Sunday, 31 May 2009
Welcome To Frengland
My series in The Sunday Times about the new capitalism finished this week wiht a look at the UK economy. The outlook is prety bleak. You can read it here.
A Quick Exit From QE
In my Money Week column, I've been arguing that central bankers need to figure out a way to stop printing money - and fast. Here's a taster.
A good rule in life is that whenever you start something, it is helpful to have a pretty firm idea of what your exit strategy is going to be. Neither Britain or the US had one in Iraq, and got bogged down in a difficult war for years longer than they planned. Now it looks as if the Federal Reserve and the Bank of England are intent upon making precisely the same mistake with their policy of quantitative easing, or what in plainer language used to be known as printing money.
They’ve started it, but there is no clear road map for getting out.
In truth QE should stand not for Quantitative Easing – but for Quick Exit.
As the policy unfolds, it is becoming increasingly clear that its main impact is going to be to stoke up another asset bubble. Central banks won’t be able to stop printing money without risking another collapse in asset prices. Even more seriously, all the asset markets now look to be largely controlled by the central banks, a dangerous situation that is hardly going to help restore healthy economic growth.
Britain, perhaps because of the scale of the problems within its banking industry, has been one of the most aggressive countries in the world when it comes to what is politely know as ‘unconventional’ monetary policy. The Bank of England has said it will pump £125 billion into the economy by printing more money. But other central banks have done the same, led by the Fed in the US. Even the conservative European Central Bank has joined the party.
It remains to be seen how effective that is at lessening the impact of what was always going to be a deep recession. There are signs it is stimulating growth, although whether it causes inflation as well we have yet to find out.
But you can’t keep printing money forever – at least not without turning into Zimbabwe. At some point, you’ll have to declare the job done, and call a halt. But when? And how?
In a speech last week Charles Bean, the Bank of England’s Deputy Governor, admitted the Bank faced a “tricky judgment” on when to exit its money-printing strategy. Perhaps most surprisingly, Bean suggested that the Bank might well start raising rates, while still printing money by buying up gilts and other assets. He also suggested the Bank might have to hold the assets it is buying until maturity, because of the risks associated with releasing them back onto the market. One thing was clear, however. The Bank doesn’t really know how to get out, or when. If it did, it wouldn’t have to discuss it.
This is more than an academic debate restricted to central bankers and economists. It matters to investors.
It is becoming increasingly clear that the rapid rise of the markets over the last two months owes a lot more to printing money than it does to any of the over-hyped ‘green shoots’ of economic recovery. The S&P is up by 35% since its February and March lows. Many of the Asian markets are up by more than 50%. As Morgan Stanley noted in an analysis last week, “as we see it, an important driver behind this rally has been the excess liquidity that central banks have pumped into the system through rate cuts and quantitative easing.”
Investors aren’t stupid. They can see that there isn’t much point in holding onto cash when central banks are printing more of the stuff by the billion. Its value is only going in one direction, and it isn’t upwards. They have been switching their cash into equities, property, gold or oil: anything that is likely to hold its value even as money becomes less and less attractive. QE was designed to push bond yields down to help stimulate the economy, but money is bit like an animal: once you release it into the wild, you have no way of knowing where it will go. In fact, much of the freshly minted cash looks to have been invested in other markets.
The trouble is, that means the prices of most assets are buoyed up artificially by the tricks the central banks are playing.
For much of the last decade, the bubble in equity markets was sustained by what was known on Wall Street as the ‘Greenspan put’. Put simply, the rule stated that it was perfectly safe to invest in equities, since if they fell the former Federal Reserve chairman Alan Greenspan would always wade into the markets with a series of interest rate cuts to bail them out.
Now we have something that looks like a ‘QE put’: when markets collapse, central bankers will keep printing more and more money until they get them moving again.
There are two problems with that, however.
