Financial market melt-up takes S&P 500 to new record

Index Jun14A year ago, the blog suggested that financial markets were reaching their most dangerous ‘melt-up’ stage, driven by investor complacency about the ability of central banks to protect them from any downturn.  This analysis was confirmed in November, when absurdly high prices were paid for works of modern art, smashing previous records.

Gillian Tett of the Financial Times (another of the few to forecast the 2008 Crisis), also sees great danger in today’s financial market complacency.  Echoing last week’s blog post on Hyman Minsky, she wrote:

“While ultra-low volatility might sound like good news in some respects (say, if you are a company trying to plan for the future), there is a stumbling block: as the economist Hyman Minsky observed, when conditions are calm, investors become complacent, assume too much leverage and create asset-price bubbles that eventually burst. Market tranquillity tends to sow the seeds of its own demise and the longer the period of calm, the worse the eventual whiplash.

“That pattern played out back in 2007. There are good reasons to suspect it will recur, if this pattern continues, particularly given the scale of bubbles now emerging in some asset classes. Unless you believe that western central banks will be able to bend the markets to their will indefinitely. And that would be a dangerous bet indeed.”

Meanwhile, the latest IeC Boom/Gloom Index (above) continues to suggest the US S&P 500 Index (red line) is very exposed at its current record level.  The Index (blue column) has again failed to confirm the S&P’s rise.

We are thus reaching a very dangerous stage in financial markets.  Investors who do their own analysis long ago gave up trying to fight the central banks.  So they invest, knowing it is all a bubble, because they have no alternative.  Put simply, they cannot sit with cash in the bank when the market is rising – they will lose their jobs.

None of us can individually fight the central banks, as they have the power of the printing press to swamp financial markets.  And they can keep printing – as the market expects the European Central Bank to announce before too long.

But can they print babies?  People, after all, are the real source of demand, not electronic bank transfers.

So we have reached the fork in the road, just as we did in June 2008 when the blog quoted Robert Frost’s famous poem ‘The road not taken’.

Two roads diverged in a wood, and I
I took the one less travelled by,
And that has made all the difference.

The central banks chose their road a long time ago, and still believe that increasing debt levels will, in the end, restore growth to sustainable levels.

If they are wrong, then this debt can never be repaid.

Instead, as the blog discussed on Tuesday, they will find they have created an earthquake ’ring of fire’, connected by deep fault-lines running across the world.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

, , , , ,