The bullish logic in equity markets is palpable, but based on the wrong set of assumptions. Liquidity is the driving force, not any calculations of global growth, which is more than suspect in the West and it is beginning to dawn on some people that the mighty engine of China may well be built on a false premise too.
The Fed, through their POMO (Permanent Open Market Operation – note the word “Permanent”) are actively buying up US Treasuries on a very regular basis; three auctions last week alone. They are also issuing vast quantities of bonds at the same time as the world scrambles to lock in some kind (any kind) of yield; the last issuance was nearly three times oversubscribed. This bizarre combination of issuance and buy backs is helping to keep yields at historically (hysterically?) low levels.
As the yield on 10 year Treasuries approaches the recent low at 2.8% (it was 4.2% in February) the pundits are again calling for an end to bubble mania. Governments are printing vast quantities of money which will surely result in hyperinflation; anathema to bond markets. The logic is reasonable but the question is when? Will they have the conviction, cash and the balls to hold on to their positions if yields go “Japanese” before the denouement occurs? The “P” in POMO stand for permanent and the Fed aren’t done yet by a long chalk.
The cash the market receives from these operations ends up very rapidly in the equity markets via the investment banks whose interests are increasingly aligned with governments. Every POMO day bar none has seen the S&P 500 rise regardless of news flows. And it would not be unreasonable to suggest that some of this money finds its way into the emerging sector which accounts for some of the bullishness in those markets.
The bears are as convinced of a bubble in equities as others are in bonds, but as the Fed continues “pomoing” down the road we could have the best of both worlds; for a time. The S&P will continue to be ramped into the November elections. Historically bull markets have served the incumbent well on voting day. (NB Clinton, who was “unelectable” for a second term, but a roaring bull saved him) The electorate are now more sceptical (the last 21 weeks on the trot have seen significant redemptions from mutual funds) and the ploy may well not work this time, but it won’t stop the powers that be from trying!
Last night the Senate passed a bill to “somehow revalue the yuan”; aka Trade Wars part one. “You don’t know what you are doing” doesn’t even come close as an observation. The Chinese will do what they want to do, when they want to do it and the Senate can go whistle. They have enough on their plate already without this “minor” irritation. Have you ever wondered how they grind out GDP numbers to die for year after year? Part of it is the old communist bugbear of misallocating capital. Unprofitable steel companies can borrow at 1% and the “eclectic” owner of Eclectica Asset Management, Hugh Hendry, has a $2 billion short position on that particular market! Chinese margins are miniscule at the current exchange rate and the latest way to keep the economy going is to tear down buildings they have only just put up and rebuild them!
The other significant “bubble” is gold; and how the Central Banks would like to prick that one. The US Mint has “run out” of 24 carat gold to press any more 1oz “Buffalo” coins and won’t be issuing anymore in 2010. This sounds like the thin edge of the proverbial. Coin dealers are again finding it hard to source supplies of “Eagles”, “Sovereigns” and “Krugerrands” as people become increasingly concerned about the value of the “pound in their pocket” and scramble into the “prehistoric relic”. Call me a dinosaur if you wish, it would be a compliment compared to some of the other names on the list, but when it comes to a choice between fiat paper and gold as a store of value there is seriously only one option.