Summary
- Our thoughts on the impact of extraordinary monetary policy on markets.
- Several indicators that will give equity Bulls many sleepless nights.
- A worldwide obsession of buying stocks on QE…here we go again….
In life, it is said, only two things are certain: death and taxes. In the current financial markets, there are also two certainties: (1) we are in a period of extreme, never-seen-before monetary stimulus, and as such no one can know the extent nor the duration of current market distortions; and (2) that free market forces will one day retake the upper hand and current distortions will end badly. Perhaps very badly.
We give our two cents on the current state of financial markets and review several key market indicators in this article.
The Root Cause: Inappropriate Monetary Policy
Back in the Good `Ole Days, successful investors used to rely on either a superior analysis of company fundamentals and/or an accurate reading of technicals to make money in financial markets. Neither of these skills have been very useful of late. It's difficult to explain to a fundamental analyst why a company's shares are trading at record highs when earnings are lackluster and aggregate demand is relatively weaker in comparison to past cycles. Similarly, a technical analyst may not understand how the sell-off in October, for example, which broke through major supports on many key equity indexes, saw an even quicker V-shaped rebound without evening forming a base.
Today, trading fundamentals and technicals is no longer the game…it's all about trading market liquidity. For this we can thank our Central Bankers. Most astute market observers understand that equities are making successive new highs almost solely on the back of zero interest rate policy (ZIRP) and quantitative easing (QE). Equity price action is just one form of market distortion resulting from current monetary policy. Whether your portfolio is profiting from current Federal Reserve policy or not, most objective observers agree that current monetary policy is no longer appropriate. As a favorite commentator on CNBC aptly summed up: "the Fed has given us a 6-year cure for a 2-year flu". Two important consequences of this 6-year cure are:
- Asset prices have raced ahead of earnings and fundamentals. This is nothing more than the definition of an asset bubble.
- The Fed will most likely end up tightening at the very end of this business cycle and screw up the next several generations.
A real concern is that the Fed does not manage to raise rates significantly before the next recession. Will QE become the principle counter-cyclical monetary tool, with the Fed Funds rate permanently at zero? What would be the implication for asset prices?
Full article at: http://seekingalpha.com/article/2741815-long-u-s-stocks-caveat-emptor?ifp=1
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