Why should we think there is anything amiss by looking at the global capital markets? The S&P 500 and the German DAX are at record levels. The Japanese market is at 20-year highs. The MSCI Emerging Equity Index moved higher every month this year through August. It slipped a little more than 0.5% in September but is up 4% in the first half of this month.
Aren’t interest rates low, despite trend or better growth in the US, EU and Japan? The BRICs are expanding. The IMF revised up its global growth forecasts. Although low-flation remains a significant concern for central bankers, deflationary forces appear to have been arrested. There are an estimated $3 trillion of debt still offering negative interest rates. The US benchmark 10-year yield has turned back from the 2.40% area as it has done a few other times over the past six months.
The 10-year German Bund yield is capped at 50 bp. It did spend some time above there in July and August and flirted with it again in late September and early October, but it is now testing the lower end of its recent range near 40 bp. A trendline is drawn off the last time the Bund yield was below zero, October 2016, and off this year’s April, June and September lows comes in now near 33 bp.
The persistent dollar strength seen from the middle of 2014 through the start of the is the year, faded this year. The dollar’s strength was a factor cited behind the recent disappointing inflation readings. Although the foreign exchange market has not been a major source of stress for officials, there does seem to be some effort to talk it down when it has strayed above $1.20.
We suspect that infatuation with the so-called cyber currencies, which have little in common with what we know as money, and even fiat money at that, is partly driven by the same underlying factor as other financial assets. There is too much capital relative to the demand by industry and much of the surplus capital that is not simply wasted gets circulated in financial assets.
Moreover, companies used to be the net borrower of capital, and now they are net suppliers. US, Japanese, and European corporates are sitting with an estimated $7-$8 trillion of cash and cash equivalents on their balance sheets. Since the early 2000s, when US laws were changed to exempt share buybacks from stock manipulation rules, US companies have bought by an estimated $7 trillion of their shares.
One of the developments this year has been the stepped-up corporate buybacks of their debt. According to Bloomberg data, through the end of September, S&P 500 companies have bought back nearly $180 bln of their bonds after a little more than $87 bln all of the last year.
Leave aside the lessons that Minsky taught, and many of us had to re-learn during the Great Financial Crisis, that financial stability itself leads to its opposite, through financial engineering, leverage, and mispricing of risk. Leave aside that the spread between the Russell 1000 Value Index and the Russell 1000 Growth Index is the widest since the end of the tech bubble in 2000. The immediate problem is that the rewards of the market economy and appreciating asset prices benefit the few, and, in various forms and numerous ways, the response has become a potent political force.
Indeed with the arguable exception of the UK, which publishes its latest CPI, retail sales, and employment reports, politics dominate the agenda next week and in the run-up to the ECB meeting on October 26. The market has gone as far toward pricing in a December rate hike as seem prudent at this juncture. It peaked as we surmised after the September employment report. Six Fed officials speak in the week ahead. Yellen and Dudley’s comments are the most important, but investors should not expect more insight into the December meeting, and we would pencil in zero chance of a November hike.
