Monday, March 23, 2015

View from 10,000 Feet

After a weekend to clear the mind and look at the markets with a fresh perspective, we are clearly building a top.  Not just in the S&P 500, but in global equities.  It is not earnings expansion driving prices higher, but valuation expansion.  In U.S., Europe, and Asia.  Shanghai Composite is at a post 2009 high.  So is the Eurostoxx, and the S&P 500.  The bull market is 6 years old.  The economic data is coming in weaker than expected.  The faith in central banks keeping the liquidity going is at an all time high.

Here is the problem.  The central banks can provide the liquidity, but they do it through the bond market.  The money does not have to flow from the bond market to the equity market.  There is no rule that says so.  The money can just stay in the bond market, or cash, or the money that went into equities can go back into bonds, or cash.  Only because we've had such a long lasting rally in equities that people assume that QE automatically equals higher equity prices.  Going forward, I don't believe that will be the case.  Rather, I believe QEs going forward will greatly distort the bond market, leading to unthinkably low yields, even in Treasuries.  I would not be surprised to see a 1.0% 10 year Treasury yield in 2016.  10 year yield, not Fed funds!

You would think the S&P and commodities would gap up pretty strongly on this weaker dollar, but its not.   I see very limited upside here, and see a sideways trade for the rest of the month that lures in more inflows before we get another move lower.


Ivanovich71 said...

Or central banks can be like the BoJ and openly buy the market.

Market Owl said...

Yes, that's always a possibility, but according to the federal law, Fed cannot take credit risk when buying securities, so it would be considered illegal. Doesn't mean that they won't try to get around the law if they are really desperate to pump up equities, but that wouldn't happen unless we crash again.