Seldom can a stockmarket rally have been greeted with such universal scorn. As shares around the world started to show some signs of renewed life, they were met with a chorus of boos and catcalls. All the usual caveats were duly trotted out. Sucker’s rally, they said. A bear market blip, warned the chart-wielding experts. Nothing more than a dead cat bounce, declared the sages. From the disdain heaped upon what was in fact a modest recovery, you’d think most people want the stockmarket to remain flat on its back.
Actually, they are dead wrong. The rally is real enough. There are plenty of good, solid reasons for stocks to start climbing again, and the investors who get behind it will do just fine. There is just one snag. The recovery is taking place for all the wrong reasons.
There is no mistaking the way that shares have recovered. In America, the S&P 500 index staged its steepest nine-week rally since the 1930s, rising 37% from the 12-year low it reached back in March. Financial stocks led the way, with a 23% rise last week alone as the stress tests set by the Obama administration were passed with ease.
Meanwhile, the MSCI Asia Pacific Index is up by 38% since its low point back in March. The Hong Kong market by itself is up by 52%. Here in Europe, the FTSE 100 index has soared 27% from its 3 March low, and is now just about in positive territory for the year. The Dow Jones Stoxx 600 Index, measuring the main European firms, is up by 33% since its 9 March low. It too has erased all its losses in the early part of the year.
This is not exactly ‘green shoots’. It is more like a whole garden blooming with daffodils and tulips. By any measure, it is a remarkable recovery, particularly since only at the start of the year we were being told the global economy was poised on the brink of the worst downturn since the 1930s.
Naturally, many people aren’t convinced. Many of the reasons put forward for the rally were about as convincing as an MP’s expenses claim. We were told that the US economy was still shrinking, only not quite so fast as it was a few weeks ago, which hardly seemed much of a cause for joyous celebration. Business leaders were lined up to argue that their sales weren’t quite as bad as they expected, which, again, hardly seemed enough to mark share prices up by a quarter.
After all, economies are still getting smaller. Company profits are still getting hit. There has certainly been no evidence of a return to robust growth to provide some solid foundations to the rally. Not surprisingly, that opened up a field day for stockmarket historians. Plenty of people were quick to remind us that US stocks bounced 50% in the first few months of Franklin Roosevelt’s reign, hardly an auspicious comparison.
And yet, the rally is perfectly justified. It is just that there is nothing comforting about it. Investors have looked at the policies of ‘quantitative easing’ (QE) announced by central banks around the world. They have seen the way the Bank of England has just said it will pump an extra £50bn in freshly minted pound notes into the economy in the next few months. And they have noticed that even the European Central Bank, previously heir to the stern anti-inflationary hawks of the Bundesbank, has joined the party, with its own plans to create more euros. And they have drawn the right conclusion. QE, or printing money as it should be called, is going to have two consequences, both of which will be good for equity prices.
The first is that it will create inflation further down the line. There is little escaping that conclusion – more money, poured into a shrinking economy, has to raise prices. The only refuge from that for investors is in real assets. Gold is one option, although there’s little evidence left to suppose it has any monetary value. Property is another, yet the market is so debt-laden it may take years to recover.
That leaves blue-chips. In a climate of moderately accelerating inflation, where prices start pushing up 5% to 6% a year, strong and powerful firms should be able gently to nudge up their prices, profits and dividends. Stocks will inflate along with everything else. We can already see that in the firms leading the way. The rally in the FTSE, for example, has been led by sectors such as industrial miners, banks and retailers – precisely the kind of companies that will do well out of inflation.
Next, there is already evidence that QE is spilling out into another asset bubble. If you print money, it has to go somewhere – nobody throws the stuff away. It was meant to be pushing down bond yields, but there isn’t much sign of that (bond yields have been rising modestly). In fact, all the fresh cash is slipping into the equity markets.
Printing money is not going to do much for the long-term health of the global economy. That will depend on the same things it has always depended on: free trade, deregulated markets, lowish taxes, and the rate of technological progress. But it will create asset bubbles. And that’s a good basis for a stockmarket rally, even if it is bad news for everything else.