During a bull market, it seem like every single year a chart will start circulating comparing the current price action to a terrible period like 2008, 1987 or even 1929. Well today is that time again. Yogi Berra said it best: “It's like déjà vu all over again.” Here is the chart that is making its rounds on Wall Street.
Sweeping changes coming to the Fed
Since the Great Recession, market participants have had to hang on to every word coming out of the Fed and its governors. Central bankers became the driving force behind the bull market. It is no surprise that we have written far too many blog posts on Central Banks and their influence. Thankfully since May 2016, we haven't written anything on the Fed because they were essentially on hold. Furthermore, the economy has been gaining momentum and fundamentals are now the driving force behind the stock market hitting new highs.
Economic Data Says Market Can Go Higher
Stocks continued to move up last week as all major U.S. indices hit new highs. Investor optimism rose as expectations for deregulation, possible tax cuts and fiscal stimulus under the new administration accelerated. These same factors put upward pressure on bond yields and the U.S. dollar. A strong Dollar has historically been good for the stock market. The reasoning is simple. If you are a European or Japanese, would you leave your money in a bank which takes a piece of your money given negative interest rate policies; or would you rather send your money to the US where we have positive interest rates and a rising stock market?
QE side effect: Corporations are getting paid to borrow
We have all seen pharmaceutical commercials on TV where a listing of common side effects may include diarrhea, nausea and drowsiness. In today's financial markets, central banks are expanding their balance sheets by trillions of dollars annually and new side effects are on the way. This week saw a new milestone in the world of negative interest rates, when Henkel and Sanofi became the first public companies to sell new Euro bonds for more than the buyers will get back.
The Deflationary Impact of Negative Interest Rates
The Japanese and European central banks have taken extraordinary measures to resuscitate their economies. Instead, they may be sending them further into a deflationary spiral. If you take a quick look at the major stock markets around the world, you will observe a clear pattern that is likely to surprise you. Zero/negative rates are highly correlated to poor stock market returns this year; while higher central bank rates correlate with high market returns. It is the economies that are in the worst shape that are having to test negative rates.
Black swan watch: European banks
In 2007, Nassim Taleb published his best-selling book “”The Black Swan: The Impact of the Highly Improbable.”” Taleb contends that banks and trading firms are very vulnerable to hazardous Black Swan events and are exposed to losses beyond those that are predicted by their defective financial models. This proved to be right on the mark as one year later, the financial system almost collapsed due to poor financial models that predicted real estate prices would go up forever.