In the short-term markets are overbought and due for a correction. In the medium-term however, markets are likely to continue to rise on a sea of central bank liquidity. In short, investors should make the most of the fact that we are in the eye of the storm, because long-term the outlook is distinctly-bearish.
In the short-term markets are overbought and are due for a correction.
Since the March 2009 low of 666.79 the S&P 500 has risen 124.9%, while the FTSE 100 has risen 81.5%. In the US we have now had 470 consecutive days during which we have not seen anything more than a 10% correction, and according to the Bespoke Investment Group, 80% of S&P 500 stocks are in overbought territory. In addition, 90% of the stocks in the S&P 500 are trading above their 50-day moving averages.
Danielle Park, portfolio manager at Venable Park Investment Counsel, noted recently that, “the current collection of valuation metrics, price behaviour, over-bullish sentiment and rising yields, have only ever come together in the way they are right now, at very infamous times in history; being just before the 1973-74 collapse, just before 1987, just before 2000, just before 2007, and just before 1929.”
Medium term bullish
There is a well known adage on Wall Street which says that you should “never fight the Fed”, something which can now be extended to many other central banks, including the ECB, BoJ, BoE, PBOC, SNB, etc.
The scale of the money printing that we are seeing from these institutions is unprecedented, and the huge amounts of liquidity they are pumping into the global economy and financial markets, are fuelling this counterintuitive rise in risk assets, particularly stocks.
In this environment sectors such as energy, industrials, financials and healthcare should be among the best performers. Japanese stocks, particularly the exporters, should also continue to benefit from the BoJ’s efforts to devalue the yen, and certain commodities should continue to benefit from the turnaround in the Chinese economy.
Sooner or later money velocity will begin to increase and we will enter a period of stagflation. During this period, economic growth (in real terms) will remain anaemic or even negative, unemployment will remain high, and inflation will begin to pick up. As inflation reduces the buying power of paper currencies, discretionary spending will be cut and corporate profit margins across most sectors will be squeezed.
In his book, Human Action: A Treatise on Economics, first published in 1949, Austrian economist Ludwig von Mises wrote that, “the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
The actions of G20 policymakers over the past 12-18 months indicate that they are not even close to considering
“a voluntary abandonment of further credit expansion”. In fact, many of them have spent the past 5 days congratulating themselves for successfully navigating a sea of “tail risks” and putting their collective economies on the path to a “sustainable recovery”.
What this ignores however, is that without the trillions of dollars that the world’s central banks have injected into the global economy and banking system over the past five years, we would have undoubtedly experienced a global depression. The solution to too much private sector debt was simply to replace it with public sector debt, and that debt continues to grow.
Ludwig von Mises believed that the severity of a recession is determined by the scale of the excesses that built up in the boom that preceded it, and as the can is repeatedly kicked down the road, the excesses continue to build.
The bottom line
The bottom line is that in this environment investors need to make hay while the sun shines, and after a short-term correction, and before the long-term structural forces exert themselves once again, there looks to be a window during which all risk assets should provide scope for decent returns.