Markets being driven by central banks

Stocks in the United States fell last week after a run that had taken it to record highs.

The Standard & Poor's 500 index fell 0.7 percent to 1,936.16, its first weekly slide in a month, despite gaining 0.3 percent on Friday and after hitting a new record high on Monday.

Notwithstanding the decline last week, trader and blogger Macro Man said in a post on Thursday that the strong performance of stocks recently has been mainly due to the combination of monetary stimulus from the Federal Reserve and high corporate profitability.

[I]s it any wonder that stocks are at their highs when corporate profits as a percentage of GDP are as well? As is corporate cash as a percentage of GDP? It's a well-known aphorism ... that the market is not the economy.

As for the Fed ... it is very much the case that the Fed's assorted piss-taking policies have significantly impacted overall liquidity conditions as well as the volatility environment...

Long-time readers may recall that Macro Man has a proprietary model...

... Macro Man can break the factors into two segments: what he would term as “growth” and “liquidity” drivers of forecast return.... [T]he liquidity factors have been very consistently high during the past few years' bull market. For most of the past several years, however, the growth components have been somewhat below average- that's the “secular stagnation” bit.

And the Federal Reserve is not the only central bank whose monetary stimulus is boosting stocks. The European Central Bank's policies have also helped European stocks do well recently, according to a Bloomberg report.

The two-year rally that has restored more than $4 trillion to European share prices is sending equity valuations to levels not seen in a decade just as investors turn away from record low bond yields.

Gains have pushed the Stoxx Europe 600 Index to 17.5 times annual earnings, the highest since 2002, data compiled by Bloomberg show...

The advance in the Stoxx 600 since June 2012 has pushed the gauge up 48 percent and sent its price-earnings ratio 26 percent above its decade average relative to reported earnings, according to Bloomberg data...

[ECB President Mario] Draghi’s policies have encouraged investors to bid up European assets from bonds to stocks and avoid cash. They’ve added $43 billion to European mutual and exchange-traded funds traded in the U.S. this year, according to EPFR Global data tracked by Bank of America Corp. Meanwhile, they poured $3.3 billion into American equities funds.

And of course, there is the Bank of Japan, whose asset purchases are now paralysing markets, according to a Bloomberg report.

The Bank of Japan’s unprecedented asset purchase program has released a creeping paralysis that is freezing government bond trading, constricting the yen to the tightest range on record and braking stock-market activity.

Historical price volatility on Japanese bonds slid to a 2 1/2-year low of 0.913 percent on June 13 and a lack of activity delayed the start of trading for four days last week. The yen has been in a 4.68-yen range since Jan. 1, the tightest since Japan ended currency controls four decades ago. Average trading on the Topix index is near its lowest level in 1 1/2 years.

Asset purchases have not only made BOJ Governor Haruhiko Kuroda the biggest player in Japan’s $9.6 trillion bond market, they have also given him the most leverage over currency and equity markets in the world’s third-largest economy...

The idea that monetary stimulus from central banks has driven up markets is not new. Many analysts have been saying this for years.

An International Monetary Fund paper published in May last year said that central banks' monetary stimulus may be leading to greater risk taking (see “Economies and markets have improved, thanks to central banks”).

The paper also said that the eventual exit from exceptionally easy monetary conditions may prove “challenging”. This view has recently been echoed by others (see “As US economy improves, monetary policy normalisation becomes a risk”).

Until then, though, Macro Man thinks that “the strategic trend in stocks (as opposed to shorter-term tactical developments) looks to be head-scratchingly higher, floating on a liquidity tide that lifts all boats (and more than a few turds.)”.