Could the stock market be headed for a huge fall now that central banks are removing stimulus measures?

Jerome Powell
Fed Chair Jerome Powell speaks in the Rose Garden shortly after his nomination in November, 2017

In the wake of the financial crisis over 10 years ago, the world’s largest economies were left in a precarious situation. Low growth, hampered investor sentiment, lower spending and high unemployment all combined to create an economic malaise which forced central banks to act, in an effort to stimulate the ailing economies which they served.

In the years that followed, the Federal ReserveBank of JapanEuropean Central Bank and Bank of England all took measures to deal with a major economic downturn, which had spread globally.

One way they did this was through quantitative easing, where they bought large amounts of assets from commercial banks and institutions (including government bonds) while raising the supply of money in the economy.

The overall goal was to encourage lending, borrowing and consumer spending and to improve business sentiment, but there was another side effect they were hoping for — an increase in asset prices (including stocks). This side effect was realized, though not only through QE, but also because banks slashed interest rates to historic lows, which meant that bonds became less attractive for investors (due to lower returns). Because of this, investors sought riskier assets like stocks to generate higher returns. With more money being pumped into the stock market, the price of those securities increased. Central banks also hoped that by improving returns from stocks, they could also create a ‘wealth effect’, that would lead to higher spending too.

But that was the past and now all of this is changing.

The Fed in the US and the ECB in Europe are reversing their ‘easy money’ policies, because they think that the US and Eurozone economies are strong enough to stand on their own. It has taken 10 years, but economic markers are now being dubbed healthy enough to begin a long period of ‘unwinding’. The ECB confirmed in a statement on June 14th it would end QE bond purchases by December, while the Fed has already started unwinding its massive balance sheet after ending QE and is raising interest rates as both banks move to ‘normalise’ monetary policy.

What does this mean for investors?

Could things get bad for stock prices now that central banks are removing some support for the economy? Did QE really make that much of a difference to stock market valuations and is broader policy normalisation definitely going to hurt your portfolio? Opinions differ wildly on the matter, which makes things all the more confusing!

Writer Thomas H. Kee Jr. at investment publication MarketWatch said: “We believe that bonds, stocks and real estate will experience significant repricing in the years ahead, with the stock market at greatest risk. A 40% correction in the S&P 500 is possible.” Given the fact that many stocks in that index (particularly big names in the tech sector) look overpriced relative to their peers in other markets around the world, the earlier part of the argument seems like a fair assertion.

Then we have the counter-arguments. A report from Deutsche Bank in late 2017 said that QE may have impacted stock market movements by artificially boosting corporate profitability and by raising investors’ animal spirits, but the overall message was that strong earnings potential for US corporations indicated that corporate America is strong enough to withstand the withdrawal of QE and higher interest rates, and that fears that a withdrawal of stimulus could trigger an equity market meltdown appeared overblown.

Invstr CEO and former Deutsche Bank Director Kerim Derhalli is not so optimistic. He explained: “QE worked by boosting liquidity in the economy as the central banks bought bonds and gave the sellers of those bonds dollars or other cash in return. Many people agree that the liquidity that was generated contributed to the phenomenal rise in financial asset prices. As the Fed continues to unwind its $4.3trn balance sheet, the opposite will be true. The Fed will sell bonds on its balance sheet and drain US dollars out of the economy. This will reduce the liquidity available to purchase equities.”

He added: “Four other factors also bear watching: 1) Interest rates will rise making equities relatively less attractive than bonds. 2) Companies, especially emerging market companies who have added $40trn of debt since the debt crisis (!) will find it much harder to re-finance their bonds and loans in the capital markets. They will be competing for US dollar liquidity with the Federal Reserve. That will lead to more corporate insolvency and create pressure in the equity markets. 3) The US government has massively increased its budget deficit following President Trump’s tax cuts. That means that companies will be competing against both the Fed and the Treasury for liquidity. 4) The consequence of greater competition for dollar liquidity will mean a sharp rise in the value of the US dollar. This will have negative implications for US exporters and commodity producers creating further negative feedback for equity markets.”

Stock markets in the US in particular saw a large correction back in February this year, but relative stability has remained since then. Even with the knowledge that the era of QE and ultra low interest rates is beginning to come to an end, the S&P500 index is still up over 14% since June last year, with a slew of strong corporate earnings for bluechip companies through 2018 thus far too. It seems for most of the year, investors were betting that Jerome Powell and his fellow central bankers across the world would not make any significant missteps and that stock prices could remain high in the face of gradual policy normalisation.

