A rally without a cause, or even a driver
Last week certainly was an interesting one.
“Brexit” polls shifted toward the “leave” camp in a fairly decisive way, before the horrible murder of a pro-EU member of the British Parliament sparked a relief rally in the markets that continued on Monday, as the balance of odds appeared to move sympathetically back to the “remain” camp.
We had the Fed do a major mea culpa with a dovish press statement, an extremely dovish Q&A session, followed by St. Louis Fed president James Bullard (who was openly calling for a rate hike just a month ago) using a new economic model showing the Fed should hike just one more time and then sit easy through the end of 2018.
Just a few weeks ago, July was widely acclaimed to be a “live meeting.” It is now pretty much dead, with the futures market pricing in just a two-per-cent probability for a move next month.
You can go all the way to February 2017, in fact, and the markets are handicapping just 40-per-cent probabilities for a hike then!
There was also the action in the bond market. German 10-year bund yields swung to a historic -0.03 per cent, though the move below zero did not manage to last beyond a few days.
The yield on the 10-year U.S. Treasury note slid to an intra-day low of 1.52 per cent on Thursday, the lowest level since August 2012.
The stock market remained in a schizophrenic state. The S&P 500 has suffered six weeks of losses, the longest stretch since August. Yet the index closed just 2.6 per cent short of the intra-day 2016 high.
One reason why the stock market manages to bend but not break is that it’s under-owned at this time.
For example, the most recent Bank of America Merrill Lynch global fund manager survey shows that cash levels as a share of assets have risen to 5.7 per cent, the highest in 15 years, and the latest Lipper data reveal U.S.-based equity funds have had seven straight weeks of net outflow ($3.4 billion last week).
But who can blame them when there is such a dearth of global leadership to go along with an extremely fragile economic backdrop? Why is it that after seven years of post-crisis recovery, so few believe in this expansion?
Maybe because, unlike its predecessors in the post-Second World War era, this cycle has lacked a catalyst for sustainable growth, relying increasingly on zero interest rates and money printing by the world’s central banks for its survival. Not much fundamental in that.
In the 1950s, we had U.S. President Dwight D. Eisenhower rolling out the massive nationwide highway infrastructure programs, and we saw a population surge from veterans coming home. This decade ushered in the credit card, a truly revolutionary concept.
The 1960s ushered in the space age and the massive economic spinoffs it created — in no decade were so many improvements made to motor vehicles (like front-wheel drive) as was the case in the 1960s.
The 1970s, with three recessions and chronic inflation, represented the onset of globalization that really picked up steam with the Tokyo round of General Agreement on Tariffs (GATT), with over $300 billion in tariff reductions.
The 1980s were a combination of deregulation, tax cuts, the breakdown of communism and even more free trade, not to mention the rapid technological advances, from the Apple computer to Microsoft going public. And how about the baby boomers coming of age?
The 1990s were all about the Internet, and all the wealth and prosperity that went with that positive shock to the capital stock.
In the first decade of the 2000s came the 9/11 terrorist attacks, and the Iraq War.
From a growth and market performance perspective, what dominated was the creative financial engineering that ushered in a debtfinanced housing boom of epic proportions. We know how that ended, but the ability to use your house as an automatic banking machine created enormous growth in the economy (as artificial as it was).
So even though we have had 10 recessions in the post-war era, as all the new themes ultimately were hoisted on their own bubbly petards, they did manage to generate years of economic growth.
As bad as it turned out, that housing and credit boom in the 2003 to 2007 period did create tremendous growth, and at least it was a theme.
What is the theme today? Negative interest rates? Central bank balance sheet expansion and asset market manipulation? Subprime auto loans? Terrorism? Political and social uprisings? iPhones?
So many of us get so caught up in the minutia of the incoming data
As bad as it turned out, that housing and credit boom in the 2003 to 2007 period did create tremendous growth ...
flow that we miss the bigger picture — there is no apparent catalyst for a self-perpetuating economic expansion this cycle.
If this cycle is going to be labelled anything, it is going to be the failure of our central banks and elected officials to have dealt effectively with the extreme levels of global indebtedness that triggered the last crisis — and remains a pervasive overhang over world growth today.
Even at the highest level of global banking, confusion reigns supreme. The Chinese often say “may you live in interesting times,” yet nobody ever asks, “what precisely do you mean by interesting?”