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A file photo of Shanghai Stock Exchange (Photo: Bloomberg)
A file photo of Shanghai Stock Exchange (Photo: Bloomberg)

Opinion | Why global stock markets will leave a lot of bears disoriented

The stars seem aligned for stock market bubbles to grow bigger and sceptics to be confounded

A tweet by a former fund manager and investor, Jesse Felder, attracted my attention. He had tweeted that Advanced Micro Devices (AMD) was trading at triple its dot-com mania peak valuation with revenue growth today at roughly half of what it was then. The current price-earnings ratio of the stock is 228 times. AMD’s price-sales ratio is 9.0 times. Another tweet drew my attention to the fact that after its recent run of +94% appreciation over the last three months, Tesla Motors’ market capitalization is 50% larger than that of either BMW or Daimler. Now, I am not a stock picker, nor is this a call to sell or go short any stock in the market. But, clearly, the chart of the S&P 500 in recent weeks looks ominously vertical.

In the meantime, a friend in the US, a long-standing market observer and commentator, asked for my views on stock markets. I told him that my views did not merit any consideration, drawing his attention to my recent track record on gauging the top in stock markets around the world (see “Will the mother of all asset price bubbles burst in 2020?", 10 December 2019). He said that he had never felt so disoriented as he was feeling now. Clearly, it was a case of two souls commiserating with each other on our failure to divine investors’ logic. He alerted me that the monthly manufacturing gauge of America put out by the Institute for Supply and Management (ISM) suggests contraction in the manufacturing sector that is beginning to entrench itself. The ISM index began 2019 on a strong note and ended the year in contraction territory. During the year, the S&P 500 price index returned more than 30% and, including reinvested dividends, it was more than 33%. Now, commentators are talking of a return to better times for Europe and for emerging economies in 2020.

For the current stock market trend to continue and forecasts for other markets to bear fruit, investors and analysts know that a weaker dollar is essential. Hence, all forecasts are for the US dollar to weaken in 2020. Dollar depreciation usually means improved liquidity in financial markets and flows of funds to emerging economies. The broad trade-weighted dollar index has had a good run in the last two years. Thus the prediction that the trend will reverse.

In an insightful speech (“What is behind the recent slowdown?", 14 May 2019), Hyun-Song Shin of the Bank for International Settlements pointed out that the formation, spread and expansion of global value chains (GVCs) and dollar liquidity went hand in hand in the first decade of the new millennium and that the shrinking of bank lending in US dollars has played its part in the shrinking of GVCs in the second decade of the millennium. The rise of China had coincided with the rise of GVCs in the first decade of the 2000s. The recent economic travails of China can be traced in part to the partial dismantling of GVCs. Dollar weakness and a rise in dollar lending by banks will alleviate some of the economic hardships of China in 2020.

China has huge dollar repayments coming up this year and the next. Chinese companies are defaulting on loan repayments both in local currencies and in US dollars. The fortunes of stock markets and that of China are linked to dollar weakness, and hence, Wall Street is pinning its hopes on continued monetary policy accommodation by the US Federal Reserve, resultant dollar weakness, economic recovery in the Eurozone, and hence some recovery in the euro against the US dollar. This is how Wall Street’s interests are currently aligned with that of China.

In a recent column (“Containing China", 25 December 2019) that appeared in Business Standard, Prof. Deepak Lal wrote that if America were serious about containing China, it had to tame Wall Street. He is right. I had made a similar argument in these pages in April 2018 (“The US should tame finance to tame China", 10 April 2018). Unfortunately, however, now there is a convergence of interests among Wall Street, stock market investors, China, and a US president seeking re-election. US President Donald Trump is keen to cut a deal on tariffs with China, as that removes one risk for stock markets. Simultaneously, he is keen on a looser monetary policy in America and weaker dollar. All of that would improve financing conditions for Chinese companies looking for dollars and ease pressure on Chinese monetary policy too.

Hence, on the face of it, the stars are aligned for stock market bubbles to grow bigger and the GVC bubble, as Hyun Song Shin calls it, to re-emerge because the Federal Reserve is determined to err on the side of monetary policy accommodation than restraint, notwithstanding the fact, as Hyun Song Shin noted in his speech, that real investment unrelated to property was more closely tied to the health of the manufacturing sector and had been subdued.

In the name of investing, private equity would continue to hollow out companies and immiserate workers. Stock markets will reach new highs. My friend and I have to be prepared to stay disoriented for some more time.

V. Anantha Nageswaran is the co-author of ‘The Rise Of Finance’ and ‘Can India Grow?’ These are the author’s personal views.

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