When the Australian share market breaks through the 6000 point level, the cheering from the market analysts is sure to be deafening.
Breaking this psychological level has been a long time coming. The All Ordinaries index hasn’t been north of the 6000 point mark in more than seven years.
The Aussie market’s recovery from the lows in March 2009 has been a much tougher grind compared to the US indices. The Dow Jones and S&P 500 have soared to record highs…thanks to the concerted efforts of the Fed to supply an abundance of cheap newly minted dollars.
Even the most one-eyed share investors would acknowledge the rise of the US share market has been more to do with the Fed’s stimulatory efforts than any economy recovery.
The QE recently introduced by the European Central Bank (ECB) has produced similar positive results on European bourses (with the exception of the Greek share market). Ditto in Japan.
A torrent of money has been channelled into global sharemarkets and they have floated higher…much higher than fundamentals warrant.
The old adage on Wall Street is ‘don’t bet against the Fed’. And with good reason.
Ever since Greenspan came to the aid of the US share market in the late 1980s (known as the Greenspan Put), Wall Street expects the Fed’s white knights to always save the day.
Fed chairmen and women know which side their bread is buttered after their days in office are over…lucrative speaking engagements and consultancy positions await, courtesy of Wall Street’s finest. Just play the game and you’ll be looked after…wink, wink, nudge, nudge.
However, it does not always go to scrip. The unintended consequences of the Fed’s meddling in the markets have resulted in significant market downturns in 2000 and 2008.
In spite of these monumental capital destroying periods in the market’s recent history, the omnipotence of central bankers has never been higher than what it is today.
The Fed’s engineered market recovery since the GFC, has bestowed upon them an aura of invincibility. Belief in the Fed’s ability to somehow find its way down safely from the increasingly shaky scaffold that supports the market’s lofty valuations has never been higher.
Betting against the Fed has been without a doubt a losing (as in return, but not in capital) bet in recent years.
The vast majority of the investment industry tow the central banker line and play the game. They are rewarded. However, there is a minority that questions the ‘wisdom’ of these unhinged academics and they are punished.
The central bankers have both bases covered to ensure no-one screws with the mad professors monetary experiment.
A recent article from an equity (share) analyst titled ‘A smart strategy for a fully valued stockmarket’ caught my attention. Silly me thought a smart strategy for a fully valued market would be to take profits and reduce exposure. Not according to the article — the ‘smart’ thing to do is remain invested. To me this is a dumb strategy…but beauty is in the eye of the beholder.
Of the four possible scenarios canvassed in the article — iron ore price falls, Aussie dollar depreciates further, ECB and Japan keep the foot on the QE accelerator, Aussie employment numbers weaken — the end out come is…the share market is going be the best place for your capital.
Apparently (emphasis mine),‘The first response is not to have too much cash, which is dead money given equity markets should continue to be supported by central bank stimulus and real cash yields are nil or negative.’
This article pretty much reflects mainstream investment industry thinking. Cash is trash and central banks have the market’s back.
On every long term market valuation metric — Shiller PE10, Tobin Q ratio, Market Cap to GDP — the US market is well beyond being fully valued. These time honoured market metrics place the current US share market on the podium right next to the nosebleed high of the dotcom bubble. We all know what happened after this gold medal market high.
Unless the Fed’s brilliant minds have discovered how to repeal the laws of market gravity, history tells us the real dead money will be the capital of investors that lies in ruin at the bottom of the Fed’s collapsed market scaffold.
There are some (the minority) in the investment industry who have an opposing view (emphasis mine):
‘Mohamed El-Erian, the former chief executive of giant [US] bond fund PIMCO, sent a chill down investors’ spines this month when he revealed he was now holding most of his portfolio in cash.
‘’In a television interview, El-Erian said his money was "mostly concentrated in cash. That’s not great, given that it gets eaten up by inflation. But I think most asset prices have been pushed by central banks to very elevated levels.”
Financial Review 17 April 2015
El-Erian (a highly respected figure in the US investment industry) has put most of his personal wealth in so-called ‘dead money’.
Why? El-Erian knows from experience that ‘what goes up too high is certain to fall much harder’.
In these conditions you’re better of having 100% of your money earning nothing, rather than risk turning 100% of your money into (virtually) nothing.
As more smart money looks to cash out of these seriously expensive markets, the central bankers are scrambling to ensure this cash is trapped within the system.
Zero bound interest rates have worked a treat in forcing investors to seek income returns outside of bank accounts and term deposits. However as markets become more and more expensive, even zero interest is attractive compared to seeing your capital vaporised in a market collapse.
Will the Fed go below zero to force this money back into markets?
Denmark and Switzerland, in an effort to take some strength out of their currencies, have reduced their cash rates below zero.
‘Since the [Swiss] national bank has introduced negative interest rates, pension funds in the country are in trouble. Banks are passing the negative rates on to them. This results in the saved pension money shrinking, instead of producing a return. ‘
It didn’t take much for the large pension funds to work out that for every CHF (Swiss Franc) 10 million, the negative 0.25% interest rate costs them CHF 25,000 in return.
What’s the solution?
Withdraw the cash from the bank and place the physical cash in a secure vault. The costs of Armaguard transportation and vault fees are much less than the negative 0.25%.
According to the article, when asked to accommodate the request for cash, the pension fund received the following reply from their bank:
‘We are sorry that within the time period specified, no solution corresponding to your expectations could be found.’
In other words, p**s off. The denial of the pension fund’s redemption request is illegal and it may well be challenged. However, what it does highlight is the conundrum central banks find themselves in.
If cash rates are reduced too low below zero (for currency depreciation purposes and/or supporting funds flow into investment markets), it becomes attractive to hold the physical cash. However, the fractional banking system means there’s not enough physical cash in the system to satisfy a steady stream (let alone a flood) of withdrawal requests. Cash hoarded in secure vaults (away from the bank’s supply and demand control) puts strains on bank reserves and liquidity within the economy. The cogs of credit seize up.
To prevent this cash drain from happening, do central banks impose controls/limits on cash withdrawals? What sort of panic does the denial to access your own money unleash within the community? A bad situation can quickly morph into something really ugly.
The interference in the normal and healthy functioning of markets by the false idols at the Fed and other central banks may be cheered on by self interested market participants, but they need to lift their eyes above their screens to survey the entire landscape.
The believe without question in the Fed’s powers to ‘leap tall buildings in a single bound’ is a sure sign of ‘stability creating instability’.
The current bull market is entering its seventh year…yet another record for this market. This track record is used as evidence as to why the market will go higher…what has been will continue to be.
In fact, history shows us repeatedly the longer the trend, the greater the likelihood of a savage reversal.
Zero interest rates and over-egged market valuations (thanks to QE forever) have a limited shelf life.
The entire financial system is being propped up by a hope and a prayer. The Fed hopes the investment industry (out of self interest) keeps telling people how smart it is to invest in shares and prays the smart money’s move to cash doesn’t catch on.
My hope is for this insanity — the belief that man is mightier than market forces — finishes sooner rather than later and we avoid a process of capital destruction on par with the Great Depression. I pray that cash controls are not implemented in Australia.
Editor, Gowdie Family Wealth