Overall though, as billionaire investor Howard Marks put it to The Irish Times late last year: “We are in uncharted territory with all these central bank policies. We can’t say what will happen.” He added, “Anyone who says ‘I am completely confident in my understanding of the situation’ is really not that smart.”

A smart move for investors would be to keep an eye on this narrative as it develops. Whether the outcome of the withdrawal of stimulus measures is a huge correction in the markets, or whether it’s relatively minor in comparison, the end of the ‘easy money’ era is definitely going to have some impact on global stock indices.

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India’s economy set to overtake UK – knocking it from The Commonwealth’s top spot

This week Britain is playing host to the leaders of The Commonwealth nations. As the event takes place, the UK will still hold the crown as the largest economy out of the 53 countries included in the lineup, but by the time of the next meeting in Malaysia in 2020, it’s almost guaranteed that India’s economy will have surpassed Britain’s in size. It will be a change that symbolises the tectonic shifts in the world economy, as Asia’s booming nations continue to challenge the economic dominance of the West.

Currently India stands at number 6 on the International Monetary Fund (IMF) world GDP rankings, with a GDP of over $2.26 trillion behind Britain’s $2.61 trillion, but bullish forecasts from both the World Bank (WB) and IMF suggest India will cruise comfortably into 5th place behind Germany in the next 2 years. The WB forecasts 7.3% growth this year for India’s booming economy, up from 6.7% last year, while IMF pegs it at a slightly more upbeat 7.4%. This will make India the world’s fastest growing economy in 2018, surpassing China.

But it’s not only India’s current shorter-term (1-2 year) growth prospects that should be cause for excitement, not least for investors in Indian equity markets. The longer-term equation looks equally lucrative. The Indian economy has plenty of room for future growth. Putting aside any external tailwinds from problems elsewhere in the world which could affect global trade and investment, India has the recipe for success including:

– A rising middle class which is spending and investing more.

– A young population (more than 65% below the age of 35) with more and more people entering the workforce, growing the pool of labor available for companies.

– A massive rural population that currently has low access to digital services and infrastructure, but with a government that is pushing to create a digital revolution in India, ecommerce companies like Amazon and Flipkart will be able to grow quickly as people who once never had access to internet start buying goods online.

– A stable government that has launched a flagship health insurance scheme to cover over 100 million families, while also pledging to invest large sums in the agricultural sector (the most important sector of the Indian economy accounting for 18% of India’s GDP which employs 50% of the nations workforce).

The IMF said today that India needs to address weaker aspects of its labour market and reform issues in its financial sector. With these issues solved, more jobs will be created and banks will feel more comfortable lending, both adding yet another stimulus to an already rapidly expanding economy.

Britain will now be looking to secure an even closer partnership with India, (which was referred to the ‘crown jewel’ of its empire in the colonial period), especially given the need it has to establish new trading relationships post-Brexit. It is likely that trade will be a key factor of discussion as representatives from both nations, and all other members of the Commonwealth community representing over a quarter of the world’s population, meet in London this week.

Stock markets rise despite growing Syria tensions

Markets are still poised for the possibility of military conflict erupting in Syria between the US and her allies (Britain, France, Saudi Arabia and possibly Turkey) and Russia, with the backing of Iran and the Syrian regime. While NATO members are preparing a response to the alleged chemical weapons attacks in Ghouta, Trump’s Defense Secretary James Mattis warned any strike should be carefully planned to avoid a major conflict between the superpowers.

Even if a war is avoided, the events of the last 2 weeks (including US sanctions on Russian businesses and oligarchs) have severely damaged US/Russia relations. Reports say Russian lawmakers have drafted legislation which proposes to ban American imports including software and medicines, as well as stopping cooperation on atomic power and more.

The American sanctions put in place a week ago, caused the Russian RTS index to fall -11.4% on Monday, it’s biggest one-day decline since December 2014. The Russian Ruble also suffered a dramatic fall against both the Euro and Dollar as foreign investors pulled out of Ruble-denominated Russian government debt.

At the moment, peace reigns and stock markets are in positive territory. European indices are on track to make weekly gains despite geopolitical worries. The FTSEurofirst 300, which tracks the 300 largest companies ranked by market capitalisation in the FTSE Developed Europe Index, is up for the week despite geopolitical turbulence (see the chart below).