First, as Bean puts it, central banks face a ‘tricky judgement’ on when to put the brakes on QE. But so do investors. At some point, the monetary authorities will have to stop printing money, and when it happens the results will be far from pretty. In effect, anyone trying to put together an investment strategy doesn’t really need to be looking at the future of company profits, trade flows, or new technologies. They mainly need to be worrying about when the central banks will pull the plug – and making sure they aren’t the suckers holding bonds or equities when it does.
Next, it causes massive distortion of capital markets. It is not just bond markets that will take a big hit when central banks stop printing money. So will equities, commodities and property. They are all being kept afloat in the same tide of new money. But in the end, the health of a capitalist economy depends on the markets allocating capital efficiently between different sectors of the economy – and yet right now, the prices of most assets are, in effect, being decided by the central banks.
In reality, that is the real reason why quantitative easing will turn out to be a mistake - because of the massive distortion of the capital markets it creates. It would be better for the central banks to get out now while they still can.
A good rule in life is that whenever you start something, it is helpful to have a pretty firm idea of what your exit strategy is going to be. Neither Britain or the US had one in Iraq, and got bogged down in a difficult war for years longer than they planned. Now it looks as if the Federal Reserve and the Bank of England are intent upon making precisely the same mistake with their policy of quantitative easing, or what in plainer language used to be known as printing money.
They’ve started it, but there is no clear road map for getting out.
In truth QE should stand not for Quantitative Easing – but for Quick Exit.
As the policy unfolds, it is becoming increasingly clear that its main impact is going to be to stoke up another asset bubble. Central banks won’t be able to stop printing money without risking another collapse in asset prices. Even more seriously, all the asset markets now look to be largely controlled by the central banks, a dangerous situation that is hardly going to help restore healthy economic growth.
Britain, perhaps because of the scale of the problems within its banking industry, has been one of the most aggressive countries in the world when it comes to what is politely know as ‘unconventional’ monetary policy. The Bank of England has said it will pump £125 billion into the economy by printing more money. But other central banks have done the same, led by the Fed in the US. Even the conservative European Central Bank has joined the party.
It remains to be seen how effective that is at lessening the impact of what was always going to be a deep recession. There are signs it is stimulating growth, although whether it causes inflation as well we have yet to find out.
But you can’t keep printing money forever – at least not without turning into Zimbabwe. At some point, you’ll have to declare the job done, and call a halt. But when? And how?
In a speech last week Charles Bean, the Bank of England’s Deputy Governor, admitted the Bank faced a “tricky judgment” on when to exit its money-printing strategy. Perhaps most surprisingly, Bean suggested that the Bank might well start raising rates, while still printing money by buying up gilts and other assets. He also suggested the Bank might have to hold the assets it is buying until maturity, because of the risks associated with releasing them back onto the market. One thing was clear, however. The Bank doesn’t really know how to get out, or when. If it did, it wouldn’t have to discuss it.
This is more than an academic debate restricted to central bankers and economists. It matters to investors.
It is becoming increasingly clear that the rapid rise of the markets over the last two months owes a lot more to printing money than it does to any of the over-hyped ‘green shoots’ of economic recovery. The S&P is up by 35% since its February and March lows. Many of the Asian markets are up by more than 50%. As Morgan Stanley noted in an analysis last week, “as we see it, an important driver behind this rally has been the excess liquidity that central banks have pumped into the system through rate cuts and quantitative easing.”
Investors aren’t stupid. They can see that there isn’t much point in holding onto cash when central banks are printing more of the stuff by the billion. Its value is only going in one direction, and it isn’t upwards. They have been switching their cash into equities, property, gold or oil: anything that is likely to hold its value even as money becomes less and less attractive. QE was designed to push bond yields down to help stimulate the economy, but money is bit like an animal: once you release it into the wild, you have no way of knowing where it will go. In fact, much of the freshly minted cash looks to have been invested in other markets.
The trouble is, that means the prices of most assets are buoyed up artificially by the tricks the central banks are playing.
