This wonderful phrase was uttered by a colleague responsible for foreign exchange last week. Financial markets are displaying a pattern that reeks of manipulation, massaging and management by sovereigns. These are hard to prove, but people with long years of experience in the market can feel it. Of course, in the foreign exchange market, they actually even know who is doing the buying and selling. It turns out that the active buyers and sellers are mostly sovereigns. One look at the tight range in which many major currency pairs have been trading in the last several months would convince us that these could not be a reflection of the intentions of a large number of buyers and sellers who are individually incapable of influencing market prices with their preferences.
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Media is part of this massaging of market prices. Good news is blown out of proportion while bad news or disappointing economic data are buried. For instance, on Thursday, most of the US economic data were disappointing. Mortgage foreclosures rose. It is higher than what it was in end-2009. Leading indicators rose less than expected. Capacity utilization in January declined from the revised figures of December. Claims for unemployment were higher than expected. But, news agencies focused on the fact that the index of manufacturing activity compiled by the Federal Reserve Bank of Philadelphia (for its region) had improved better than expected.
At one level, their success in managing this high-wire Orwellian act successfully for the last two years is impressive. The world stock market capitalization has rebounded by nearly $24 trillion since March 2009. But one wonders if they are pushing their luck too far in aiming for quick fixes to the problems thrown up by the 2008 crisis. The S&P 500 is now trading at a cyclically adjusted price-earnings multiple of 24 times. According to John Hussman of Hussman Funds (http://www.hussmanfunds.com/wmc/wmc110214.htm), this valuation was bettered only on two occasions in the past. One was in 1999-2000 and the other was in August-October 1929. We all know what came after that on both occasions. The volatility index of the S&P 500 is trading at levels before the world came to know of the global debt binge and housing bubbles.
While inflation worries have held back stock markets in developing countries, it is still deemed a remote concern in the developed world and hence, they are said to be in a sweet spot—moderate recovery, low inflation and low interest rates. This is an ideal backdrop to blow bubbles and, egged on by policymakers and their cheerleaders, investors are blowing a bubble right now in US stocks.
US’ dependence on and obsession with asset price appreciation borders on desperation. In spite of the weak dollar since March 2009, its current account deficit has been widening. In other words, its economic recovery is being engineered through consumption by indebted households and not through a revival of manufacturing led by lower wages and a cheaper currency. The US household savings rate has declined a full percentage point from 6.3% in June 2010 to 5.3% in December 2010. This is not what a good doctor would have ordered for the US household debt disease. But US policymakers could only come up with low-interest based debt-fuelled asset price based consumption led economic growth. That is the game they had played successfully since 1987 and they think they could keep getting away with it. The rules of the game have changed.
The growth-inflation trade-off has worsened globally and the great moderation of the last two decades of the previous millennium was an exception. Easy monetary policy, especially when combined with loose fiscal policy, curbs real investment, encourages speculative investment, creates asset bubbles and in a resource and real-investment deficient world, produces inflation.
This insight still eludes the Federal Reserve. Without acknowledging the role played by the Federal Reserve in precipitating an unsustainable housing boom, in a recent research paper (http://www.federalreserve.gov/pubs/ifdp/2011/1014/ifdp1014.pdf), Ben Bernanke and his co-authors list an array of other domestic factors and, secondarily, the portfolio preferences of international investors from Asia, Europe and from commodity producing countries for the financial engineering alchemy that turned subprime mortgages into triple-A rated securities.
While Bare Talk has often criticized the conflicts of interest that turn research from investment banks into sales and marketing brochures, there have always been exceptions and two recent ones deserve mention here. The US Equity Strategist at Credit Suisse wrote in his latest strategy update ( “Utopia”, 18 February) that his year-end target of 1250 for S&P 500 would be realistic if the Fed did not embark on another round of quantitative easing and that if fiscal tightening kicked in, 1250 might be too optimistic. The Global Economics Weekly of 11 February from Barclays Capital (“Policy mix-behaviour”) exhorts policymakers to be more humble, risk-averse, and, importantly, forward-looking.
Policymakers would not heed the message and, if Bare Talk may add, neither would a vast majority of investors.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com
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