A month ago we told you "We are fretting about markets again like it was 2000, 2007 or 2011. The only problem is that we don't yet know whether 2015 will end up being the start of a new equity bear market (like 2000 and 2007); or whether we might be experiencing a short and violent correction in global stocks, just like the one that happened in 2011.
One month later it is looking a lot more like 2011 than 2000, or 2007. The quick and violent correction we saw in August seems like a dream. U.S. stock prices have recovered so quickly that it would be easy to forget the correction ever took place. Was it real or was it a dream?
It was real enough, but the central bankers of the world teamed up to make sure it didn't turn into your most recent Halloween nightmare.
Since the correction European Central Bank, the Bank of Japan and the People's Bank of China have all jawboned the markets and/or taken action to ease monetary policy. The central bankers of the world have been supplying the "crack" to stock markets since the financial crisis started in 2008. They don't seem ready to cut off the supply.
Much is said about the U.S. Fed being "out of ammo" to assist markets. Let's just say they are "low on ammo" but they could take interest rates negative if they have to. The People's Bank of China has plenty of ammo left. They have lots of room to ease monetary policy.
CNBC interviewed David Tepper this morning. Tepper is founder and President of Appaloosa Management.
Here is an excerpt from that interview: "If there's a magic formula for the U.S. stock market, it would be China heavily easing its much too tight monetary policy. If there was going to be a paradigm, it would be China really easing; not one quarter, but they could lower a couple hundred basis points."
Last week, China's central bank cut interest rates for the sixth time since November, and the European Central Bank signaled it would consider extending its massive bond-buying program well into 2016 and even beyond.
Mariah Quish, co-founder and managing member at Quish & Co in Boulder, Co. recently wrote: "China seems to have the world by the short curlies. With global growth at its weakest since the financial crisis and most of the world out of ammo, China seems positioned to make or break the global economy.
Earlier this month, on October 6th, the International Monetary Fund downgraded 2015 global growth expectations from 3.3% to 3.1%. This is slowest growth rate since 2009 (when global growth was a whopping zero). Since 2010, growth has averaged just under 4%/year.
Developed countries and China responded to the financial crisis with extreme monetary policy. Coordinated historically low interest rates helped flood the world with (cheap) cash, boosting global growth. Much of this cash found its way into stocks. Higher stock prices are ideally a harbinger of real economic growth to come. Yet, unfortunately, forward earnings growth - an indicator that companies are truly growing - has generally remained stagnant in the post-crisis period.
Now, with global financial Armageddon firmly in the rearview mirror, the world's major economies are on different growth trajectories and are therefore pursuing different monetary policy priorities. The US has run its easing course. We wait with baited breath to know when - not if - the Fed will raise rates. Japan and Europe, on the other hand, are not out of the woods. Their economies are still flirting with deflation and their governments remain firmly committed to looser monetary policy.
In the US, just the prospect of higher rates - especially against the backdrop of continued easing and currency depreciation in Japan and Europe - has strengthened the dollar. A strong dollar hurts US exports. Combined with increased wage pressure, the strong dollar is eating into corporate earnings just when US firms need to deploy capital for the thing that truly help grow the economy and create more and better jobs, such as building factories, adding skilled workers or investing in research and development.
With the US committed to tightening and Europe and Japan at zero rates, there is little room to maneuver. Enter China. Firstly, China has the room to reduce interest rates. Unlike the US where rates stand at 0.25%, China's rates are a solid 4.6%. Secondly, China's government must remain committed to growth. Already, China's middle class is bigger than the US's and continues to grow. Earlier this month, Credit Suisse reported there are 109 million Chinese with incomes between $50K and $500K.
The unelected government in China knows that unless there is continued growth - with a satisfied middle class - its citizens could (literally) revolt. We predict with some certainty that China will continue to implement fiscal and monetary policies that keep the country's growth at or near 7%/year. For example, in a surprise move in August, the Chinese government depreciated its currency by nearly 4.5%, helping Chinese exports (which become cheaper), and implicitly boosting USD strength, further hurting US exports.
For better or worse, how and when China pursues its domestic growth agenda will greatly affect the rest of world. Recent history shows that China tends to surprise. We could therefore see increased market volatility, as the world waits to see what China does.
At 5T we are expecting increased volatility in markets during 2016 but as long as we continue to live in the "age of central bankers" that volatility is likely to continue to resolve to the upside. The question for individual investors is likely to be "how much volatility can you take to get returns in the stock market.
We talk a lot about the influence of central bankers on markets. It is "break room" talk in our office. We all agree that they have done wonders to mute the impact of the financial crisis of 2008-2009. Yet we all grow wearier of their daily influence as the years have dragged on.
I am reminded of this quote from Odysseus as the movie Troy was ending and the credits were about to scroll.
"If they ever tell my story, let them say... I walked with giants. Men rise and fall like the winter wheat... but these names will never die. Let them say I lived in the time of Hector, tamer of horses. Let them say... I lived in the time of Achilles."
Four thousand years later we live in the time of Yellen (USA), Draghi (Europe), Shou (China), and Kuroda (Japan). It is hardly as heroic or inspiring as Hector and Achilles, but it is what it is!
Patience friends. The time of central bankers will end one day too, and when it does so will the great distortions in asset prices. But not today!
All the best. Happy Halloween.
Disclosure and Disclaimer - Updated last on July 23, 2012 by Paul Krsek:
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