Wednesday, May 22, 2013

Is "Easy Money" The Cause of the Market Rally?

Writing in the London Telegraph yesterday, columnist Ambrose Evans-Pritchard commented on the schizophrenic nature of the global equity rally.

Recent economic data is showing a slowdown in economic activity in many parts of the world, which normally would lead to market weakness.

However, it seems that investors are viewing economic weakness as bullish for stocks, since it means a continuation of massive central bank intervention.

Here's an excerpt from what Evans-Pritchard wrote:

The latest poll of Morgan Stanley's top clients from across the world says it all.
Chief economist Joachim Fels tells us that not a single investor at the bank's Florence forum thought the world economy would rebound with any strength later this year.

Just a quarter expect a return to trend growth. Some 57pc think there will be no escape from the "twilight" conditions afflicting the western world, and 20pc expect an full-blown global recession. That is a remarkably bearish set of views. Yet the same investors are overwhelmingly bullish on stocks and property.

This schizophrenic exuberance seems entirely based on the assumption that QE and central bank largesse will keep the game going, flooding asset markets with liquidity. Indeed, 80pc think the ECB will cut rates again, and half think it will have to swallow its pride and join the QE club in the end.

Four fifths think equities will gallop on upwards over the next year. Complacency is rife. "It became very clear – and many investors were quite explicit about this – that markets are lulled by the lure of liquidity resulting from negative real interest rates and global QE," said Mr Fels

However, in that same column, Evans-Pritchard cites another paper which questions the assumption that markets are rallying solely because of central bank policies.

Scott Sumner of Bentley University in Waltham writes a blog titled "The Money Illusion".  The blog has quietly become one of the most widely read sites on economics in the financial community.

In his most recent note, Sumner questions whether monetary policy is really as easy as widely assumed. 

While interest rates are low in Europe, for example, bank lending remains tight, which is exacerbating weak economic trends.  Low interest rates, according to Sumner, do not necessarily mean easy monetary policies.

And as far as stock prices being buoyed by central bank liquidity, Sumner writes the following:

Is there any excuse for the press to still be talking about “easy money” throughout the developed world?  (A view that seems to be based on little more than low interest rates.)  I mean seriously, after the last 6 months in Japan, how can people still equate easy money with low rates?  Just to refresh your memory, Japan’s had near zero rates for 16 years and nothing has changed in the past 6 months.  Yet when you talk to finance-types you get the impression the current stock market booms are due to low interest rates caused by easy money.  That “easy money” policy of low rates  brought the Japanese stock market from 39,000 in the early 1990s to 8675 by mid November 2012.

I am not an economist, but I think that Sumner is right.  Stocks are rising in part because of low yields on other investment vehicles, but corporate earnings are also improving, albeit at a sluggish rate.

On an inflation-adjusted basis, the S&P 500 today stands at roughly the same level as it was in 1997.  Perhaps some of the recent rally could also be attributed to the fact that stock prices have lagged the growth in Corporate America.