"Stock prices have reached what looks like a permanently high plateau" - Irving Fisher, 1929
"The Economist" had a pair of articles out this past week that continued their implicit/explicit endorsement of Extend and Pretend.
An Economy only an Economist could Love
The first article extolled the success of the American economy in redressing its imbalances and "remaking" itself towards renewed growth. The first major point in the article is that the "imbalances are being balanced" via deleveraging of the private sector. Unfortunately, the fiscal imbalances of the private sector are not getting rebalanced, they have only been shifted to the Federal Government which doubled its debt since 2005, and at the current deficit ($1.3t), will increase by another $7 trillion in just 5 more years. They also forgot to mention that the U.S. has been monetizing more of its debt than any other country on the planet (more on that below). Meanwhile, a major difference between the U.S. and Europe (not mentioned in the article) is that American companies were a lot quicker to shed workers, many of whom are now among the ranks of the terminally long-term unemployed.
Quantitative Easing, What Could Go Wrong?
The next delusional article regarding Extend and Pretend took an academic look at the impacts of Quantitative Easing (debt monetization).
First they say that QE boosts equity prices and therefore help the economy: "higher equity prices raise consumption". Later in the article they hedge on whether or not QE boosts the stock market, indicating that some of the impact may get pre-discounted. And the point is? They cite Jackson Hole 2010, which I highlight in blue below. The fact remains that stock prices jumped the minute QE2 was announced, and remained well bid through full implementation and then fell off a cliff when it ended:
You don't have to be a genius, an economist or a statistician to see the correlation between QE (and LTRO the European equivalent) and stock prices. You just need one eye that's half open...
Then the article asks the key question as to whether QE benefits the real economy. The apparent answer is a "cautious yes", yet they then totally ignored the impact of QE on commodity prices which hammered household incomes, as pointed out here.
But more importantly, they never explored the long-term impacts of artificially raising stock prices. As commonsense would dictate, there is no free lunch, so by becoming the marginal buyer of stocks, Central Banks have de facto taken over control of the stock market. The first thing that Econ 101 would expect is that public demand for equities increased, therefore prices rose, supply rose but private demand fell at the higher price level. And that is exactly what has happened. Self-evidently, prices rose. Natural buyers (aka. retail buyers) exited the market, insider selling rose bringing more supply to market, and overall volumes have been falling steadily throughout the QE period.
So essentially, what Central Banks have done is levitated the stock market to an unsustainable level which is totally disconnected from the underlying economic fundamentals. This is similar to what happened during the housing crisis circa 2003-2006, when decades worth of demand were pulled forward into a few years thanks to ultra-low interest rates, subsequently creating a supply overhang, and destroying the market. Meanwhile, as shown many times, this entire QE era is typified by low volatility and complacency, as money enters the market like an IV drip at a metronomic rate, now via 'Operation Twist'. This complacency is manifesting itself in an underpriced options volatility (VIX) index indicating that risk is systematically underpriced in the markets.
It used also be that the stock market was a good barometer for economic recession, however, due to this mispricing, that linkage has now been definitively broken. As ECRI has pointed out for months, the U.S. is headed for (or in a recession) currently, yet the stock market is in total denial. What is even more amazing is that most Leading Indicator Indices use the stock market itself as one of the parameters, so if the ECRI uses the stock market, which is giving false signals, that implies that the other parameters are that much weaker and there is even that much more of a fundamental disconnect.
It's All Fun And Games Until Someone Loses An Eye
So far, low volumes have not been a problem, because there have been no major asset reallocations. Recently, the only only asset reallocation occurred within the equity markets as investors shifted from growth stocks (Apple, Priceline et al.) to safer dividend plays such as WalMart and Philip Morris. This internal reallocation kept the money within the stock market and therefore helped to keep the overall indices strong, although many individual stocks got "monkey hammered" to borrow a ZeroHedge term. That said, these last refuge stocks WalMart et al. are going late stage parabolic, and recessions of any duration always cause a rotation out of stocks into bonds and cash. When that occurs, the low volume bid side is going to get tested, big time. In summary, it looks like the stock market has reached yet another "permanent plateau..."
