Who doesn’t love magic. Whether an illusion by use of deceptive devices or a perceived supernatural force, it is more fun to believe than not. Non-believers are too serious, seek truth, are skeptical and probably hate cotton candy as well; no fun.
Although the Fed and other central banks do not have supernatural or mystic powers they do have deceptive devices. Apparent unlimited currency, monetary policy, and the kicker, zero accountability. When it comes to the stock market, these are magical tools.
So what’s the illusion? Sustained economic growth corroborated by asset price inflation. The devices: debt and 0% interest rates – some central bankers are trying to redefine zero by going negative. Pay me to borrow from you.
Whether with borrowed money or not, a purchase does equate to demand. What happens when demand wanes and asset prices are ready to reverse? The illusion is over to the sound of applause; at least you would think. But, what happens when you have a magician who’s committed to transforming an illusion into reality and feel as if they indeed have supernatural powers? Well, then you have a central banker.
650 rate cuts globally and $60 trillion in additional global debt since 2008, alongside the expansion of central bank balance sheets at a rate and scale never seen before. The Federal Reserve’s balance sheet sits near $4.5 trillion and has not contracted although QE3 has ended.
Big trick.
The illusion that was supposed to become a reality, however, has not; no organic or sustainable economic growth has been achieved since 2008, no matter the devices used. What has occurred is a shift of wealth from the many to the very few, via asset price inflation, and a hollowing out of the middle class as the cost of living has soared while wages remain stagnant to declining.
3, 2, 1…no, I’m not about to make the words on this page fly away, I’m counting US GDP growth from 2014 to the present. The GDP estimate for the first quarter of 2016 starts with a zero and the US National debt is over $19 trillion; that’s a debt to GDP ratio hovering around the 250% mark.
As my research partners at Hedgeye have pointed out, never has the stock market not had a drawdown of at least 20% from peak after two consecutive quarters of negative earnings growth. We are in the midst of the third as US equities trade within a few percentage points of their lifetime highs, but have not made new highs in 11-months – this, by definition, is not a bull market. New highs, however, would be bullish and investors are best served respecting price as the illusion, allegedly, has not concluded.
The risk to stocks and financial markets as a whole, is that the economic data continues to deteriorate and market participants recognize that central bankers are not divine beings. That perpetual debt is not sustainable in a decelerating economic environment. Being bullish on the stock market, here and now, is being bullish on debt in perpetuity, and having deep faith in government and central bankers to unwind the greatest financial experiment in human history.
Maybe this time is different, but if it’s not, reality can be summarized in one word: gravity.
Disclaimer: The comments and opinions expressed herein reflect the personal views of Alim Abdulla. They may differ from the opinions of Leede Jones Gable Inc. and should not be considered representative of the research beliefs, opinions or recommendations of Leede Jones Gable Inc. The information included in this document, including any opinion, is based on various sources believed to be reliable, but its accuracy and completeness is not guaranteed. Member CIPF.