At MoneyWeek we’ve never really believed that the long-term bear market in stocks ended in March 2009. But at the start of 2011, we did say that the prospect of ongoing central bank money printing (quantitative easing – QE) would probably prop up stocks for much of the year ahead – barring a crisis.
Well, now we have our crisis. It took stockmarket investors a little while to grasp that a rolling series of revolutions in one of the world’s most geopolitically volatile regions was actually bad news, rather than yet another opportunity to ‘buy the dips’. But they seem to have got the message now, helped by surging oil prices and rumours of upheaval in Saudi Arabia. Stockmarkets were arguably overvalued anyway – Jeremy Grantham at GMO pointed out, in a recent letter written before the Tunisian revolt, that bulls are “living on borrowed time” and that by his calculations the S&P 500 is worth around 910 (it’s currently at around 1,300).
But on top of this, an oil shock is a very tough economic nasty to deal with, particularly if you’re a net oil importer, as Britain is. High oil prices both slow the economy down (people spending more on fuel bills have less to spend elsewhere) and drive prices higher. That’s the unholy combination known as stagflation. With Britain already in a fragile state, “this oil price spike couldn’t be happening at a worse time”, as Stephen King at HSBC puts it.
Bank of England governor Mervyn King is still talking about how these price rises are temporary and will work their way through the system. In the absence of wage rises, he may even win his argument that interest rates should stay low, particularly if it becomes obvious that consumers are wilting and wage demands remain tame.
But there’s another external factor that makes me suspect that inflationary pressures could get a lot worse: US monetary policy. Federal Reserve chief Ben Bernanke denies that money printing by the US has had any impact on commodity prices – dismissing any responsibility for the spike in food prices that first sparked the revolutions in the Middle East. But as respected analyst Andy Xie of Rosetta Stone Advisors wrote this week, “food and energy prices began to surge right after the Fed began to talk about QE2 – it is too much of a coincidence”.
Why does this bother me? Because while US inflation may be edging up, it’s still a lot lower than ours (on official measures, at least). So if US stocks take a serious tumble, I suspect Bernanke will start talking about QE3 and it’ll be up to the rest of the world to cope with the inflationary consequences. “Maybe the Fed will change its mind when the streets of Washington burn like Cairo’s,” says Xie. Sure – but there’ll be panic on the streets of London well before that happens.