For much of the last decade, the bubble in equity markets was sustained by what was known on Wall Street as the ‘Greenspan put’. Put simply, the rule stated that it was perfectly safe to invest in equities, since if they fell the former Federal Reserve chairman Alan Greenspan would always wade into the markets with a series of interest rate cuts to bail them out.
Now we have something that looks like a ‘QE put’: when markets collapse, central bankers will keep printing more and more money until they get them moving again.
There are two problems with that, however.
First, as Bean puts it, central banks face a ‘tricky judgement’ on when to put the brakes on QE. But so do investors. At some point, the monetary authorities will have to stop printing money, and when it happens the results will be far from pretty. In effect, anyone trying to put together an investment strategy doesn’t really need to be looking at the future of company profits, trade flows, or new technologies. They mainly need to be worrying about when the central banks will pull the plug – and making sure they aren’t the suckers holding bonds or equities when it does.
Next, it causes massive distortion of capital markets. It is not just bond markets that will take a big hit when central banks stop printing money. So will equities, commodities and property. They are all being kept afloat in the same tide of new money. But in the end, the health of a capitalist economy depends on the markets allocating capital efficiently between different sectors of the economy – and yet right now, the prices of most assets are, in effect, being decided by the central banks.
In reality, that is the real reason why quantitative easing will turn out to be a mistake - because of the massive distortion of the capital markets it creates. It would be better for the central banks to get out now while they still can.
Monday, 25 May 2009
Welcome to BRICapitalism
In part two of my series on The New Capitalism for The Sunday Times, I've coined a new term, BRICapitalism. I wonder if it will catch on. Anyway, you can read about it here.
Blank Walks The Plank...
In Money Week, I've been writing about how chief executives are going to start getting a much rougher ride. And about time too....Here's a taster.
Nobody will be sorry to see Sir Victor Blank depart as the chairman of the newly-created Lloyds Banking Group, least of all its shareholders. The rushed merger with HBOS, cobbled together after a drink with Gordon Brown, will surely go down in British corporate history as one of the most spectacular financial catastrophes of all time. The only surprise is that he hung on to his job all the way to May rather than being forced out as soon as the mess he had made of the job became clear.
But Blank will be far from the last FTSE chief forced to walk the plank. Indeed, the next five years look set to be very rough for the pampered executive class. Heads will roll on a scale that would make even the most blood-fevered Jacobin revolutionary feel queasy. Chief executives and chairmen have grown used to hiding behind a booming economy, whilst lining their own pockets with salaries, pensions and bonuses that would make even a backbench MP feel embarrassed.
The far tougher economic conditions of the next five years will sort out the really skilled businessmen from the mere clock-watchers and time-servers.
Indeed, Blank himself is emblematic of the kind of executive who prospered during the great bubble. He was a skilled net-worker: just about everyone in the City will have been to one of the summer cricket matches at his Oxfordshire estate. But there was very little evidence of any real commercial talent. He started his career as a lawyer, becoming a partner in what was then Clifford Turner, before switching to corporate finance and dabbling with mostly non-executive roles. He was chairman of Trinity Mirror for many years, during which the Daily Mirror began its long descent into irrelevance. He was the architect of the merger with the Trinity local newspaper group, another catastrophe for shareholders. But it was at Lloyds that he really got found out.
It is probably a good rule that lawyers shouldn’t be put in charge of banks: another lawyer, Lord Alexander, was the chairman of NatWest for a decade in the 1990s, and that ended up being sold to Royal Bank of Scotland, with results that are now plain for everyone to see. Blank certainly seem to have very little idea what he was wading into when he took control of HBOS last autumn. Lloyds had sensibly avoided the worst excesses of the bubble. But years of careful management were blown in a few days with the £7.7 billion acquisition of HBOS.
A career banker would have been a lot more cautious: there were already plenty of stories circulating about wild and imprudent lending at HBOS. Blank’s naivety, and his lack of hands-on experience of retail banking, were cruelly exposed.
He will have plenty of company of the next few years, however.
