Talking Points:
- A short-term focus and belief in text book financial views leads to beliefs markets, economy and policy aren't connected
- In reality, all three of these critical factors are indelibly connected but on a longer-term and amid speculative skew
- We discuss these connections along with why realities that 'QE infinity', a constantly rising market and more can't exist
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There are many claims circulated about the changing nature of the global financial system. These questionable beliefs have in turn encouraged a significant change in trading habits (like deep complacency) that contradict basic tenets of investment. 'Central banks will pursue QE infinity.' 'US equities can rise forever.' 'Growth will enjoy/suffer its persistent but moderate pace through the foreseeable future'. These are some of the flippant assessments of varying degrees of dubiety that all stretch the bounds of practicality. Adopting these views as gospel can lead to frustration - but more problematically, it promotes increasingly risky behavior. It is important to recognize what the markets reflect in terms of conditions, influence and exposure now; but that doesn't mean that we should immediately presume a systemic shift. There are important connections and balances between markets, monetary policy and economic activity.
Historically, economies and markets have risen and fallen on the back of cycles in capital and human output. There have been many times where extremes or persistent trends have inevitably drawn out those that believe 'this time is different.' It is assumed because of circumstances unique to that particular oscillation that the rules of the system have changed and what often bends will break. While regulations, technology, motivations and structure can and do change; the true functioning of the markets does not. What is truly different about that current situation more often than not is that it happens to be the most recent iteration; and for many, it is the first meaningful tack they have experienced. In the run of current tide changes, we have certain practicalities to consider. Stimulus cannot continue to rise forever because there is a limit to the supply of viable assets and at a certain level it would destabilize the system. Markets cannot advance forever as asset inflation would lead to a dilution of value, hyperinflation on goods and/or a disincentivized population to produce. As for economies, cycles follow natural utilization of resources, distribution of capital and the progress in technology.
We look at the connections between market, economy and policy. Aggressive (easy) monetary policy was in response to a financial crisis and the threat of an economic seizure. That accommodation has lingered far beyond the rebalance of both systems. In turn, benchmarks like the S&P 500 have charged continuously higher. However, the economic benefit has tapered off long ago. What is left is considerable imbalance that is not well positioned to withstand fresh troubles. It has incentivized a chase of inflation and low returns. In response, the Federal Reserve has started to shift slowly back to normal ground. This reversion can send ripples through market and economy that over-react given the extreme conditions that have been fostered, but they will inevitable level out. We discuss the connection between markets, economy and policy while dispelling some of the more extreme beliefs floating around out in the ether in this weekend Strategy Video.
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