Central banks rule! We’ve seen it in 2013.
They’ve accomplished the impossible: Separating stock markets from the economies they’re based on. Oblivious to the real economy in the U.S., the S&P 500 (CME:SP1!) soared nearly 30%, the largest gain since the dotcom-bubble days of 1997, the Nasdaq 38%. The German Dax jumped 25%, hopping from record to record, although the German economy has stalled since late 2012. The French CAC 40 rose 18% even though the French economy is mired in stagnation, with a record number of people out of work. The Nikkei soared 56.7%. And investors expect another glorious year with nary a cloud on the horizon to muck up their picnic.
Alas, after a long phenomenal run, the bond market took a hit. On the last day of the year, 10-year Treasuries dropped, and yields spiked to 3.04%, the highest since mid-2011. The Barclays Treasury Index is down more than 2.6% for the year. More broadly, the Barclays U.S. Aggregate bond index is down 1.92% for the year, the first loss since 1999 and the worst since 1994.
It all started in May when gentle taper suggestions were transmogrifying into the taper tantrum. After all hell had broken loose in the credit markets, the Fed pulled in its tail in September – only to start barking again in December. For bond investors, the writing is on the wall. But stock investors haven’t seen it yet.
All eyes are riveted on stimulus. Nothing else matters for the markets, as we’ve seen in 2013. But the U.S. and China are making noises about turning down that stimulus, not because they’re worried about consumer price inflation or that their economies would run too hot – that would be wishful thinking – but because of asset bubbles. When bubbles pop, and they always do, it gets ugly; and the bigger the bubble, the uglier it gets. But preemptively unwinding this massive stimulus by the two largest economies in the world has consequences.
“Even if no financial turmoil emerges, some assets are likely to come under strong pressure,” writes economist Andy Xie, in his article, When the Giants Unwind (Caixin). That would be the best-case scenario. The other scenarios? Various degrees of turmoil. He goes on in his rosy manner:
After the 2008 financial crisis broke out, I predicted widespread monetary and fiscal stimulus all around, and such stimulus wouldn’t bring back sustainable and sound growth, eventually leading to another crisis. I also predicted that stimulus advocates will blame the failure on insufficient stimulus. My predictions are coming true halfway there. Another financial crisis will make them whole.
The amount of stimulus in the U.S. after 2007 has been enormous. No-holds-barred deficit spending by the Federal government added over $8 trillion to the national debt, nearly doubling it in six years! And the Fed printed more than $3 trillion, more than tripling its balance sheet. All this moolah inflated asset prices to the point where household wealth increased 60% from the crisis low and is now 21% above its prior peak in 2007 – “a level considered a bubble that led to the 2008 financial crisis,” Xie reminds us.
Turns out, most of that wealth is owned by a small group of people. How many benefited from the stock market bubble? 10% of the population in the U.S. own most of the stocks. When the Fed set out to inflate stocks, it made a deliberate decision to artificially enrich these people. The other 90%? They’re still mired in an economic downturn, with employment and real wages below pre-crisis levels.
The Bloomberg Consumer Comfort Index, which tracks the economic outlook of various demographic groups, reflects that beautifully. Only those making more than $100,000 per year are feeling positive about the economy. Those below it, even those making $75,000 to $99,999, are negative about the economy. The less they make, the worse they feel. It cuts across all ethnic groups, educational levels and geographic regions, whether they’re homeowners or renters, male or female, old or young, employed or unemployed (depressing chart). It’s an indictment of the Fed-engineered “recovery.”
Stimulus in China has been enormous as well, mostly related to lowering of credit standards that led to a 175% increase in M2 money supply since 2007. Much of the growth was based on local governments going on a borrowing binge and splurging on construction projects, goosed by breathtaking property speculation.