This recession will sort out the smart business brains from the public relations men and networkers. In a bubble, all manner of weaknesses can be quietly swept under the carpet. All that is now about to change.
First, the bubble allowed lots of pretty ordinary businesses to look as if they were doing pretty well. Since it burst, we’ve discovered that British Telecom isn’t really a world-beating, science-based company on the cutting edge of technological change. It’s a fairly dull old utility, with some big pension problems. Marks & Spencer turned out not to be a brilliantly re-invented retail concept ready to conquer the world, but a slightly odd combination of an over-priced food chain with an underwear retailer added on (or maybe it’s the other way around). Plenty more chief executives will find the next few years a chastening experience. It wasn’t that hard to push up sales and profits in an economy growing at 3%-plus a year. It is a lot harder in one contracting by 3% a year.
Next, there isn’t going to be much leverage around to pep up performance. During the credit boom, plenty of chief executives borrowed some tricks from the private equity industry. Even if they company wasn’t doing that well, they could spice up returns by calling in some investment bankers and re-engineering the balance sheet. Debt could be pushed up. Properties could be sold off and leased back. With the money, you could raise dividends or launch share buy-back programmes. None of that is going to be possible for the next few years. The cash won’t be there.
On top of that, there isn’t much chance of an M&A boom. A mega-merger allowed companies to promise growth in the future. Even if that didn’t materialise, you could strip out a lot of costs, and grind out higher profits. GlaxoSmithKline has been playing that trick for years. But with the markets in no mood to finance any mega-deals, that won’t be on the table either.
Lastly, investors are about to get a lot more demanding. Capital will be scarce – and the huge borrowing requirements of every major government will suck up much of what money there is available. For much of the last decade, shareholder oversight of big companies has been largely a fiction. Company boards could essentially do whatever they liked. That too is about to change. Companies will have to pay close attention to what their shareholders want. If they don’t, they’ll find themselves quickly voted out of office.
Chief executives have done well out of the boom of the last decade. Million-plus salaries that once provoked headlines have become the norm. Pension packages were lavish. Bonuses were paid out regardless of whether they were any results to justify them. And yet of the British companies in the FTSE, only BP, HSBC, Tesco, Vodafone and RTZ could really be argued to have made much progress as global businesses in the last decade. The rest were just treading water, and that is putting it kindly.
The easy days are over. In the next five years, company directors will have to understand their businesses inside out. They will need to know how to create new products, expand into new markets, and deliver improved returns for shareholders. Otherwise, they’ll soon find themselves keeping Sir Victor Blank company in the ex-Chairman’s club.
Nobody will be sorry to see Sir Victor Blank depart as the chairman of the newly-created Lloyds Banking Group, least of all its shareholders. The rushed merger with HBOS, cobbled together after a drink with Gordon Brown, will surely go down in British corporate history as one of the most spectacular financial catastrophes of all time. The only surprise is that he hung on to his job all the way to May rather than being forced out as soon as the mess he had made of the job became clear.
But Blank will be far from the last FTSE chief forced to walk the plank. Indeed, the next five years look set to be very rough for the pampered executive class. Heads will roll on a scale that would make even the most blood-fevered Jacobin revolutionary feel queasy. Chief executives and chairmen have grown used to hiding behind a booming economy, whilst lining their own pockets with salaries, pensions and bonuses that would make even a backbench MP feel embarrassed.
The far tougher economic conditions of the next five years will sort out the really skilled businessmen from the mere clock-watchers and time-servers.
Indeed, Blank himself is emblematic of the kind of executive who prospered during the great bubble. He was a skilled net-worker: just about everyone in the City will have been to one of the summer cricket matches at his Oxfordshire estate. But there was very little evidence of any real commercial talent. He started his career as a lawyer, becoming a partner in what was then Clifford Turner, before switching to corporate finance and dabbling with mostly non-executive roles. He was chairman of Trinity Mirror for many years, during which the Daily Mirror began its long descent into irrelevance. He was the architect of the merger with the Trinity local newspaper group, another catastrophe for shareholders. But it was at Lloyds that he really got found out.
