The US stock market, as reflected by the S&P500 index, reached an all-time high yesterday. According to the FT:
The S&P 500 index briefly rose to a high of 3395, eclipsing the previous record that was reached in February before coronavirus fears gripped the market.
They added:
The barometer has soared 54 per cent since the low on March 23, fuelled by central bank and federal government stimulus, with the gains being led by America's biggest technology companies including Apple, Amazon, Microsoft and Google parent Alphabet.
But it is curious that in the same email that delivered this news there were other headlines that cast doubt on the relevance of this:
It's no secret to long time readers of this blog that I have long felt that the connection between stock markets and reality disappeared many years ago. It's good to note that many, if not most, serious investors might now agree, even if the market algorithms that now drive so much investment still drive the herd along despite the obvious failure within the logic that results in this illogical behaviour.
I am pleased to see that my old friend Larry Elliott agrees. In one of his best articles that I might have ever read, he was in damning form in The Guardian saying:
The rapid bounce in stock markets helps to give the impression that everything is under control and the economic crisis is drawing to a close. Traditional wisdom has it that share prices anticipate events so rising stock markets reflect the fact that the world is on course for a rapid recovery that will see life return to normal in 2021. This might be true for the high net-wealth individuals invested in hedge funds. For almost everybody else, it is nonsense on stilts.
Larry is right. What we have got is a stock market that is utterly disconnected from a number of realities.
The first of these is the reality that such markets fund business, because they do not now. Stock markets raise very little new capital for business and all serious business investment is now funded by debt.
The second follows on, and is the claim that stock markets appropriately allocate capital to markets. If they did the current disconnect could not happen.
The third is that stock markets reflect underlying value, which is very obviously untrue: when the world is heading for the most severe recession for more than a lifetime this cannot be the case.
The fourth is that markets are efficient, which is only now true if you accept that they efficiently reflect the massive amount of financial support that they enjoy from governments, which is the sole reason why they have recovered as they have.
And fifth, the reality that says that these markets are important (as maybe once they were) should also be consigned to history. I long for the day when the BBC stop reporting movements in the stock market almost every hour as if it matters. It does, but only if you think the results of the 3.15 at Kempton are also worthy of being reported in the same way.
The simple fact is that nothing markets have done, and nothing that those companies quoted on markets have done, has in any way given rise to this record valuation. It has actually arisen because the US government has bailed out markets because Trump thinks that the S&P500 is essential to his popularity (which claim is also wrong). As a consequence vast amounts of Federal support has produced this outcome.
But as Larry asks:
If low interest rates and QE don't lead to investment in productive enterprises, is there anything to prevent governments from bypassing the financial system and investing itself in things like green infrastructure? Not really. Central banks say this would undermine their independence by getting them into the world of political decisions, but this suggests that steps taken to boost asset prices are not political decisions, which of course they are.
Or to put it more bluntly, central bankers and the politicians on whose behalf they act are already lying through their back teeth when they say they are not already picking winners and losers in our economies and societies, which they are actually doing day in and day out.
They choose to support markets.
They will very soon be choosing not to support employment.
Or smaller businesses.
Or a Green New Deal.
Or an economic recovery.
And that's because none of these things matters to the high net-wealth individuals invested in hedge funds who central bankers and populist politicians spend much of their lives mixing with.
That stock markets are disconnected from reality is because our politicians, our central bankers and our financial elite are also wholly disconnected from that reality.
My question is, how long can that last? This is a recipe for instability, and I think it might happen.
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Once again, totally correct.
Why are the central banks continuing to print money? It is being used by the spivs and bookies in “the markets” to make bets, not to, for example, invest in medical facilities, better nursing home facilities, more facilities to enable older people to remain at home, etc.
Even if there might be money available ‘when things improve’ there are needs now for investment.
One quibble – ‘stock markets’ are not up. I believe those in Europe inclyding London and most elsewhere are not up. They are actually about 20% down compared to February. Some sectors (cars and travel for example) down a lot more. Yes the S&P and Wall Street are up, but only because of the tech sector. Remove that and the S&P is also significantly down. Even within tech it is certain companies that are up most. Amazon for example. It has booming online retail sales worldwide as folk shop online and don’t go to the high street. Tesla has also boomed with the pressure to go green with electric cars. For those shares to go up is not entirely irrational. The energy sector within the S&P is down maybe 30%.
So it is a little bit like 1929 in that you are looking at headlines that reflect a very narrow picture. The 500 companies in the S&P are hardly representative of the world or the USA, so it is actually another tech bubble. In 1929 the Dow Jones was a very small index and by August 1929 the rises in the index were reflecting less than 10 companies.
