The Rally Has Legs....

In Money Week this week, I've been arguing that the stockmarket rally can last for quite a while yet, although not for the reason most people think. Here's a taster....

Seldom can a stock market rally have been greeted with such universal scorn. As shares around the world picked themselves up off the floor, dusted themselves off, and started to show some signs of renewed life, they were greeted with a chorus of boos and catcalls.
All the usual caveats were duly trotted out. Sucker’s rally, the said. A bear market blip, warned the chart-wielding experts. Nothing more than a dead cat bounce, declared the sages. From the disdain heaped upon what was in fact a modest recovery, you’d think most people want the stock market to remain flat on its back.
Actually, they are dead wrong. The rally is real enough. There are plenty of good, solid reasons for stocks to start climbing again, and the investors who get behind it will do just fine. There is just one snag. The recovery is taking place for all the wrong reasons. It doesn’t signal that the global economy is in any better shape than it was a few months ago. It signals that inflation is heading down the line, that printing money is igniting a fresh bubble, and that the stock market is one of the very few places you can protect yourself against that.
There is no mistaking the way that shares have recovered.
In the US, the S&P 500 index staged its steepest nine-week rally since the 1930s, rising 37% from the twelve-year-low it reached back in March. Financial stocks led the way, with a 23% rise last week alone as the stress tests set by the Obama Administration were passed with ease.
The MSCI Asia Pacific Index is up by 38% since its low point back in March. The Hong Kong market by itself is up by 52%. Here in Europe, the FTSE 100 index has soared 27 percent from its March 3rd low, and is now just about in positive territory for the year. The Dow Jones Stoxx 600 Index, measuring the main European companies, is up by 33% since its March 9th low. It too has erased all its losses in the early part of the year.
That is not exactly ‘green shoots’. It is more like a whole garden blooming with daffodils and tulips. By any measure, it is a remarkable recovery, particularly since only at the start of the year we were being told the global economy was poised on the brink of the worst downturn since the 1930s.
Naturally, many people aren’t convinced. Many of the reasons put forward for the rally were about as convincing as an MP’s expenses claim. We were told that the US economy was still shrinking, only not quite so fast as it was a few weeks ago, which hardly seemed much of a cause for joyous celebration. Business leaders were lined up to argue that their sales weren’t quite as bad as they expected, which, again, hardly seemed enough to mark share prices up by a quarter. After all, economies are still getting smaller. Company profits are still getting hit.
There has certainly been no evidence of a return to robust growth to provide some solid foundations to the rally. Not surprisingly, that opened up a field day for stock market historians. Plenty of people were quick to remind us that US stocks bounced 50% in the first few months of Franklin Roosevelt’s reign, hardly am auspicious comparison.
And yet, the rally is perfectly justified. It is just that there is nothing comforting about it.
Investors have looked at the policies of ‘quantitative easing’ announced by central banks around the world. They have seen the way the Bank of England has just said it will pump and extra £50 billion in freshly minted pound notes into the economy in the next few months. And they have noticed that even the European Central Bank, previously heir to the stern anti-inflationary hawks of the Bundesbank, has joined the party, with its own plans to create more euros. And they have drawn the right conclusion. ‘QE’, or printing money as it should be called, is going to have two consequences, both of which will be good for equity prices.
The first is that it will create inflation further down the line. There is little escaping that conclusion – more money, poured into a shrinking economy, has to raise prices. The only refuge from that for investors is in real assets.
Gold is one possibility, although there is very little evidence left to suppose the metal has any monetary value. Property is another, although the markets are so depressed and the companies so debt-laded it may take them years to recover. That leaves blue-chip companies. In a climate of moderately accelerating inflation, where prices start pushing up 5% to 6% a year, which is what we are heading for, strong and powerful companies should be able to gently nudge up their prices, profits and dividends. Stocks will inflate along with everything else.
Indeed, we can already see that in the companies leading the way. The rally in the FTSE, for example, has been led by sectors such as industrial miners, banks and retailers – precisely the kind of companies that will do well out of inflation.
Next, there is already evidence that QE is spilling out into another asset bubble. If you print money, it has to go somewhere – nobody throws the stuff away. It was meant to be pushing down bond yields, but there isn’t much sign of that (bond yields have been rising modestly). In fact, all the fresh cash is slipping into the equity markets. Central banks are determined to re-flate the bubble. And it looks as if they are starting to succeed.
In truth, printing money is not going do much for the long-term health of the global economy. That will depend on the same things its has always depended on: free trade, deregulated markets, low-ish taxes, and the rate of technological progress. But it will create inflation, and it will create asset bubbles. And that’s a good basis for a stock market rally, even if it is bad news for everything else.