The good news, as we kick off another week, is that things appear to be getting back to normal. On Friday US employment data came in much weaker than expected for the second month in a row. In January, employment rose just 113,000. Expectations were for much greater growth.
Stocks soared on the news, as the market punted on a taper of the taper to keep the liquidity party going for a little while longer. So we’re back to the old ‘bad news equals good news’ theme.
But is the market right? Not according to Fed mouthpiece Jon Hilsenrath, writing for the Wall Street Journal.
‘Federal Reserve officials don’t appear inclined to alter the course they have set out for monetary policy, despite a disappointing jobs report Friday that raised questions about the economy’s underlying strength.
‘Central bank officials are on a path to reduce their monthly bond buying by $10 billion at coming policy meetings. At their meeting in late January, they lowered the purchases by that amount to $65 billion and will consider cutting them to $55 billion at their next meeting March 18-19.‘
This week should provide a few more clues for the liquidity desperate and dependent. New Fed Chair Janet Yellen testifies before Congress on Tuesday and Thursday, with Tuesday’s session giving her an opportunity to explain the link between employment growth and the maintenance of low interest rates.
It should be a fascinating conversation…
But more importantly, it will provide the world’s biggest speculators – the hedge funds – with an idea of just how easy Yellen will be on the monetary front. Is she willing to ‘push back’ on the rate of tapering, or even to reverse it should subsequent data come in weaker than expected?
If she hints at maintaining the ‘Bernanke put’, the stock-speculator insurance scheme first initiated by Alan Greenspan, and refined and enlarged by his successor Ben Bernanke, then it could be ‘off to the races’ for global equity markets, led by bourses in the US.
Here’s the rationale for such a move to take place…
Back in 2007, when the stench from the rotting sub-prime market became too much to ignore, investors began to look for a safe haven…something that represented good value and would benefit from the easy money policies that would inevitably come from the sub-prime fallout.
So the punters moved into commodities. While global stock markets peaked around late October 2007, commodities were just starting to move higher. From early October 2007 to 1 July 2008 the CRB index (a commodities benchmark) surged over 40%.
Oil in particular drove the move higher, but the rationale for the spike was that commodities and emerging markets would be immune from the troubles in the US housing market.
The market was right…for a while. Then it was spectacularly wrong. From its peak in early June 2008, the CRB index collapsed by 50% in five months. So much for a safe haven.
We’re recounting this little story because we can see a historical rhyme emerging. That is, ‘the developed markets will be a safe haven from the problems in the emerging markets.’ The nimble hedge fund punters will get in on the trend early, pushing share prices higher. Then, the investing public will see the solid gains in a risky world and follow, pushing prices higher again.
Then you’ll see a terrible collapse.
Of course, we have no idea if it will play out or not. All we can definitely say is that stock prices are very expensive in such an uncertain world. But we can certainly see a case for a ‘blow-off top’ rally before this whole house of cards collapses. The thing is, no one says, ‘I’m going to invest in this coming blow-off top rally before the market plunges.’ No, they rationalise it in a completely, errr…rational way.
They believe in the safe haven argument, that stocks should be more expensive in the developed markets, or at least relative to the ‘third-world’ emerging markets. A bubble needs genuine belief to be a genuine bubble.
So, will Australia benefit from the tailwind should capital increasingly flow into US equities?
Maybe…but the world looks like it’s having trouble knowing how to classify Australia these days. We’re like a quasi-emerging market, our fortunes completely tied to what’s going on in China. Data out last week showed that we generated a much needed trade surplus in December and November for the first time in two years…but that our dependence on China grew even more. In December, 37% of our exports went to the Middle Kingdom. That is some dependency.
Much has been written about China’s economic rebalancing and move away from investment (commodity dependent) led growth. In fact, this talk has been going on for years.
But as we keep pointing out, it hasn’t even started yet!
Here’s Yu Yongding (former member of the People’s Bank of China) writing on the issue of economic rebalancing in a recent article at Project Syndicate:
‘In the aftermath of the global economic crisis, China appeared to be on track to complete such a rebalancing. Its current-account surplus fell from more than 10% of GDP in 2007 to 2.6% in 2012, and it ran a large capital-account deficit for the first time since 1998. Moreover, China added only $98.7 billion to its foreign-exchange reserves in 2012, compared to an average annual increase of more than $435 billion from 2007 to 2011. That meant diminishing upward pressure on the renminbi’s exchange rate.
‘But, over the last year, China’s imbalances returned with a vengeance. Its 2013 trade surplus likely exceeded $250 billion; its capital-account surplus exceeded $200 billion in the first three quarters of the year; and its foreign-exchange reserves soared by $509.7 billion. Meanwhile, the lower current-account surplus (as a share of GDP) could be a result of its increased investment-income deficit. And, while recovery in the advanced economies boosted exports, persistent overcapacity, combined with slower household-consumption growth than in 2012, caused investment growth, though still rapid, to decline to its lowest rate in the past 11 years.‘
But as a percentage of GDP, investment is still massive, thanks to weak household consumption. And household consumption remains weak because of financial repression, the act of keeping interest rates on deposits artificially low. These low rates provide cheap investment capital to China’s state-owned enterprises, which keeps China’s commodity intensive economic growth ticking over.
Our point here is that for all the talk about China’s rebalancing act, the show is yet to start. When it does, it’s likely that the rest of the world will look upon us as an outpost of China, a ‘developed, emerging market’ with quite a few imbalances of our own.
The alternative to the melt-up scenario is that we just get a meltdown instead. Yellen might not offer the reassuring words the market is looking for, and this latest rally could fizzle out, followed by an escalating sell-off and liquidation of assets.
Either way, the message is that years of prolonged easy money has caused a whole host of problems in markets and economies. We’re not getting out of this lightly.
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