Promises of additional monetary easing measures seem to arrive on a weekly basis, providing a boost to share prices globally as investors are encouraged to take on more risk. At the same time, we’re seeing increasing signs of a global slowdown. History has taught us that the “stock market is not the economy.” We are seeing perhaps the most extreme example of this today.
China is the latest country to join the global easing party, lowering its one-year benchmark deposit rate by 25 basis points to 2.75%. Back in June, the ECB moved to negative interest rates. Mario Draghi is ramping up his “whatever it takes” rhetoric leading most to expect some form of quantitative easing to be announced in the coming months. Here in the U.S., we’re approaching six years of 0% interest rates with the Federal Reserve continuing to promise to keep rates at 0% for a “considerable time.”
Japan’s central bank is now the exemplar of easing, having held interest rates near 0% for almost 20 years. Earlier this month, the Bank of Japan announced additional quantitative easing measures that included increased direct purchases of equities by the central bank.
With all of these easing measures in place, how is global growth faring? To get snapshot, let’s take a look at the top five global economies in terms of GDP: The U.S., China, Japan, Germany, and France.
China is showing its slowest growth since 2009, with year-over-year real GDP down to 7.3%.
China’s manufacturing index is down to a 6-month low, teetering on the edge of contraction (50 level).
Japan has entered its fourth recession since 2008, with year-over-year real GDP down to -1.2% and two consecutive quarters of negative growth.
Household spending in Japan is showing continued declines on a year-over-year basis.
Germany-France: The Eurozone
GDP in the Eurozone is running at 0.8% year-over-year.
Leading indicators there show this growth is likely to slow considerably in the coming months, with the most recent PMI reading hitting a 16-month low.
Retail sales in the Eurozone are also likely to move to negative territory on a year-over-year based on recent PMI sales data.
That brings us to the U.S., which nearly everyone views as the best house. The U.S. is currently growing at 2.3% year-over-year. Not terrible but hardly an example of a booming economy. The current expansion that began in 2009 has been the slowest growth recovery in U.S. history.
Given this backdrop, why are so many economists and the Federal Reserve expecting growth rates to accelerate in 2015?
In my view it stems from the belief that the stock market is a good representation of the health of the economy. If stocks are hitting new all-time highs every day, then the economy must be strong. And if the economy is not strong today, then it must be signaling stronger growth to come.
While there certainly has been a relationship between the stock market and the economy in the past, they are anything but one in the same. And with unprecedented easing measures in place that are specifically targeting higher stock prices, this is truer today than ever before. We must now question whether some or all of the signaling power of stocks has been lost. For proof of this look no further than Japan whose economy is entering its fourth recession since 2008 while stocks are hitting new highs.
As for why the U.S. is considered to be the best house in the global economy, look no further than market prices. U.S. stocks have been, to put it mildly, crushing their global peers. In the chart below you can see that the S&P 500 Index has outperformed the rest of the world by over 60% in the past five years.
The narrative created from this price action is that the U.S. economy is going to decouple from the world.
Perhaps, but an alternative scenario must also be considered and may warrant a higher probability than market participants are currently assigning to it. What if the stock market is wrong today and U.S. growth is set to slow here, catching the flu from its global peers? With an increasingly global economy and 40-50% of S&P 500 revenues coming from outside of the U.S., is decoupling a more realistic assumption than this?
We may be starting to see the early stages of a re-coupling. The growth rate in the ECRI Weekly Leading Index is quietly moving lower, in the opposite direction of the equity market. It recently turned below zero for the first time since 2012.
The Flash PMI also came in at 54.7 this week, a 10-month low. While these figures are far from recessionary, they may be an early indication that growth in the U.S. is about to slow.
The stock market is not the economy, particularly in the current environment of unprecedented monetary stimulus across the globe. The danger in assuming otherwise is twofold. First, from a signaling standpoint, similar to waiting for an inverted yield curve, it could lead investors awry who are buying stocks at extreme valuations on the belief that the economy is accelerating.
Second and more importantly, from a policy standpoint the assumption that the stock market is the economy is inherently dangerous. It can lead to the situation in which central bankers start targeting and pointing to higher stock prices as both proof that their policies are “working” (helping the real economy) and as an instrument of growth (wealth effect). If the public and fiscal policymakers buy into this unproven notion, they will sit idly by instead of engaging in true structural reforms that promote long-term economic and real wage growth. They will also continue to incur higher debt loads, borrowing from the future to satisfy the whims of today, as the cost of money is too cheap to resist. A boom-bust economy is thus created that is increasingly dependent on central bankers continuing to inflate asset prices and propping them up indefinitely. This precisely where we stand today.
If we continue on the current path the end game is clear even if the timing is anything but: another bursting bubble and the economic fallout that comes with it. Perhaps this is what most people desire (I personally doubt that given its deleterious effect on the middle class) but shouldn’t we at the very least be engaged in a national debate over it? Is this truly the economic and monetary policy we should be pursuing?
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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