisis or swine flu. At one point, he properly encapsulated his personal philosophy, echoing the sentiments of Dickens' fictional world, without the literary waffle: "Things are never as good as they seem and never as bad as they seem." Which is both a good working definition of keeping cool, and also a good recipe for successful living.

I come from a family where this paradigm was both practiced and quietly preached - the dinner table was a good place for bringing individual achievements back down to earth, and also acknowledging failure as just part of the learning process.

In the current case of the extended financial market rebound, I would like to recreate the Neill dinner table, and temper the animal spirits by suggesting that things are not as good as they seem. Financial institutions around the world, almost without exception, have been making money from new lending and trading in the 1st quarter of 2009. This isn't all that surprising given the fact that interest rates are effectively 0% in the US and almost the same in the UK - so you would imagine that a banker's job in terms of the new stuff is pretty easy. It's the old stuff that continues to be the problem - and the rescue efforts of the past 24 months are still to be paid for.

Interestingly, the "stress testing" of US banks that has caused the financial world to suddenly feel more optimistic seems, to me at least, to be made of the same smoke and mirrors stuff that investment bankers have become famed for. In the tense back-room negotiations that preceded Thursday's release of the results, bank executives were able to persuade regulators to alter many of the assumptions on the sector's future health that they had independently made. They flooded the briefcases of Treasury and Fed officials with the same brightly coloured charts, spreadsheets, long presentations and the same brilliantly put-together sales pitches that sold sub-prime CDOs and the like - and consequently these regulators were jockeyed into thinking that the "worst case" scenarios for capital adequacy of these banks is not as bad as their previous assumptions suggested.

The FT makes the case that on one particular point, the Fed and the Treasury officials held firm. This was the idea that banks could recapitalise themselves out of expectations of future earnings. According to the FT the authorities "took a relatively dim view of the financial sector's earnings power". Apparently Citigroup (for example) claimed that it's expected earnings over the next 2 years would be $80bn - which the authorities "hammered down" to the figure of "only" $49bn. All of these people are clearly taking some form of amphetamine that has yet to hit the broader market. While each of the banks should be making a few bucks on current business, the write-downs on legacy business will be a bigger drag for some time yet.

I'm pleased that optimism is back, but the context is that this banking system will still be woefully under-capitalised if even a not-very-good scenario plays out, let alone any sort of worst case. Aside from discussions over whether banks have enough capital there are other more systemic issues that are at play.

Forgive me for paraphrasing John Authers commentary in the FT this weekend:

Firstly, the scale of the stimulus package that has got us to this renewed confidence in the financial markets has come at a very significant cost, which is currently like an unpaid credit card bill. Someone will have to pay for what has been the biggest fiscal stimulus the world has ever seen, which means a combination of inflation, higher interest rates and higher taxes. None of these things will be good for stocks, as they are counterproductive for the private sector.

Secondly, companies still have a lot of capital raising to do, which will dilute their stock market valuations.

Thirdly, history has shown that once bond yields go above a certain level, it becomes difficult to justify buying stocks. They could reach this level when the Treasury bond market finally chokes on the huge new issuance governments are trying to push down its throat to fund the various deficits. The extra risk of investments in companies versus investment in government backed bonds may create a form of "crowding out" of private sector investment.

Finally, there are demographic issues. The developed world is ageing, which will put a greater drag on public expenditures, and lead to sales of stocks as the baby-boom generation retires and cashes in what is left of its savings.

Given that the world is pretty tired of bad news after very tough times over the past 18 months, and several false dawns in between, the current enthusiasm for an extended bull market run is understandable. Without wanting to spoil the party, the grounds that the new found risk taking is based on, namely the outcome of the US banks "stress tests", is disturbing in itself. It seems to me that the 19 participating banks have done a marketing job to the Fed and the US Treasury that works out relatively well for them, and not-so-hot for the people who are financing many of these banks currently. The taxpayer stitch-up continues. Quite apart from the outcome of these tests, the backdrop is a global economy where there are still very significant structural issues to be addressed, which aren't going to be solved by a few months of rising stock markets. It's not quite the worst of times, but it's certainly not the best of times either.