It is probably a good rule that lawyers shouldn’t be put in charge of banks: another lawyer, Lord Alexander, was the chairman of NatWest for a decade in the 1990s, and that ended up being sold to Royal Bank of Scotland, with results that are now plain for everyone to see. Blank certainly seem to have very little idea what he was wading into when he took control of HBOS last autumn. Lloyds had sensibly avoided the worst excesses of the bubble. But years of careful management were blown in a few days with the £7.7 billion acquisition of HBOS.
A career banker would have been a lot more cautious: there were already plenty of stories circulating about wild and imprudent lending at HBOS. Blank’s naivety, and his lack of hands-on experience of retail banking, were cruelly exposed.
He will have plenty of company of the next few years, however.
This recession will sort out the smart business brains from the public relations men and networkers. In a bubble, all manner of weaknesses can be quietly swept under the carpet. All that is now about to change.
First, the bubble allowed lots of pretty ordinary businesses to look as if they were doing pretty well. Since it burst, we’ve discovered that British Telecom isn’t really a world-beating, science-based company on the cutting edge of technological change. It’s a fairly dull old utility, with some big pension problems. Marks & Spencer turned out not to be a brilliantly re-invented retail concept ready to conquer the world, but a slightly odd combination of an over-priced food chain with an underwear retailer added on (or maybe it’s the other way around). Plenty more chief executives will find the next few years a chastening experience. It wasn’t that hard to push up sales and profits in an economy growing at 3%-plus a year. It is a lot harder in one contracting by 3% a year.
Next, there isn’t going to be much leverage around to pep up performance. During the credit boom, plenty of chief executives borrowed some tricks from the private equity industry. Even if they company wasn’t doing that well, they could spice up returns by calling in some investment bankers and re-engineering the balance sheet. Debt could be pushed up. Properties could be sold off and leased back. With the money, you could raise dividends or launch share buy-back programmes. None of that is going to be possible for the next few years. The cash won’t be there.
On top of that, there isn’t much chance of an M&A boom. A mega-merger allowed companies to promise growth in the future. Even if that didn’t materialise, you could strip out a lot of costs, and grind out higher profits. GlaxoSmithKline has been playing that trick for years. But with the markets in no mood to finance any mega-deals, that won’t be on the table either.
Lastly, investors are about to get a lot more demanding. Capital will be scarce – and the huge borrowing requirements of every major government will suck up much of what money there is available. For much of the last decade, shareholder oversight of big companies has been largely a fiction. Company boards could essentially do whatever they liked. That too is about to change. Companies will have to pay close attention to what their shareholders want. If they don’t, they’ll find themselves quickly voted out of office.
Chief executives have done well out of the boom of the last decade. Million-plus salaries that once provoked headlines have become the norm. Pension packages were lavish. Bonuses were paid out regardless of whether they were any results to justify them. And yet of the British companies in the FTSE, only BP, HSBC, Tesco, Vodafone and RTZ could really be argued to have made much progress as global businesses in the last decade. The rest were just treading water, and that is putting it kindly.
The easy days are over. In the next five years, company directors will have to understand their businesses inside out. They will need to know how to create new products, expand into new markets, and deliver improved returns for shareholders. Otherwise, they’ll soon find themselves keeping Sir Victor Blank company in the ex-Chairman’s club.
Thursday, 21 May 2009
Great Timing
I've done a piece for The Spectator this week on the threat of a ratings cut for the UK. And, on the same day is comes out, S&P downgraded the UK's debt.
Sunday, 17 May 2009
The New Capitalism...
I've starrted a new series this week in The Sunday Times about The New Capitalism. You can overdo this stuff: capitalism will overcome this crisis as it has past ones. But it will look different, and the interesting bit is tryig to work out how. Anyway, you can read it here.
Saturday, 16 May 2009
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.
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.
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