Since I have small holdings in them I can tell you personally that Lloyds Bank is down by 55%, International Airlines Group is down by 60%, Daimler AG is down by 60%. Only the traditional widows and orphans like Unilever 0%, National Grid 0% have kept their value. It is a rarity that has gone up Glaxo Smith Kline 10%.
So don’t go just by headlines and sweeping statements as that is much too simplistic. You should look at the other boom in fixed interest. Some gilt prices have doubled. I was looking at one UK gilt that now sells at £300 per £100 face value. That is where much of QE has gone – extra savings and driving down interest rates.
Tim
I accept: the UK FTSE is 20% down, but there again 20% up from March….
And I dispute that indices do not matter. They’re reported. They matter a lot as a result, expecially when many are in tracker funds now
And maybe those declines are still too small…
Richard
I didn’t say indexes don’t matter – they do as that is what makes the headlines. The 1929 market boom relied on nobody looking behind a ‘Dow at new record’ headline. If they had they would have seen it was 10 companies out of several thousand on the NYSE. Yes today there are things like tracker funds but the alternative would probably be everyone piles into tech and sells the rest which would cause a much bigger bubble. Automated trading and instant trading should probably be banned. In fact just churning stuff should be taxed as it is gambling and not investing. I tend to hold companies for years as does Warren Buffet.
Effectively what you are saying Tim is that there was targetted lending for the asset bubbles before the 1929 Great Depression and 2008 Great Recession. The first was for shares based on misinterpretation of a narrow index, the second was based on inadequate checking of ability to service debt (house mortgages) and deliberate fraud in the creation of Mortgage Bonds. The logic that emerges from all of this is that there really is no such thing as pure free market fundamentalism because politicians have to impose restraints on the market, particularly the market for lending and creation of financial instruments by the financial sector.
“The first was for shares based on misinterpretation of a narrow index, “
What does this mean??
“Yes the S&P and Wall Street are up, but only because of the tech sector.”
Correct.
From the New York Times:
“The stocks of Apple, Amazon, Alphabet, Microsoft and Facebook, the five largest publicly traded companies in America, rose 37 percent in the first seven months this year, while all the other stocks in the S&P 500 fell a combined 6 percent, according to Credit Suisse.”
The 1% rule works everywhere
I think you need to do a video (s) about commercial banking Richard. If QE has left banks “awash with cash” as Larry describes, which is supposed to encourage them to lend, how does that work if banks create credit out of thin air? Why do banks need to be awash with QE
cash to lend money which is magiced out of thin air? I presume it has to do with requirements for reserves against loan default risk which impairs the assets side of the balance sheet but I’m sure that I and many others would benefit from an explanation of the role of banks in money creation and how they are licenced to operate and regulated.
OK….will do….
I think that most of the recent UK £300 billion of QE has not gone to banks as such. It has gone to:
1) The chancellor who has used it to fund the furlough and other schemes;
2) Other state spending such as higher benefits, grants to various sectors and the like.
and the BoE has directly created money for loans to large corporates. So it has actually been a lot more beneficial to the wider economy than previous QE that did go mostly to banks.
The Covid loans to SMEs have been funded by the banks, though the government is paying the interest and charges for the first year (and they have a guarantee not to lose). While banks do create money every time they grant a loan they do have to worry about their reserve accounts in the clearing system. If you are a small bank then there is a high chance that when you grant a loan the funds will be transferred to another bank. For a very large bank that does not matter as there will be an equal flow of funds being transferred to you and therefore the net change in the reserve account is almost nil. For the small bank, though, the net change in the reserve account could be a significant outflow as your loans flow out and few people transfer loans from other banks to you. So yes any bank can easily create say £1 billion by simply crediting your current account with £1 billion and debiting your loan account with the same, but if you then ask to transfer that £1 billion from say Lloyds to Santander then Lloyds has to have enough reserves to be able to transfer £1 billion to Santander. That is essentially why banks go bust when there is a run – if all the funds start to leave the bank then the ability to create money does not work and they will quickly run out of reserves. To some extent you can get around that with the help of the central bank. If the CB will accept your loans as collateral for a loan then you can borrow the reserves needed – this is essentially what goes on with the BoE’s day to day lending on things like the overnight market or in the US with the Fed Funds market.
I agree with you on banking
But not on the first but: QE is QE, is QE
And this QE was used to buy back government debt like all the rest, albeit that did then fund (circuitously) furlough, etc
Isn’t what you describe as QE not actually DMF by the Bank of England Tim?
