SINCE the 2008 financial crises, US investors have got seriously wealthy playing the "Bernanke put". If the economy grows, stock prices go higher while if the economy stalls, the US central bank prints money and stock prices go up. It is as simple as it is beautiful. A win-win scenario that some professional investors believe is virtually risk free.
And last week the trade got even more potent and has been renamed the "Bernanke-Super Mario put". Global sharemarkets had conniptions when European Central Bank president Mario Draghi announced a big round of quantitative easing (QE) to help allay fears of a eurozone break-up.
As investors get wealthy, a legion of experts are flummoxed by the way markets are reacting to the seemingly endless money printing by central banks. At economic and finance schools around the world we have been taught for decades that money printing is an evil that must be avoided at all times. Academics quickly point out the calamities caused in Zimbabwe recently and in Germany in the 1920s as examples of how events can unravel when the printing presses are cranked up.
In theory, more dollars chasing the same amount of goods will lead to inflation and send the currency on a downward spiral. But in the four years since US Federal Reserve chairman Ben Bernanke ventured into the dark world of quantitative easing, none of these cataclysms have surfaced. Sharemarkets in the northern hemisphere have rallied unabated and now are close to record highs.
Even more confusing for the academics, economic growth has refused to fire in these countries and the issue of swollen sovereign debt levels has been largely left unresolved. Uber-bears such as Nouriel Roubini, Marc Faber and Harry Dent have been on the wrong side of the trade.
The events of the past four years have severely challenged the long-held belief that equities require strong earnings growth and general economic growth to move higher. Instead, stocks have climbed a skyscraper of worry, firmly supported in a harness of endless cheap money from central banks. And to the joy of most sharemarket investors Bernanke and Super Mario have shown no inclination to cut the harness.
Investors are salivating at the prospect that Draghi's cash splash will be followed by a similar announcement by Bernanke at the conclusion of the Fed's next meeting on Thursday. They are so enamoured of the central banks' actions they seem to hold no concern for any negatives, including the looming US fiscal cliff. This involves a series of tax increases and spending cuts that economists believe could cut US GDP by up to 4 per cent next year. The level of complacency among investors can be measured by the VIX index (US fear index), which is sitting at near five-year lows.
The Dow Jones Industrial Average now sits just 6.5 per cent away from the record set before the GFC in October 2007. The German and British markets are similarly poised. If Bernanke pulls out his bazooka this week it is highly probable that these markets can shoot straight past their previous records over the next six months. At that stage we would have to declare the secular bear market in equities that kicked off in the US and Europe back in March 2000 officially over. In its place would be a new secular bull market.
If, however, equity markets don't breach that old high but rather start to trend down over the next few months, things could get nasty. The prophets of doom who believe the fundamental issues of excessive sovereign debt and benign economic growth have to be tackled could yet be proved correct.
The bears will point out that Japan indulged in quantitative easing between 2001 and 2006 to find it had a negligible impact on stimulating domestic demand. To compound the problem, when Japan dumped QE the sharemarket faded as well. The benchmark Nikkei Index sits about 20 per cent below where it was when Japan began its QE programs a scary thought for the bulls and the central banks of the US and Europe.
All this means we are now at the most critical point for global equity markets since the events of August and September 2008. We are on the verge of finding out who is right: the complacent sharemarket investors or the bears.
What of Australia's languishing sharemarket? If the events in the northern hemisphere are anything to go by, there is a lot of reason to be optimistic about stock prices here. With the collapse of mining stocks largely behind us, the sector should not prove to be an anvil around our necks in the future.
Also, the increasing likelihood that official interest rates will be cut in the next six months has to be a big positive. As shown in the US and Europe, investors will chase assets for better returns if they get next to nothing for their cash.
While our big banks live in fear that their hard-earned deposits might run out the door, the equity market would be the prime winner.
Even if the northern hemisphere markets fail to breach their previous records but turn south, the Australian market is not likely to fall by the same degree. The fact it has not rallied anywhere near as much as other markets and the support of interest rate cuts should allow for a more tepid retreat.
matthewjkidman@gmail.com
Frequently Asked Questions about this Article…
What is the "Bernanke put" or "Bernanke–Super Mario put" and why do investors care?
The "Bernanke put" refers to the idea that US Federal Reserve actions (like quantitative easing) will prop up stock markets when the economy weakens. After ECB president Mario Draghi announced big QE, investors started calling it the "Bernanke–Super Mario put" — a belief that central banks in the US and Europe will print money to support asset prices. Everyday investors pay attention because it helps explain why stocks have rallied even when economic growth is weak.
How has quantitative easing (QE) affected global stock markets since the 2008 crisis?
Since 2008, large-scale QE programs have been linked to sustained rallies in northern hemisphere sharemarkets. Despite sluggish economic growth and high sovereign debt levels, central-bank money printing has supported equity prices and pushed many indexes close to or near record highs.
If central banks keep printing money, why aren't we seeing high inflation or currency collapse as economic theory predicts?
The article notes that while theory says more money chasing the same goods should cause inflation and currency declines, the major QE programs since 2008 have not produced those cataclysms. Instead, equities have rallied and runaway inflation has not surfaced, a development that has surprised many academics and market observers.
What signs of investor complacency should everyday investors be aware of?
A key sign highlighted is the VIX (the US "fear index") trading near five-year lows, along with investors assuming central banks will always step in. The article also points out investors seem unconcerned about risks like the looming US fiscal cliff, suggesting a high level of market complacency.
What are the potential market outcomes the article says could happen next?
The article outlines two scenarios: if central-bank actions push major indexes past previous records, we could enter a new secular bull market. Conversely, if markets fail to breach those highs and instead trend down, bears who point to unresolved sovereign-debt problems and weak economic growth could be proven right, leading to a nastier downturn.
Why do some bears compare current QE to Japan's experience, and what was the result there?
Bears point to Japan's QE from 2001–2006, which had a negligible impact on stimulating domestic demand and was followed by a fading sharemarket. The article notes the Nikkei remains about 20% below the level where it was when Japan began its QE programs — a cautionary example for proponents of QE.
What does the article say about the outlook for the Australian sharemarket?
The article is cautiously optimistic about Australia. It suggests the worst of the mining-stock collapse is largely behind us, and that the prospect of official interest-rate cuts in the next six months could support local equities. Australia may not rally as strongly as northern markets, but could also avoid as deep a fall if overseas markets turn south.
How might lower interest rates affect Australian investors and asset chasing behavior?
According to the article, lower official interest rates would make cash returns very unattractive, prompting investors to chase higher-yielding assets. That dynamic tends to be positive for equities, which could benefit from inflows if rates are cut.
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