Markets: Equities are crossing bull-market milestones. The UK FTSE-100 index this week climbed above 5,000, while the US S&P 500 has been above 1,000 for more than a month. The MSCI World index is at its highest level since last October. But why?
The rally – the MSCI World is up 63% from its March low – might just be the end of the bank panic of 2008. Fear and the sudden evaporation of trade credit last year led to a precipitous drop in business activity. But, as Jonathan Wilmot of Credit Suisse points out, such panics have typically been followed first by sharp GDP bounce-backs.
The non-financial world does seem to be over the worst. GDP is expected to grow in most of the world in the third quarter. Stock-market investors may just be discounting many subsequent stronger quarters.
But if there is a bounce in economic activity, it more has the feel of a patient waking up quivering after a long operation under the sedation of general anaesthetic. Wednesday’s Federal Reserve’s Beige Book, the US central bank’s survey of the economy, showed flat retail sales, weak demand for commercial real estate and still declining construction activity. The Baltic Dry Index, an indicator of world trade volumes, has fallen 42% since June.
What has bounced back, or perhaps flooded back, is financial liquidity. Deutsche Bank’s Sebastian Becker calculates that excess liquidity – money available to buy financial assets – has been increasing faster in recent months than any time in the last two decades. This cheap money looking for a home explains the rise in the price (fall in the yield) of government bonds. It also helps explain the rising price of gold, the narrowing of credit spreads and the resilience of the oil price in the face of rising inventories.
Any rally that has more to do with crude money more than prescient investors is fragile. The advent of tighter money or a wave of cash-hoarding could end it. And until the financial system can allocate credit normally – without huge amounts of official support – the economic recovery is also going to stay pretty fragile.