Keep in mind that in the long term, a US strike in Syria may not have too much of an impact on indices, and may only cause a short term bearish movement. It all depends on whether the situation deteriorates further. Right now NATO countries seem to be waiting on Trump’s administration to act, but what they will do is no clearer now than it was earlier in the week.

Eurofirst

Trump adviser Kudlow calms the markets. Is now the time to buy the dip in stocks?

President Trump’s key economic adviser Larry Kudlow (pictured) jumped into action to try and soothe volatile stock markets yesterday, which were flagging at the open due to China’s announcement of retaliatory tariffs on over 100 American goods. Speaking to Fox Business, Kudlow said Trump’s tariff plans were just “the first proposals”. He added: “In the United States at least, we’re putting it out for comment, it’s going to take a couple months. I doubt if there will be any concrete action for several months.”

The statement seemed to indicate the US is flexible in its approach, and may soften tariffs. Perhaps all of this could just be Trump’s ‘art of the deal’ in action – talking tough to make China come to the negotiating table. Regardless, stocks moved up at the close after the big early selloff yesterday. The S&P500 closed up 1.15% higher. Investors took Kudlow’s words as a good thing.

Is it time to buy the dip in stocks?

It could very well be. Fear over the trading situation between America and China was a significant part of the reason why stock prices (particularly in key US indices) fell over the past month. However, now that reports seem to indicate the two nations are trying to find a way to resolve the dispute behind the scenes in private talks, it seems there is a chance that fears of a full-scale trade war may not come to fruition. Any confirmation of a cessation of hostilities over trade may prompt a surge upward for stocks, not to mention the fact that the start of the earnings season is just around the corner – another potential boon for stock market indexes.

Buying the dip in stocks ahead of the upcoming earnings season could bode well for investors, historical data from Jefferies shows. Analysts at the bank said in a note last week that the S&P500 averaged a gain of nearly 2 percent during an earnings season since 2000 when the period follows a monthly decline.  Keep this in mind as the U.S. earnings season kicks off on April 13 with J.P. Morgan Chase, Wells Fargo and Citigroup releasing quarterly results!

It was a tough first quarter for equities. Here’s some reasons why…

It has generally been a rough first quarter for global stock markets. The rip-roaring gains that made 2017 so lucrative for investors came to a screeching halt in the first 3 months of this year.

The Nasdaq index, which boasts the biggest names in American tech among its constituents (including Apple, Amazon, Facebook and Nvidia among others), went into the red (a loss) for the year after a 3.5% fall during trading this week. The weakness came as investors worried about the future profitability of these companies, in light of a spate of bad press for them recently.

For example, Facebook shares were pulled down by over -12% for the month due to concerns about user privacy following the Cambridge Analytica scandal, while Amazon stock has been under pressure after coming under fire from Trump as well the European Union, which has had the Bezos behemoth in its sight for some time. Last month, the European Commission revealed plans to clamp down on the market dominance of the business of Google amongst other tech titans including Amazon by aiming to tax consumers differently.

Nvidia shares took a large hit too this month (down over -5%) after the firm said it would be halting tests for its autonomous vehicles in light of an incident in which a self-driving Uber hit and killed a pedestrian in Arizona.

The broader picture for stock markets

Despite individual company woes, the broader macro picture is also worrying the markets. It seems reasonable to point out that a lot of selling may be taking place off the back of worries about the future of the US/China trading relationship. In response to President Trump’s tariffs on steel and aluminium enacted last month, China unveiled retaliatory duties worth $3 billion on US food imports, which was quickly followed by tariffs for over 100 goods on April 4th, including cars, certain aircraft, tobacco products, whisky and many others.

Investors will be watching closely for any further escalation in rhetoric and action. Given that both economies provide so much to the engine of global economic growth, the outcome of the trade dispute will be seen as very important for investors trying to predict the future for world stock markets.

Elon Musk takes the wheel at Tesla to try and solve Model 3 production issues

It’s no secret that the Tesla Model 3 car has had its share of issues in production terms. The vehicle was touted as the first affordable model for the mass-market, with a lower price tag compared to Tesla’s of the past which would encourage consumers to make the move to electric cars, but deliveries of it to customers have been delayed multiple times, a fact which has repeatedly frustrated investors over the last year. Some were worried that the side projects of Tesla CEO Elon Musk (the Boring Company and SpaceX) were taking up far too much of his attention, contributing to the bottleneck in deliveries.

