Photo from CNBC.
Central banks around the world have been unable to advance economic growth and raise inflation in the last five years despite declining interest rates and added stimulus to their national economies. Their egos fail to recognize that their monetary policies and actions have a smaller impact on real-world economics. Individuals still cannot get loans because poor economic conditions disallow many to qualify. And housing inflation skyrockets as speculators re-enter the market. This has created an environment not unlike 2008 that could lead to another stock market crash in the very near future.
Continued pessimism with regards to the economy is justified by falling corporate earnings and low GDP growth. The US market has now had four consecutive quarters of falling earnings - termed an earnings recession. Just this month, we have seen three behemoth technology stocks that rule the world, Apple, Microsoft, and Google disappoint followed by significant reductions to their market capitalization. Yet, the stock market maintains its current valuations propelled by low interest rates.
Low interest rates has been the culprit for the extension of the bull market. With no other assets to invest in that can yield significant returns, investors are forced to turn to the equity markets where dividend yields are relatively higher than bonds. During a time of significant pessimism, this can be dangerous when smart money pulls the trigger and starts selling the moment the Fed raises rates as it will have to do if inflation starts to rise. This rate hike is predicted for June 2016 unless conditions worsen, a truly lose-lose situations for main street.
In December, the market fell 8 per cent when the US Federal Reserve moved to raise rates a quarter basis points. It was the first rate hike in a decade. It was concluded that the stock market was in a fragile state for a rate hike because of its significant correction, but four months later, the stock market is right back where it was. With little options, as discussed, the flow of money continues to drive the market higher while the Fed remains hesitant on its second move.
The second component of this rally may be corporations buying back stock. Large names like Apple, Starbucks, etc. are borrowing billions of dollars, instead of using their cash deposits, to buy back stock. An interest payment on a bond would be less than the dividend payment owed to investors because yields on the safer bonds are often lower than equities. This creates a situation that may be arbitrage and allows corporations to boost earnings per share without having to increase revenue and net income.
The conditions created by low interest rates will only cause another fallout. A housing bubble is being created by the few speculators that have access to low-cost money. The UK posted in December 2015 that housing inflation was at 7 per cent, exceeding both inflation and wage inflation. Housing now costs 10 times the earnings of first-time buyers versus 2.5 in the 1990's. As of March 2016, the Canadian housing index is up 7 per cent year-over-year as well, also exceeding the consumer price index average of 1.5-2.0 per cent.
Sweden, one nation with negative interest rates, recently posted a significant growth in its GDP. It is heavily debated whether it is a direct result of negative interest rates, but the main concern now is the significant amount of consumer debt that has been created. Housing has risen 11 per cent as more people take on mortgages fueled by low interest rates and this may be an unhealthy as it creates a bubble.
Central banks do not get it. They have pumped trillions of dollars in international economies over the last half-decade and lowered interest rates to record lows, some nations at negative interest rates, with very little to show. This is because the average individual has not prospered through some trickle down economics. Jobs are still as scarce as ever and housing prices are beyond the affordability of most people. Stability in the market is uncertain and GDP growth in first world nations will not reach 2 per cent for another decade. The law of big numbers, an idea that as a company or entity gets bigger its rate of growth slows down, has now hit world economies. Japan went through a decade of tepid growth and our world is near its peak, but it is still a shining example of innovation and the envy of many.
Perhaps we have entered a new economic environment that does not prosper as it once did, but maintains small growth equal to inflation. All I know is this. Economics and business analysts are concerned. Central banks continue to believe their stimuli will work. They will continue to delay and prolong an interest rate hike and it will allow the stock market to soar, but when they realize it has failed and its decisions are less effective, it will pull the carpet from under investors in the stock market and the average person will see another crash. It is only a matter of time.
Read:Bank of America believes not investing equal to investing in 2016
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