Now I have been in the markets for long enough to now that calling short term trends is likely to end with egg on face…so that’s not what I’m about to do. However recent market movements have been interesting and a fundamental weakness appears to be setting in, which would leave the market vulnerable to, oh I don’t know, what’s the word….mmmm…..cinnamon?……no..sausages?…no……antidisestablishmentarianism?..no definitely not that.
Nooo, what is it I’m worried about the market paying attention to? Oh yeah……REALITY! That’s the ticket, and of course that is the worry now QE3 is coming to an end.
The reason for this concern is that the markets have made little attempt to rally off their lows, in marked contrast to the Buy the Dip mentally that has pervaded for two solid years. This may mean that investors really have taken it to heart that the central banks won’t come to their rescue every time things get bad and may be looking at the disappointing economic news askance and asking if assets and reality are running together. The following chart from ZeroHedge, pointing out the serial disappointment of global growth forecasts and the disconnect of equity markets makes the problem crystal clear:
(Source ZeroHedge) Click/Tap to enlarge
Now this chart should not be taken to mean stocks will drop to the bottom right, that’s not the relationship on display but it does, more importantly, highlight how printing money has a much closer correlation to the stock market than the path of actual growth, something we have talked about a lot here.
Now that QE is coming to an end is this the end of the low volatility market rally? Certainly it has been notable how the US markets have made a few attempt to start the day well but have lost momentum and have seen their most significant falls towards the end of the trading day, almost the reversal of the weaker days on the way up. This could mean that the narrative has changed completely and it is worth noting that following the end of the previous periods of QE not only did market volatility pick up, we also witnessed some significant market falls.
What happens now with valuations much more stretched? Well we may yet find a bottom, a pause if you like, and with many fund managers thinking about year end performance this could unleash a desperate wave of buying that then might become sustainable, for a while, but without macro economic support (highly unlikely) it would be just for a while.
So the question remains will the Federal Reserve allow this. As we have argued before it should as we need real price discovery in markets, which even if painful will stop shielding reality from the denizens of Wall Street and hopefully stop the ongoing dangerous re-gearing of the economy from getting (any further) out of hand. However the siren calls may become strong and the (often false) narrative of stock market health equaling real economy strength may become unignorable to the members of the Fed, who are undeniably now extremely politicised, meaning the big bank lobbyists have way too much sway over their thinking
Now let’s be clear some parts of the world are growing, and of particular note is the US. However bulls need to step back and take a good hard look at this growth, which still represents their most anaemic economic recovery on record, from one of the bigger downturns, with average wages depressed, real breadwinner jobs thin on the ground, continuing high levels of debt (growing among students) a recovery in sales of some items (cars particularly) based upon sub-prime lending criteria, and this weakness despite a supportive environment of increasing energy self sufficiency against a background of zero interest rates and the greatest monetary stimulus in all of history. So yes there is growth but it is already long-in-the-tooth and frankly by any truly objective analysis pretty pants (technical term) all round.
The straightforward truth is that global growth has continued to disappoint, while imbalances remain high and indebtedness (and remember it was debt that brought us here all those moons ago) on global measures has actually got consistently worse.
And then there is the Eurozone………..’nuff said for the moment.
Honestly I’m not sure if this is the beginning of the significant reset I fear, but the momentum is strong for the moment so hard hats remain at the ready.