There is a very good chance
the global equity rally has finally reached the end of the road. Stock market
sentiment has been at a tipping point for quite a while and last week’s shock
over the Bank of Japan’s refusal for now to go any deeper into negative
territory on interest rates could prove to be the last straw. Market fears
about the era of central bank monetary super-stimulus coming to an end are gaining
ground.
Japan has reached a policy
impasse. The economy is grinding to a halt and another recession seems on the
cards. Consumer demand is dead in the water, industry is riddled with gloom and
the economy is stuck in deflation. Government finances are in a mess, leaving little
room for further fiscal reflation. And now the Bank of Japan is throwing in the
towel on further interest rate cuts, unless there is an emergency. Japan’s
macroeconomic policy has just hit a brick wall.
It is no surprise that
Japanese investors are taking matters into their own hands and selling stocks
and buying the yen. Last week the yen posted its biggest weekly gain since
2008, bad news for exporters and an ominous portent of increasing risk aversion
to come. Normally, when Japanese investors are spooked they liquidate overseas
investments very quickly. Repatriation of funds back to Japan is a classic
knee-jerk reaction in times of market stress.
The yen was one of the
biggest beneficiaries of the global financial crisis and seems a reasonable
barometer for risk appetite. What is worrying now is that the yen is rallying
before any deep-seated crisis has occurred, almost in anticipation of worse to
come. Stock markets need a healthy diet of good news to maintain a positive
momentum, but the market mood is coming unstuck quite quickly.
For the last seven years, the
global bull market has been fed by a constant flow of positive support and super-stimulus
from the major central banks. Equity markets have been pumped up by zero
interest rates and aggressive quantitative easing, which has generated a huge
cash pile of cheap liquidity for investors to buy risk assets. Since 2009, central
banks have spent $15 trillion on bond and equity purchases, creating a market dependency
that will be all the more painful when it ends.
This glut of global money is
providing a strong cushion for markets at the moment but as soon as the central
banks enter into a more definite phase of policy normalisation the safety net
will quickly disappear. Investors already seem to be scaling back their
appetite for risk in anticipation. In Europe, investors already battle-scarred
by euro zone uncertainties, have cut their exposures to equities back to their
lowest level since the 2011-12 crisis. The trend is clearly heading lower.
There is no sense of extreme
market crisis just yet, just a gradual creep towards the exits. The trouble is
that there is nowhere to hide if events turn nasty. Investor holdings of safe
haven government bonds and cash are close to historic highs, despite wafer thin
and even negative rates of return. Investors are being driven by an overriding
need to protect capital far and above the usual goal of maximising returns.
Safe haven demand for yen, Swiss francs and German government debt are likely
to surge as the going gets tougher.
The usual suspects are lining
up to ambush the markets. Business cycle slowdown, hard landing risks in China,
the danger of epic debt defaults, another euro zone crisis and deepening
geo-political tensions all have the potential to wreak major damage on investor
confidence and global financial stability. Perhaps the greatest risk of all is
the central banks not coming to the rescue any more.
Right now, it looks like the
US Federal Reserve, the Bank of Japan and the Bank of England are done and
dusted with easing. Even the possibility of additional European Central Bank stimulus
looks more remote now that euro zone growth has had a 0.6 per cent GDP surge in
the first quarter. However tenuous the recovery, ECB hawks have their excuse to
dig their heels in.
If the central banks do come
in again with additional easing, the markets will know it will be for crisis
management reasons. And as soon as the BOJ hits the panic button to lower rates
again, financial markets will have added proof that the global equity rally has
finally hit the buffers.
Article appeared in the South China Morning Post 3rd May 2016
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