A 'dime a dozen' dip in a healthy recovery

The recent pull back in global stock prices looks a little disconcerting when compared with recent highs, but when viewed with a more considered perspective, the falls are of the run-of-the-Amill, plain vanilla, variety.

Share prices have taken a bit of a hit as they usually do when a central bank (in this case the US Federal Reserve) starts to signal that a monetary policy easing cycle is over and that a monetary policy tightening cycle may soon begin.

Whether the pending monetary policy tightening is a scaling back of bond purchases or the old fashioned hiking of interest rates, it matters little because the central bank will be working to dampen private sector liquidity and with that, economic growth, profits and or course future inflation.

This is certainly the case as the Federal Reserve now awaits a few more months of solid economic data before it starts to taper off the $US85 billion a month bond buying program, which of course will represent a monetary policy tightening when it happens.

Certainly the economic news overnight in the US continued that very positive theme – house prices continued their upward surge rising 12.1 per cent in the year to April, consumer sentiment rose to a fresh five-year high, while home sales also lifted. Durable goods orders rose 0.7 per cent to again beat expectations. 

As I wrote yesterday (A foretaste of QE’s final triumph, June 25), there is little doubt the US economy is on a path to stronger growth, which reinforces the case for policy makers to start thinking about the withdrawal of the monetary policy stimulus in the not-too-distant future.

US stocks rose 1 per cent on this news, plus signs that the People’s Bank of China will ease the liquidity problems which had caused Chinese stocks to fall.

In the US, the S&P 500 index this morning has closed at a level just 6 per cent below the peak of a little over a month ago. In isolation, this is a marked fall and there are many nervous nellies extrapolating this fall to sharper decline if in fact the economy improves and the Fed does in fact follow through with its plans to tighten policy.

The peak a month ago was a record high. The recent fall is therefore from an impressive level and compared with the low in September 2011, less than two years ago, the S&P is 40 per cent higher. Not a bad return when viewed in this context. Compared with the crisis lows in March 2009, the S&P is still nearly 135 per cent higher.

It is a similar story with the stock markets throughout Europe, the UK and Canada. The recent falls, which had been close to 10 per cent in just over a month in these markets, followed a stellar recovery from the lows reached four years ago as the crisis reached its deepest level.

There is no doubt that the very easy monetary policy of the US Federal Reserve has fuelled the stock market rise. But this was an intended and desirable outcome as policy was set to stimulate spending, profits, wealth creation and jobs. The counterfactual argument would be that without the super stimulus, business costs would have remained excessively high and asset prices uncomfortably low, both of which would have undermined spending and job creation.

One policy lesson of the 1930s Great Depression was that policy was not eased sufficiently and that the stimulus as it was, was taken away too early. Bernanke has not made that mistake, a point all too clear with the current stance of policy still in place more than five years after the onset of the Great Recession. And even then, it is clear that the stimulus will not start to be phased out until the economy is strong enough to stand on its own feet.

Even the Australian market is not bad. Compared with the peak a little over a month ago, the ASX200 is down around 11 per cent but since June 30 2012, it is up 14 per cent and since the low in September 2011, the ASX200 is up a very nice 21 per cent. The SPI futures this morning suggests the ASX will edge up half a per cent or so today, which again adds some context to the recent dip.

All of which goes to show that context is needed when looking at markets. While the falls in share prices over the last month or so are no doubt a little uncomfortable, we are a long way from reaching a point where there is true wealth destruction and meaningful consequences for the real economy from the price falls.

Stocks should remain buoyant and should be given a boost with a stronger US economy, which in turn will support corporate earnings and profits, even when the Fed starts to phase out the stimulus.