Risk On
Investors have not been this optimistic about the global economy since the financial crises. And as of late, there have been a consistent number of positive economic reports that have continued to contribute to this rally in the equity markets. With the yield on US 10 year bonds back up over 2 percent today, it is evident that a risk on play is continuing to develop in the markets. And as safe haven sovereign debt sells off, metals have benefited from this trade.
I think it’s in my blood to be a skeptic, and that side of me will overcome the joyousness shortly, but it is important to start with the positives in this market right now. Despite the rejigging of corporate balance sheets and the profits that prevailed from businesses vastly cutting costs, the US private sector looks to be optimistic about the economy, and for that reason they are hiring. The job numbers released this morning (which are looked upon with caution because of their volatility) are for the first time since the financial crises one level above mediocrity. Given the US labor market requires growth of anywhere between 90 to 120 thousand jobs a month to keep up with population growth, seeing payrolls add over 220 thousand positions is very positive and hopeful for economic growth.
It is also the hope and optimism of investors that has continued to fuel this rally in the stock markets. The Dow Jones Industrial Average took out its previous high set in October of 2007, and came back from the low of below 6,500 in March of 2009. There were many pundits who did not seem to care because of the Dow being an outdated and undiversified index, and in a sense they are all correct, but the real reason it is attracting this much attention is because the valid S&P 500 will shortly tell a similar story.
There is no question these markets have come back from some very dark days, and right now it’s hard to argue that equities are not the place to be, but there is more than the optimism of investors that is carrying this market. Since its bottom in March of 2009, equities have been lifted by the operations of the US Federal Reserve as they ensured liquidity in the US financial markets. It was the fact the Fed could act as a back stop for creditors, and guaranteed to borrowers that interest rates would not skyrocket that there is this level of optimism in the market. Referring to the graph, the highlighted time periods represents purchases of treasury bonds and Asset Backed Securities by the US Federal Reserve and the actions of their efforts is quite clearly evident.
With this much optimism in the markets it does not take too much time for the typical economists or analysts of other views to raise warning flags. Nouriel Roubini, the economist known for calling the housing market collapse believes the crash from this bubble in this bond market will be greater than the previous crash of financial markets in 2008-09. There is no question as to whether or not there is a bubble in the bond market, especially when you have the world’s most powerful central bank suppressing interest rates and holding up prices. The question is instead, what’s there exit plan?
US stock markets have come back from the lows of 2009 and that is great. And broadly speaking, US stocks do represent the opportunity in this market at the moment. But instead of trying to make my case myself, I’ll quote former Citi CEO Chuck Prince.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” That was in July of 2007. Refer to the graph above to see what happened next.