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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The world economy is stronger but tensions are rising – a look at the OECD’s latest report

The OECD says the global economy will see its strongest growth in seven years in 2018 thanks to a rebound in trade and investment, though it also warned today that a trade war could threaten the recovery.

In its March 2018 interim economic outlook which used the subtitle ‘Getting stronger, but tensions are rising’, the organisation updated its outlook for G20 economies and raised its global growth forecast for 2018 and 2019 to 3.9 percent – the highest since 2011, from previous forecasts of 3.6 percent for both years.

The raised forecast is partly due to expectations that U.S. tax cuts will boost the American economy.

Here were the key positive takeaways from the report:

– Growth is improving or steady in most G20 economies

– Trade and private investment are bouncing back

– New fiscal stimulus in the United States and Germany will further boost short-term growth

– Inflation (a concern for Central Banks) is set to rise slowly

– Consumer confidence, particularly in BRIICS nations (Brazil, Russia, India, Indonesia, China and South Africa) has risen sharply

The key negatives and risks were as follows:

– Income gains, particularly for median and low income households have barely improved over the last decade

– Public and private debt in G20 nations is very high, with China leading the way at over 200 percent of GDP

– The pace of structural reform is slow, in emerging market countries especially

– An escalation of trade tensions would be damaging for growth and jobs

Regardless, the overall picture is healthier. Acting OECD Chief Economist Alvaro Pereira said: “We think that the stronger economy is here to stay for the next couple years,” He added, “We are getting back to more normal circumstances than what we’ve seen in the last 10 years.”

This is good news for investors the world over, as a more robust global economy will create a better environment in which companies can grow and expand more easily, boosting corporate results and shareholder returns.

Tesla Stock Turns Bearish as Model 3 Production Disappoints Investors

Shares in electric auto-maker Tesla slipped Thursday (4/1/2018) on American stock markets, after the company announced production targets of Tesla’s highly sought after Model 3 cars had been pushed back yet again!

In the latest disappointing news for Tesla investors, the company revealed they delivered 29,870 vehicles in Q4 2017, with only 1,550 of those being Model 3 cars. These numbers fell short of forecasts, while it pushed back production targets for the Model 3 as well. This puts the Model 3 at under 2,000 deliveries for its first six months, while the Chevy Bolt just announced its best month ever at more than 3,000 units delivered. A damning comparison.

In 2017 the company said it planned to reach a production rate of 5,000 Model 3 cars per week by the end of the year, but later revised back this target to the end of Q1 2018.

Now however it says it doesn’t expect to reach this target until Q2 this year (representing yet another delay). It said it had made “major progress” toward addressing production bottlenecks, but these words will ring hollow for investors who are growing increasingly frustrated.

Tesla figurehead Elon Musk said in October that the company had been “deep in production hell” making the Model 3. The car is its first attempt to create an appealing electric vehicle for the mass market and not just niche enthusiasts.

Some investors believe the issues in the production chain could be more easily resolved if Musk spent more time on Tesla instead of his other ventures (The Boring Company and SpaceX).

Here’s a 1 month chart for Tesla’s stock. It was a poor December for shareholders.

Telsaa

With all of this being said, I find Tesla to be a fascinating company and a stock to watch for the long term.

Setbacks in production, though frustrating, are not unusual for a business which is so focused on revolutionizing the auto-sector and the way humanity will travel in the future. I think investors understand that too.

Tesla’s tentacles keep spreading further across the auto-industry. Elon Musk announced the Tesla ‘Semi’ truck in November 2017, a fully electric alternative to traditional trucks, which seems as if it will genuinely be able to compete in the space with its regular diesel/petrol counterparts.

Then there is his side-line projects like The Boring Company, which aims to relieve congestion on American roads by creating huge underground tunnels for traffic to flow through, as well as his ambition to give people the chance to travel around the world at rapid speeds via spacecraft (London to New York in 29 minutes, anyone?)

Overall, those who are shorting Tesla stock at the first sign of issues (like this production problem) are probably not the sort of people who should have bought the stock in the first place. If you believe in Elon Musk and his aspirations, then this is a long-term buy and hold and you shouldn’t jump ship when hiccups occur along the way. You can see that by looking at just how far Tesla’s vehicles have already come since its inception in 2003. The stock price has also ballooned by nearly $300 in the past 5 years despite a chorus of criticism from naysayers who doubted its ability to enact change.