“The wealth per head is very different, the politics is very different, and the philosophy and their natural economic edge is different.”
Jim O’Neill, when asked about the BRICS nations and their recent gathering to urge China to import more than just industrial goods
Commentary & Analysis
Financial vs. Real
One input to our US dollar bull market call at the beginning of the year was the potential shift in capital between the financial economy and the real economy. The stock market began a dramatic rally well before the US economic “recovery” took hold. And stocks have continued climbing.
But as resistance looms for stocks, it makes sense to revisit this financial economy versus real economy idea. Could capital flee the financial economy and in turn buoy the real economy despite a sour mood for stocks and other asset markets?
S&P 500 Weekly
I came across the following chart this morning – it’s from David Rosenberg (via Pragmatic Capitalism blog):
What the chart above shows is the amount of margin investors are using to purchase stocks. Notable is the peak at the time of the Nasdaq bubble and the peak at the time of the credit crunch. Today the level has climbed sharply since the post-credit crunch collapse and exceeds the peak of the Nasdaq bubble.
To borrow a quote from Jack: ‘Thank you, Candy Man!’
This, from Reuters, discussing recent comments made by Dallas Fed President Richard Fisher:
"After the Fed has done its job, I now above all see the risks of monetary policy being too expansive," he wrote.
"There is for example the risk of a misinterpretation of our duties. It is not currently our job now to dilute the debts of an irresponsible government," he added.
"In the past, allowing budget deficits to be financed by central banks has always led directly to the abyss. We should block this way out and throw away the key to it."
Fed hawks like Fisher have stepped up their criticism of the central bank’s super-easy monetary policy in recent weeks.
Fisher said on Friday the Fed may need to cut short its current round of quantitative easing to avoid stoking inflation.
But core members of the policy-setting committee, including Fed Vice Chair Janet Yellen and New York Fed President William Dudley, this week said the economy is still too weak for the Fed to reverse course.
Fisher, who has a vote this year on the policy-setting panel, wrote: "It can now hardly be disputed that U.S. businesses have enough financial fuel in the tank to grow and create jobs."
How can there be such a divide between these Fed heads? Are they all not looking at the same data? Anyway …
As the debate rages on between how the Federal Reserve’s quantitative easing efforts have influenced the economy, commodity prices and inflation, there seems to be little question remaining about their influence on stocks. In addition to their stated goals of shoring up investor confidence and supporting asset prices (all aimed at reversing the negative wealth effect of the credit crunch), they have succeeded in creating a speculative fervor where investors are leveraging up on stock investments.
Four months ago Jim Rickards (Senior Managing Director for Market Intelligence at Omnis, Inc. and co-head of the firm’s practice in Threat Finance & Market Intelligence) gave an excellent presentation (I just watched it for the first time) where he suggested banks were still unwilling to make loans because they were still strapped with bad assets. [The Troubled Asset Relief Program never took these assets off the banks' books as was initially intended.]
So, if you can’t get a loan in the real economy because banks still have these crummy assets littered throughout their balance sheets, why not go get one in the financial economy and then wager it on rising stock prices? Seems to have worked so far. But can this trend into margin debt continue, or slowly abate, without bringing about severe consequences for stocks?
Being in the foreign exchange market we know well that leverage cuts both ways. If investor confidence starts to turn, it could turn very quickly.
The question then is will the real economy be in a position to capitalize on the financial economy outflows?
I would say yes, but not immediately. A falling stock market – currently the flagship indicator of economic recovery in the US – would likely undermine consumer and business confidence in the short-term. But available funds freed up from the stock market could find a way into new avenues of investment in the real economy that go a long way in building a more sustainable recovery.
More immediate than the future of the real economy would be the impact a falling stock market would have on risk appetite and currencies. I’m sure you can guess where I am going with this: the US dollar might again find a default (safe-haven) bid. And if it does, it’s not hard to imagine what that might mean for all other types of risk assets that have been so effectively led higher based on the expectations of a falling dollar.