Graph 1 - Figures: FRED (Federal Reserve)
If we are to believe certain analysts, the US is in the
midst of a stock market boom, which began on 3rd September 2009.1
Should that be the case, will it result in a bust, as in the past? This
question was first asked by analysts back in April, as the current S&P 500
upturn passed the longevity of the 1982-1987 surge. Four months on, there is
still no sign of a massive drop in share values (see graph 1).
So why should we worry? Well, the issue is that current stock prices are
baseless: they have been fuelled by the Federal Reserve’s policy of
quantitative easing (QE) - printing new money to give to banks so that they
lend out to businesses and individuals, thus stimulating the economy. This
hasn’t worked and other key economic indicators in no way reflect share
prices.
If the central idea behind QE is to increase access to capital, so that
businesses can get back on their feet and make America an attractive place
to do business again. A look at the stuttering trade figures and FDI trends
show that this is not the reality (see graph 2 & 3).
Graph 2 - Source: FRED Federal
Reserve Bank of St Louis.
Graph 3
Also, a few months back the Fed announced that by the end
of 2014, unemployment would fall to 6% - its goal for recovery is in the
mid-5% range2. A look at the actual figures for employment in proportion to
population shows a less optimistic picture (see graph 4).
Graph 4 - Source: FRED Federal
Reserve Bank of St Louis.
Lending
Given that the banks were supposed to be handed freshly created
money to loan out to the population, the figures for home loans show little
movement since they bottomed out in 2011 (see graph 5).
Graph 5 - Source: FRED Federal
Reserve Bank of St Louis.
If you follow the Fed’s logic that having more debt is a
sign of recovery, commercial loan figures could be seen as more encouraging.
Yet, despite the trillions of dollars pumped into the QE programme since
2010, loan levels only got back to peak 2008 levels at the turn of this year
(see graph 6).
Graph 6 - Source: FRED Federal
Reserve Bank of St Louis.
If all the above is not proof enough of the artificial
rate of stock prices, the largest rises in the S&P 500 since autumn 2008
have occurred during periods of QE (see graph 7).
Graph 7 - Figures: FRED
(Federal Reserve) (Graph: created by author)
Of course, when analysts begin to warn of a stock market
bubbles bursting, it reminds us of the Wall Street Crash of 1929, as well as
the only slightly-less dramatic version in 1987. Looking at those two
events, it is clear how quickly the bubble can burst (see graph 8).
Graph 8 - Samuel H.
Williamson, ‘Daily Closing Value of the Dow Jones Average, 1885 to Present,’
Measuring Worth, 2012.
Investment strategist Jim Paulsen made the comparison in
April between the current situation and those events of 25th August 1987,
when after five years of rising, prices took a dramatic nosedive. Although
he doesn’t expect as large a drop as the 20% fall in one day in 1987, he
does think that when the market falls there will be a 10% correction
“sometime in the next few months”.3
FT All-Share Index last 5 years
Graph 9 - Source: Bloomberg
Over in the UK, similar alarm bells are being rung, given
the high levels of both public and private debt, yet rising stock prices:
the FT All-Share index has gone up 40% over the last 5 years (see graph 9).
The increase has been so consistent, amongst seemingly fearless buying, that
the Bank of England’s Deputy Governor Charles Bean says: “the lack of
volatility is eerily reminiscent of the run up to the financial crisis in
2007-2008.”4
Whilst it’s an easy option to remain permanently pessimistic, it is also
extremely difficult to predict when the bubble will burst. However, if
prices continue to go up, purely on speculative buys rather than a firm
economic basis, we could well be heading for a significant drop.
Footnotes:
1 http://blogs.marketwatch
.com/thetell/2014/04/02/now-theres-a-1987-chart-to-get-worried-about/
2 http://www.cnbc.com/id/101525990
3 http://blogs.marketwatch
.com/thetell/2014/04/02/now-theres-a-1987-chart-to-get-worried-about/3
4 http://blogs.telegraph
.co.uk/finance/ambroseevans-pritchard/100027346/global-watchdogs-rattled-by-lack
-of-fear-in-the-markets/
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