— Are things so bad in the global economy that they’re good? Are the markets simply dismissing all the risks in the world because they think Ben Bernanke will launch into QE3 before QE2 officially ends?
— That’s the feeling we get. Loose monetary policy is not called ‘easy money’ for nothing. And the sharks, the short-term traders who make up the majority of trading volumes these days, smell the blood of easy money in the water.
— Too many people look at market prices these days and believe what they see. Prices are meant to convey information after all. But an economy or monetary system juiced up on easy money and excess liquidity tends to throw off weird price signals. Only in an economy operating on sound money principles can you have faith in what prices are trying to say.
— So in an unsound system, investors act like Pavlov’s Dog and expect more liquidity the worse the underlying fundamentals get. Even if the assumption of QE forever is right, those buying at these levels are going to get burnt.
— From a longer-term perspective – or dare we say – from an investor’s perspective, continuing QE will not be kind to share prices. Eventually we’ll see much higher inflation, which will lead to a sell-off in the bond market. In the years ahead, 10-year US Bond yields of 5–6 per cent, or higher, will not be out of the question. (That might not sound like much but in an economy with as much debt as the US has, it’s a lot).
— This increase in the ‘risk-free’ rate will push down the value and price of equities. In periods of high inflation, high government bond yields mean the market will trade on lower multiples. So instead of a market PE (price-to-earnings ratio) of, say, 15 being the norm, under a higher inflation scenario the market PE could drop to around 12 or lower.
— As an aside, in the high inflation 1970s many developed equity markets around the world bottomed out with an average PE of around 8 times or lower. For some perspective, a market that goes from a PE of 16 to 8, without any change in actual underlying earnings, falls by 50 per cent. High inflation is not necessarily good for the market, an outcome many now seem to be betting on.
— But that all assumes Ben keeps his finger on the button and continues to expand the Fed’s balance sheet. Is the market correct to expect more QE? Won’t the Fed want to give the market the impression (however fleeting) that they have some semblance of dignity and belief in free markets?
— We don’t like betting the Fed will do the right thing. We are contrarians though and right now the contrarian bet seems to suggest the Fed will hold off on more QE until the market tips over again.
— And we think it will. As our friend and colleague Murray Dawes (our resident trader) said yesterday in an email exchange, ‘This market is an accident waiting to happen’.
— After running our amateur technical eye over the chart of the ASX200, we’d concur with Murray’s thoughts. Check out the graph below. The recent rally looks like little more than a reflexive bounce from an oversold condition. Chase it at your own risk.
— In Australia, the focus is back on what constitutes a ‘fair share’ for our resources. The Greens are refusing to back the amended mining tax in the form negotiated by Labor and the big miners. Not surprisingly, they want to bring back the original, broader tax to make the world a better place.
— Don’t get us wrong, we’re all for making the world a better place. But that doesn’t happen via tax increases and giving it to politicians to distribute to marginal constituencies.
— Under the existing system, if you want better healthcare, go and live in a marginal electorate…and keep changing your vote.
— Speaking of voting, our thoughts go out to all NSW voters tomorrow. We hope your state-based democratic duty passes as quickly and painlessly as possible. At least all those nauseating ads will be over!
— For anyone who thinks that politicians can possibly do any good for an economy, check out this SBS Dateline program about China’s property boom. It’s incredible.
— It documents China’s housing boom and takes you on a tour of its empty cities. There’s a mind-boggling 64 million apartments sitting idle in China. Many of these are purchased as ‘investment properties’, despite having no rental yield. The analyst interviewed says the situation in China ‘will make the United States (property boom and bust) pale into comparison.’
— This is all because of central planners’ desire to generate GDP growth, whatever the consequence. The stupidity of all this would be hard to believe if not for the evidence. Command economies do not work. The longer China tries to inflate the property bubble, the bigger the bust will be. The laws of capitalism will soon deal the communists a very harsh lesson.
— And China’s bust will have a big impact on Australia’s economy. There’s a lot of iron ore and coal in those 64 million apartment blocks. We’re guessing our terms of trade wont be so favourable 12 months from now.
For Daily Reckoning Australia