A major Bloomberg article gaining traction essentially lays out the case for why nothing matters anymore to equities or most other risk asset markets. Just keep calm and buy the dip–and by dip, that means any dip you can find. No dip? No problem. Buy now and ask questions later. Anything is better than getting left behind sitting in the dugout on a pile of rotting cash while passive index investors trot around the bases effortlessly. This encapsulates the state of current market sentiment across much of the G10 economies and beyond.
Trade wars, yawn. Nuclear threats, shrug. Political dysfunction, meh. Corruption, what a shame. In global markets, however, everything is awesome and selling assets is pointless when you have powerful central banks willing to buy anything with a ticker using freshly created cash at the first sign of trouble.
Welcome to the new world of financial markets where buyers of risky assets have inflatable bumper tubes in the bowling lane gutters that seemingly eliminate the prospect of tossing a “gutter ball.”
Underlying economic data is generally fairing well in developed markets with moderate growth, low unemployment, and strong consumer confidence. But nothing is going on in the real economy with fundamentals by any means which warrants the type of easy-breezy-smooth-sailing autopilot price levitation being witnessed. This is the type of hyperconfident market sentiment that gets bubble watchers shrieking from rooftops at a full-throated fever pitch because it rhymes so closely with previous eras just before market crashes.
While that sentiment may ultimately prove correct if there is a major correction in the near future, it may be missing a modernized market reaction function happening in response to a prolonged period of ultra-loose extraordinary monetary policy.
The “Fed/ECB/BOJ put” is cemented into market psyche. Risk is doing its best cute puppy impersonation of playing dead.
Short sellers have been burned by Brexit, Trump, failed attempts at business-friendly legislative reforms, North Korea, Catalonia and everything in between. Asset owners are thanking central bankers for their ultra accommodative policies by spiking a football on their head in the end zone after dancing backward across the goal line. And why shouldn’t they other than, “it wasn’t a responsible thing to do” in the past?
Wouldn’t bad news in the real world now mean lower interest rates for longer? If an economic shock were to come down the pike, wouldn’t the monetary and potentially even fiscal gas pedals get pressed to the floor again? If economic conditions really deteriorated, haven’t countless prominent central banker speeches outlined helicopter money as their preferred answer?
The primary reason to sell risk assets on a broad basis would be a sustained increase in official inflation measures to the extent it would cause a rapid tightening response in monetary policy. Assist FX research reiterates a high conviction view that official inflation indexes understate the actual rise in general price levels by at least 1% annually. That is particularly the case for the items which matter most, such as housing. This implies that the bar is quite high to produce persistently hot readings.
In fact, house prices aren’t even included in the official inflation measures. Financial asset inflation as displayed by 100x earnings multiples in a high number small-cap stocks, ultra low cap rates in real estate, and junk bonds priced like AAA sovereign debt, doesn’t count as “inflation” to central bankers.
Additionally, private surveys in the US seem to indicate a higher rate of increase in auto prices than CPI or PCE do. Goods and services people don’t buy because they rise in price and they are forced to buy substitutes are weighted lower in PCE since only items consumed are measured. Subjective quality increase adjustments are given to several items to lower their inflationary impact in the data while lower quality or reductions in service are almost never reflected as increased stated inflation.
As long as we believe there to be downward pressure on the official inflation measures that central bankers use to base monetary policy, and financial stability is not technically a policy mandate, then selling risk assets due to high valuations or bull market maturity concerns is a hard sell so to speak. It isn’t all that difficult to imagine markets falling dramatically for a number of qualified fundamental reasons, but will they really stay down if any notable bear moves are shot with a liquidity cannon by central bankers hunting for higher prices?
Markets have made up their collective mind. They have decided central banks will come to the rescue on any signs of trouble, thus removing a large portion of the perceived risk of investing. Famed bond investor, Bill Gross of Janus Henderson, has gone so far as to use the label “fake markets” to describe this unprecedented level of market intervention in the developed world. The experiment is ongoing but it continues to be wise to not fight the Fed/ECB/BOJ until the official inflation measures can get and stay hot.