Western financial markets are getting nervous that the US Federal Reserve will cut off their supply of cheap money. They went through the same panic in 2011. Now they again have to wait to see what happens.
The chart of the new IeC Boom/Gloom Index above highlights the parallels:
- Markets were strong through April 2011, with the Index (blue column) and S&P 500 moving higher (red line)
- Central banks thought that their stimulus (orange block) had revived growth: they turned off the tap of new money
- But the growth of the 2009-2011 period turned out to have been a “headfake” as Dow’s CEO noted last week
- And markets went into a dive until the Fed promised to do a follow-up to its QE2 programme
- Developments in 2014 are very similar, with the Fed now expected to end its current programme in Q4
One sign of the concern is that the Dow Jones Index closed last night below its opening level of 16576 on 1 January.
The key issue is shown in the second chart from Doug Short at Business Insider. It highlights how markets have become dependent on central banks:
- It shows the S&P500 inverted on the right-hand side (blue line),
- The left-hand scale shows when debt was rising (red area): or, rarely, when credit was reduced (green)
- Before 2000, markets moved higher without investors needing to increase their debt levels
- But since then, markets have only been able to move higher when pumped up by more borrowing
Thus the S&P’s recent peak at 1978 was matched by the highest level of borrowing ever seen at $180bn.
This quite different from the pre-2000 world, when the BabyBoomers were generating demand to boost company profits, and investing in the stock market as they saved for retirement.
The risk of this debt-dependency is highlighted by India’s central bank governor, Raghuram Rajan, in an interview kindly forwarded by a blog reader. Rajan warns investors currently “believe that central bank policies will protect them against a fall in prices“, and adds
“We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost.”
The problem, of course, is that central banks have created a debt-fuelled ‘ring of fire’. Record levels of stock market debt are just one of the fault-lines.