This may now change however. The enigmatic Musk is taking over responsibility for Model 3 production, according to sources, pushing aside his Senior VP of Engineering Doug Field. The news helped the stock to rally by over 4% on April 3rd, but may not come as a big relief to investors overall, given that Tesla shares have just seen their worst month in 7 years, down over -24%!

The biggest losses came after news broke that a Tesla driver had died using a Tesla vehicle’s autopilot mode on a California highway. Tesla say the driver received visual and audible warnings but ignored them, so it wasn’t the fault of the autopilot system but human error which caused his death.

Despite investor concerns about production bottlenecks and vehicle safety, clearly Musk has kept his trademark humour intact. On April 1st the CEO Tweeted that Tesla was bankrupt despite intense efforts to raise money including a mass sale of Easter eggs.

Though the Tweet was sent in jest, it was not a million miles from the truth. Nothing was funny about Tesla’s financial statement for Q4 2017. The company lost $1.96 billion that year, up from a $675 million loss in 2016. To boot, the company already owes investors over half a billion Dollars in interests paid annually on debt. Total liabilities for Tesla stand at $24 billion, or 84% of its assets.

There’s no guarantee that with Musk on board, the Model 3 production issues can be resolved completely, and while the massive dip in the share price might have prompted a tasty buying opportunity for investors, caution should be exercised!

Trump puts world markets on edge – but relief for stocks may be at hand

Stock markets around the world took a large blow last week. The biggest factor at play was President Trump’s instigation of new tariffs on China over concerns of intellectual property theft – the second action on trade in as many weeks after the administration enacted steel and aluminium tariffs for the Chinese and other nations.

However the other reason concerned geopolitics, and perhaps the future of the world as we know it today. The sitting National Security Adviser at the White House H.R. McMaster was axed, and Trump replaced him with a former ambassador and mouthpiece for the military-industrial complex John Bolton. This appointment has palpably raised the prospect of an armed conflict between the United States and one of its adversaries, most likely to be Iran. Indeed, John Bolton called for Israel or the US to bomb Iranian nuclear facilities as recently as 2015, in an op-ed piece for the New York Times. Bolton was also a firm supporter of the war in Iraq, which many consider to be an illegal war driven purely for the benefits of American corporate interests, including oil companies.

Trump has seen more moderate and reflective members of his administration leave in recent months. Hope Hicks, who was known as having a calming influence on the President, left her post as White House Communications Director, shortly followed by Gary Cohn – Chief Economic Adviser. A former Goldman Sachs employee, Cohn had opposed Trump’s metal tariffs, and was one of the key players behind getting the popular tax reform bill passed last year. Soon after Rex Tillerson got the chop as Secretary of State, another moderate who favoured keeping the Iran nuclear deal and seeking a diplomatic resolution to tensions on the Korean peninsula. Trump replaced him with Mike Pompeo, the former CIA Director who holds a noted aggression towards Iran.

Jeremy Bash, a former Chief of Staff at both the CIA and Defense Department said on MSNBC that Trump was “assembling a war cabinet”. Given the direction of his team, this seems hard to argue with. With less mediating influences at his side, Trump will be less likely to hear opposing arguments from more dovish staff. Instead his views on Iran may be blindly accepted in an echo chamber where voices of dissent are minimal. Ironically, Trump ran on a platform based partly on withdrawing the US from expensive overseas wars, but he has constantly reaffirmed his commitment to increase military spending since he took office.

A war in Korea has been made less likely thanks to Kim Jong Un approaching South Korean leader Moon Jae In, but a question mark still hangs over the Middle East, not only because of the possibility Trump will scrap the Iranian nuclear deal, but also the prospect of a conflict erupting over Syria, where Russian forces are still propping up the Assad regime. Just last month, The Guardian reported that scores of Russian mercenaries had been killed by US airstrikes in the country as the US attacked pro-regime forces. If events like this continue to occur, the prospect of a confrontation between the US and Russia rises. Russia already resents the fact that NATO military buildup on its borders in Eastern Europe, and it goes without saying what a war between the two could mean for the global economy.

None of this is good news for the world as a whole, except those in the military-industrial complex who hold stock in military companies!

Today though things look brighter. US stock futures are up, on reports the US and China are trying to resolve the trade dispute behind the scenes. European markets are also driving higher led by the DAX (Germany 30). We have our fingers crossed that the worlds foremost superpowers can be pragmatic, adult and reasonable – though with Trump at the helm of one of them, this is not guaranteed.