Time for the Markets to Sober Up

Look for the ASX to follow the Dow’s lead and sprint closer to 5,600 and beyond today. The index was up 44 points yesterday, and that was before news that the exchange itself ASX might be the best buy on the bourse. Call them what you will, but the boys running the New York Stock Exchange (NYSE: NYX) aren’t stupid.

First India, next Japan or Australia? Yesterday the NYSE announced its intention to take a US$115 million stake in the  National Stock Exchange of India Limited. ASX shares were up yesterday on speculation the ASX itself could be next. Or is it Japan?

Japan would probably be the bigger haul. The chart we posted yesterday shows that Japan is home to nearly $17 trillion in liquidity. And except for the penchant for buying U.S. Treasury bonds, Japanese savers (there are a lot of them) have what economists call a strong “home bias.” That means they don’t go buying all that many foreign stocks. If the NYSE wants to make money-selling stocks to Japan, it’s going to have to go Japan. If the mountain will not come to Muhammad, then Muhammad will go to the mountain!

Selling stocks is obviously a good business to be in these days. We’re just not sure buying them is such a good idea. But the selling, yes, it’s a nice little earner. Let’s see, you can borrow money cheaply if you want (although official rates are rising, as you’ll read below). Or, if borrowing isn’t your thing, there is money management. Plenty of insurance companies, pension funds, or just you everyday superannuation investors seem more than happy-eager even- to hand over money to managers willing to take any risk, buy an asset, seek any alpha.

Sure, it’s getting harder to find quality assets to earn a market-beating return with. But in the meantime, you can do what everyone else is doing, buy tech stocks! Stimulus. Response. Who knew the Pavlovian conditioning from the tech-bubble was still effective?

There is one big fat irony in all of this. With private equity taking public companies private, you may not be able to buy some of the more famous cash- flowing businesses in the world. But if you just wait awhile, you’ll be able to buy a hedge fund! Public companies with real assets are going private. Hedge funds, with, er, intangible assets are going public.

Explain to us how shareholders and pensioners win on this one? We can’t figure out. About the only thing we’re sure of is that the public is going to get screwed. And that there will be lawsuits.

Maybe not just yet, though. The party is only now kicking into the kind of mood that has nervous neighbours calling the regulators and sober bankers. “Australia adds three times as many jobs as expected,” reports a Bloomberg headline this morning. The nation’s jobless rate is at a thirty-year low, exports are booming, and the cricket team is thrashing England. It’s a magic summer. But Glenn Stevens over the Reserve Bank must be getting nervous.

Yesterday, quite unexpectedly, the Bank of England raised its benchmark interest rate by a quarter point. Ye gads! The Bank went on to say that inflation may be accelerating at its fastest pace in ten years, citing November’s 2.7 per cent rise in prices.

And here we thought inflation was always and everywhere a phenomenon in financial asset prices. Of course that’s not true, upon reflection. It is true that most of the new money in the world has poured into old stocks and bonds and new fangled assets. This is called a bull market by some and a disaster waiting to happen by others.

But inflation-when it’s not being celebrated as a way to grow net worth-is more infamous. In it’s traditional, non-descript garb, it’s a quiet thief, stealing the purchasing power of your dollar bit by bit.

It is also, we would suggest, an increasingly unstable state of mind. You live in a world where price tags for the most important items border on the edge of the outrageous. But they are always just on the margin, just this side of insane. Homes, cars, bananas…it all creates a fevered state of mind in which your average Australia/American/Briton becomes aware that things are slipping out of his control, but doesn’t seem able to do a thing about it.

And here is where people generally separate themselves into two categories. One kind of man sees the room getting dizzy around him. The noise is loud and slightly unpleasant. And he still has some cash in his wallet. He orders another drink. The next day he wakes up in the gutter, or fully clothed on the couch, broke, ill, and hazy about what happened. The other man checks his wallet, looks at the hilarious, slightly hysteric atmosphere in the room, a gets nauseous. Then he heads home to his wife, his kids, and his bed to sober up.

Judging by the market action, most investors are loading up and going long, throwing caution and cash to the wind. Even the hedge funds, whose very reason- for-being is to go both long and short, have decided they can’t afford to be short. Everyone must go long!

It would be a brave man who goes short anything right now. And the truth is, we think the central banks are already behind in race to contain inflation. Trying to catch up with a quarter point tap of the brakes simply won’t do. In other words, you can expect to see prices for everything rise a lot faster before they collapse. We could be wrong. But if the Markets and Money was an inventory of what we actually know, it would be very short indeed.

It could be that central banks, by raising rates, begin draining liquidity from the planet, leading to a gentle, feathery soft correction in asset prices, and cheaper bananas, houses, and cigarettes. But it’s not so much the actual rate rise that matters (although this is probably enough to destroy the careful calculations of unwary traders somewhere.) It is the psychology of speculation that central bankers must break. And we are so far into the evening of financial revelry, not even a cold bucket of water to the face or the drunk tank would seem to do it (perhaps a gold brick to the head would do the trick, though.)

It’s the drunk tank for the markets, we’re afraid. It’s going to take awhile to sleep this one off. We just hope investors pass out rather than going down with a fight. We’ll be watching, and it’s sure to be entertaining.

Dan Denning

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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