DMF could mean ‘direct monetary financing’ or ‘debt management facility’ ……
I say this only because people are, I suspect confused enough …..
Looking at the Guardian online this morning, a couple other pieces struck me as – in their way – reflecting the same underlying theme – a world system that works for wealth and property, rather than people: on Greenwich Market https://www.theguardian.com/uk-news/2020/aug/19/londons-greenwich-market-stalls-face-closure-following-huge-rent-increase and by George Monbiot on access to the countryside https://www.theguardian.com/commentisfree/2020/aug/19/pandemic-right-to-roam-england . And in recent days (but now dropped off), some pieces on the A-level fiasco had a similar theme.
That market issue is also happening in Dalston, where an old friend is helping the fight back
“And that’s because none of these things matters to the high net-wealth individuals invested in hedge funds who central bankers and populist politicians spend much of their lives mixing with.”
As long as human societies allow political parties to receive unrestrained funding by the private sector effort for general well-being will get thwarted. We ought to try public funding of political parties determined by vote on policy manifestos with conditionality for implementation including recall of politicians.
I’m just going to plop this in here as there seems to be nowhere else for it but it is of concern. Seems the Americans are making considerable effort to preserve economic illiteracy in future generations by teaching them nonsense in the first place using a tool called the Fiscal Ship to take advantage of the primacy effect https://www.brookings.edu/research/the-fiscal-ship-as-a-teaching-tool/
Scary stuff.
Agreed! Dire
With the collapse in interest rates though the question must be what do savers and investors do to get a return at least equal to inflation?
Hence the rise of things like peer to peer lending and crowd funding
[…] Cross-posted from Tax Research UK […]
OK, so “high nett worth individuals” can be used to replace my characterisation of the players in the market.
I suppose their political friends are better able to rub shoulders with them, after all they probably drop a few sheckels in the party coffers.
I still didn’t see any arguments for investing in real requirements. Funding out of work people who are affected by Covid 19 is a necessity, but so is pending on the future of the human race.
Barry
I admit I do not follow your logic
Richard,
Isn’t it true that the market is up 20% since you claimed it was ‘massively overvalued’?
Good job you don’t invest in equities and aren’t an investment advisor to other people!
It is just even more massively over-valued now
Any investment manager saying otherwise is recklessly irresponsible, as even the FT notes
I am wholly unrepentant. Calling out Ponzi schemes early is not something to be embarrassed about
The market price of something is based on the price at which both buyers and sellers are happy to transact.
You were wrong before and wrong now. But that’s why we don’t typically see accountants as investment managers as they font have the tight skills.
True
I don’t have the tight skills
But I can sport the difference between a price and value
Hi Richard
I love reading your blogs.
Let’s say I am very concerned citizen. How can anyone justify how stock markets are valued and how fund managers allocate money. What does a $2tn dollar company like Apple mean for society? Non-farm payrolls unemployment numbers was up 1 million yesterday.
Why wasn’t the ‘market’ suspended in Mar – April? Clearly with prices artificially deflated family offices and IB banks borrowed heavily and clocked in billions in profits with the inevitable rally due to cash pump by central banks.
Is this the biggest transfer of wealth or theft from governments to small group of speculators in modern times?
if fund managers are buying Apple, tiktok stocks, (with tax haven ownerships) then that leaves vital infrastructure left out. No new hospitals, roads, schools.
What does a S&P in 2022 look like, if 80% of the index is weighted to 5 tech stocks? and the obsession with reporting how the ‘market’ feel?
And why are some many commentators on BBC, CNBC, FT, Reuters, Bloomberg in shock that the markets are high and there literally bodies on the street. even John Auther (Bloomberg, 30 years reporting) was shocked.
Without adeqaute taxation, Rishi and co should be prepared for UBI (sorry meant permanent fur longing).
…if I were 18, i would be the first on your city course. I worry for liberal democracies and particulate Africa.
I don’t teach any more
My course was popular…..
Fortunately, your ill-informed opinion on price v value is at odds with millions of investors. I know which side my money is on, based on past experience!
Feel free to lose your money
That’s what the market let’s you do
You can lose money on bonds too.
The FACTS are that:
– long-term investors in equities have historically had much higher returns than in other asset classes
– investors in equities would have achieved returns of 20% or more since your claim that markets were overvalued
Are you not aware of this, or simply wish that it were not true, as it undermines your claim?
I was not discussing such issues
So what the heck are you talking about?