The global economy may be in the grip of the worst recession in almost a century. But stock markets are soaring.
Wall Street’s key indicator, the Dow Jones Industrial Average, blew through 30,000 points overnight, a new record, while our market this morning erased all this year’s losses.
How does this make sense, given the vast number of workers whose jobs have been laid waste by a pandemic that continues to wreak havoc across the northern hemisphere, and particularly in the US?
In the aftermath of the 1990s recession, stocks were in the doldrums for years. The Global Financial Crisis of 2008 saw share prices plumbing new lows for almost two years.
Not this time. In February, as the Australian market tanked (falls that accelerated in March), seasoned investors were stunned by the ferocity and speed with which fortunes were erased.
But rather than bounce around for a year or two, or even a month, the nadir lasted just one day.
From March 23, Australian stocks have been on the rebound, just as they have on exchanges across the globe.
The reason is as simple as it is complex.
Legions of highly paid traders, strategists and advisors will engage in baffling explanations littered with terms like rotation and differentials.
Ultimately, however, it all gets down to one thing; the sheer weight of money.
The great flood
The world’s biggest central banks have slashed interest rates to zero and have been printing money like never before.
It is a process called quantitative easing.
Essentially, central banks including our own Reserve Bank buy government bonds, or debt, in the open market. That helps lower market interest rates and pumps cash into the economy.
They dabbled in the practice around the turn of the century, in an effort to drive down the value of their currencies, then kicked it into overdrive during the GFC.
By 2012, with the Western world’s central banks holding close to $US8 trillion in government bonds, corporate debt and mortgage securities, fears began to grow as to how the process could ever be unwound.
No-one has ever quite figured that out. And what has occurred in the meantime is that whenever there is a problem either in financial markets or the real economy they resort to ever more financial stimulus.
Central banks now own $US24 trillion in financial assets. And that doesn’t include the Peoples Bank of China, which has been going hell for leather with the money printing caper.
All that extra cash has to go somewhere. Some of it is borrowed for legitimate investment. But a very large portion of it finds its way to financial markets and real estate.
This time around, governments have jumped in on the act. With global interest rates at zero, they ditched their long-held attachment to austerity and decided to spend their way out of recession.
Where to from here?
For the past month, investors haven’t been the slightest bit interested in bad news.
A much tighter than expected result in the US election didn’t faze them.
Donald Trump’s refusal to concede defeat, and the potential threat that posed, was largely ignored.
Even a huge resurgence in the pandemic across America was tolerated. Warnings from the International Monetary Fund that the economic recovery appeared to be slowing were brushed aside.
Joe Biden’s win, however, was greeted with enthusiasm.
Donald Trump’s decision to allow a transition of power to president-elect Joe Biden boosted the stock market.(AP: Andrew Harnik)
Donald Trump’s decision to allow a transition was a trigger for a huge splurge. And the prospect of three vaccines, which may be available for widespread use in 2021, sent traders into a frenzy.
This November is shaping up to be one of the best on record.
Just a few weeks ago, the world’s biggest central banks upped their cash injection programs. Coincidence?
It’s not as though central bankers deliberately set out to push stocks to the moon. It just happened as a by-product.
What they wanted to do was to inject cash into the system and lower rates, so businesses and individuals would borrow and invest. That was supposed to create jobs and get things ticking along.
But they’ve created a Frankenstein. They now can’t afford for stocks to plunge, even if markets are hugely overvalued.
That’s because of something they call the “wealth effect”. If we feel wealthy, we spend more, which is good for the economy. And if stock markets and housing are rising, those with assets certainly feel a lot more wealthy.
A crash, on the other hand, has everyone reining in the spending. And that can cause a recession.
The great challenge for the future is, how on earth will we ever be able to turn off the stimulus and return to normal interest rates, without causing markets to tank, which then might lead to a recession?
No-one has the answer. No-one wants to hear the question.