How financial markets turned upside down in 2019

With one day of trading to go, 2019 is on course to be one of the strongest in the history of financial markets after shares around the world racked up record after record in another barnstorming year.

On Wall Street the Dow Jones industrial average has gone up almost 25% having reached record highs day after day, while the broader S&P500 is up 30% and the tech-heavy Nasdaq has grown 40% in value. The FTSE100 in London is close to its record high, as is the Dax30 in Germany. In the Asia Pacific, the Nikkei is up 15% while Australia’s ASX200 is still close to its highest ever point (reached in November).

But none of these countries, with the exception of the US, are in particularly good shape. Instead their stock markets are being sustained by ultra-low borrowing costs led by the US Federal Reserve.

This latest round of rate cutting has turned many of the assumptions about economics on their head to create a bad-news-is-good-news paradigm for markets.

While once the release of poor economic data dented share prices, now it sends them upwards because investors expect more central bank intervention.

Traders have learned the lessons of the past 10 years and have grown accustomed to expect central banks to act at the slightest sign of economic distress. Markets had a serious wobble in 2018 after the Fed hiked rates. But a U-turn amid intense pressure from Donald Trump, who blamed the Fed chief, Jerome Powell, for stifling growth, has brought the good times back again.

Governments have increasingly abdicated old-fashioned pump-priming economic management, leaving it to central banks whose only tools are to cut rates or introduce money creation schemes such as quantitative easing. This hasn’t done much to revive most major western economies but it has succeeded in flooding the financial markets with cash, boosting prices of assets such as shares, bonds and property.

The prospect of a truce in the US-China trade war and the probable resolution of Britain’s Brexit imbroglio have helped boost optimism in recent weeks, says Eleanor Creagh, economist at Saxo Capital Markets in Sydney, but the really important factor was central bank policy.

“The really key driver is coming from central banks and central bank liquidity,” she said. “A whole host of central banks are in easing mood. There is a very high bar for central banks to turn back to rate hikes and normalisation of monetary policy.”

This meant investors were free to buy up assets despite high valuations, safe in the knowledge that monetary policy was effectively underwriting their trades.

“For investors, the key consideration is that the central banks have your back and you’re free to buy and it doesn’t matter what the economy is doing.”

US Federal Reserve policy – first designed as an emergency response to global financial crisis but now the norm – is so dominant that the pattern can be seen not just in the UK, European and Japanese markets, but right around the world.

Take India, for example. Indications earlier this month by the governor of the country’s central bank that there could be more monetary easing next year sent the stock market to a new high. The Reserve Bank of India has lopped 1.35% off its base rate this year, taking it to 5.15% – very low in India terms. The country’s S&P BSE Sensex index of leading shares has risen to a record 41,352. At the same time, economic growth is at its weakest for six years.

David Ingles
(@DavidInglesTV)

Australia’s stock market is within 0.2% of an all-time high. Might get there today. So excited

December 16, 2019

The Reserve Bank of Australia has reduced interest rates to record lows in the hope of improving sluggish growth. Likewise in South Korea and Thailand where the authorities have signalled that more monetary easing is on its way, confident that the Fed will keep the music playing.

Creagh says the Fed’s recent decision to pump $500bn into the repo market – short-term borrowing for dealers in government securities – added more fuel to the market fire and wa sa kind of backdoor stimulus. By January the Fed’s balance sheet (mostly bonds that it has to pay out on eventually) will surpass what it was at the height of the massive quantitative easing programme instigated after the global financial crisis in 2008, leading some to dub the current expansive policy as “stealth QE”.

The repo liquidity boost is set to end in the new year at which point markets will look for another sugar hit or, alternatively, more of a convergence between equity prices and the real economy, Creagh says. For this to happen they’ll expect to see green shoots and something more real in the economy.

Although doomsayers see this market reversal as an ominous portent, most observers agree that there are no immediate signs of the worldwide recession that many have predicted.

Holger Zschaepitz
(@Schuldensuehner)

Recession gets priced out by a stock rally for the record books. Very big years in markets rarely come right before recessions. Research finds stock returns lead S&P earnings by a quarter. https://t.co/pm0AfIWXze pic.twitter.com/sMqXjTLxH1

December 28, 2019

But they also agree that central bank policy has become increasingly ineffective and is close to running out of steam as we head into 2020.

Damien Klassen, of Nucleus Wealth in Melbourne, argues that when QE first started after the financial crisis, stock markets were slow to feel the positive impact. But with each wave the impact has been more predictable and is now already reflected in prices before it has been fully rolled out.

“We need governments to take over and start spending although it’s certainly not happening in Australia with our surplus-obsessed government.

“Trump is doing his part – he’s happy to spend other people’s money as fast as he can and the UK election was about who was going to spend more. Europe is in a holding position but at some stage politicians have to start spending.”

What happens if governments don’t take up the baton is not clear.

“The question is, do they need a crisis to start spending and will the markets provide that crisis?” says Klassen. “It could come from corporate debt this time. Otherwise the markets will grind sideways next year because I cannot see where earnings growth is coming from.”

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