The uncomfortable truth for experts who are negative on the stock market is that, these days, it is rarely correlated to the underlying economic data. Instead, it is correlated more and more to what liquidity central banks pump into the system. Many of the major western equity indices reached all time highs in the past few weeks despite the continuing gloom of the data.
US Service-Industry orders are again in contraction, as seen above.
South Korean exports, meanwhile, are again very weak.
Finally, Japanese Machine Tool orders down by 37%.
There are many other examples. And though the efficacy of central bank policy actions is increasingly being questioned, this remains just talk for now at least. In reality, nothing has really changed with the way central banks approach monetary policy.
And the law of unintended consequences strikes once more. Below it can be clearly seen that despite the “rational logic” that lowering rates should increase the amounts households save, and even having negative rates to achieve this, the demand for savings has increased!
And increasingly, like the indices themselves, stocks move up on liquidity and not earnings. Apple has added $400 billion in market capitalisation since January despite earning and revenues falling. Of course, occasionally, when the market is forced to try and price an asset properly it can certainly devalue quickly. The pre-IPO speculation for WeWork was suggesting a valuation for the Tech/real estate company at north of $50 billion. When investors came to look at at crunch time it was deemed to be worth 20% of that. Its biggest backer, Softbank, posted these earnings recently – far bigger losses than expected (Bloomberg).
In private markets, valuations are not subject to the scrutiny of public markets. Prices are marked by auditors or valuations which can have little or no bearing to reality. Once the asset is attempted to be sold, that’s when reality strikes. The following conversation on the current dangers to Private Equity is worth a read:
Back to a more macro level, and things look even more serious. One of the big, alleged benefits of easy central bank policy is for companies to borrow cheaper. But it also means that governments get to borrow cheaper. Furthermore, this usually means governments tend to borrow more than they would because rates are so low. So looking at this below chart, one can see how serious the situation is. With rates so low, these are the projected annual interest payments on US Debt, assuming no recessions.
This is almost parabolic. Will central banks ever be able to raise rates again without causing a sovereign default? It looks very unlikely. Expect to see more of this sort of policy:
It is always justified to help reduce criminality. But any asset that derives its value from a government or central bank will be further brought into disrepute the more this sort of thing occurs.
And meanwhile, political risk increases. The situation in Hong Kong is deteriorating rapidly and could soon get out of control. Street protests and general discontent are on the rise across the world. At the same time, the vilification of the ultra-wealthy has entered the mainstream narratives. Billionaires are the bad guys now for a lot of people. Articles like these are doing the rounds a lot on social media:
These articles are usually followed with comments such as “and FED, BOE, ECB and BOJ Balances sheets up 50% since then!”. And they have a point:
This is political dynamite. Already a huge issue in the Democratic primary with Elizabeth Warren and Bernie Sanders already making Wall Street nervous.
What happened to Gold?
In this context the Gold retracement looks like another opportunity to add to the portfolio. These are in unprecedented times and governments are already acting in an unprecedented fashion. But if these inequalities and monetary experiments continue, this toxic mix could send shockwaves through the political and financial worlds as governments become more extreme. In such a scenario, which looks more likely by the day, Gold will be once again very well-bid. There is too much money sloshing around and being used to over pay for assets, and lend without sufficient due diligence:
One of the world’s greatest investors, Ray Dalio, of Bridgewater Associates, recently wrote this article which is essential reading.
If such a luminary such as Dalio is so concerned, then it is time for everyone to reassess their financial situations and plan accordingly.
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Important disclaimer: this document is not an official research report and the views expressed in it are those of the authors. The authors are not registered research analysts and there is no assurance the trends mentioned will continue or that the forecasts discussed will be realised. Gold as a commodity is not a specified investment for the purpose of giving advice under the Financial Services and Markets Act 2000, therefore, this does not give rise to rights to claim compensation under the Financial Services Compensation Scheme.