Investors focus on central banks and less on fundamentals

The stock market is reacting, once again, to central bank rhetoric rather than fundamental economic data. The underlying data and the mood of the bond market are suggesting that the global economy is facing the possibility of heading into an economic recession, US indexes are once again close to all time highs. Jerome Powell indicated last week the Fed would do what they believe is necessary to keep the economic expansion going. In other words, they are now looking at the possibility of cutting interest rates. The Fed is not the only one, but they are the World Bank in this regard.  The Governor of the Bank of Japan was quoted on Bloomberg on Monday suggesting they had more tools at their disposal should they need to stimulate the Japanese economy further. The ECB, at their monthly meeting, talked about the possibility of needing to boost the eurozone economy. Finally, on Tuesday commodity prices rose on the expectation the Bank of China could add spending to infrastructure to help prevent a harder landing to their economy on the back of trade fears. The S&P 500 is now back close to its all-time highs recovering a lot of the previous month’s losses.

The Federal Open Market meet next week. It may be that the investor base has already baked in a move by the Fed. In which case, either way, a more dovish Fed or a “wait and see Fed” may lead to some volatility in equity prices.

As we enter almost ten years of economic expansion there appeared an interesting article in Tuesday’s Wall Street Journal discussing the difference between a business cycle, which traditionally lasts between 5-8 years and financial cycle that lasts much longer.

Financial cycles end when business and families are overleveraged and are then forced into destructive defaults. Two examples of the late ’80s and the mid-2000s. The article goes onto suggest that central banks are now able to maintain growth as a result of the development of global supply chains and weak unions keeping inflation down. The trouble is, as we saw in 2007, economic confidence creates complacency and eventually a meltdown. The conclusion to the article is at present household debt is not at historic peaks. What may be of more significant concern is the extent to which the level of corporate debt which has grown during this economic expansion. More importantly, according to Deloitte insights, the quality of debt has fallen as has the interest cover, effectively the ability to pay back.

The Fed may well cut interest rates again. The effect could again encourage the trend of more debt. Continuing the cycle of lower quality and a reduced ability to pay back if the Fed did look to normalise rates again. It’s a delicate balance to keep. They desire to keep the global economy expanding, allowing profits to grow to enable companies to reduce reliance on debt gently ultimately.

Posted on June 11, 2019 .