Despite everything that is happening in the real economy the stock market is sailing on as if all is well in the world. But then it was ever thus. Just as Tory leaders enjoy the support of their party until the moment when they do not, so are stock markets worth what punters claim until their confidence evaporates. In both cases, the faith in the myth disappears at about the speed of air leaving a bursting balloon.
Right now we all know the UK government is pushing the economic self destruct button, but the whole world is facing real economic issues. There really are energy prices increases, worldwide. Supply chain issues are universal because of chaos in worldwide shipping, although the FT claims this situation is improving. And the required skills mix is different from that which people have to offer in many countries, even if most have the advantage of free movement to help sort out the resulting problems.
The result is that there is a widespread fear of inflation that extends far beyond the UK. That there will be inflation this winter at rates ahead of those that central bankers artificially target (since none can really explain what is so magical about their two per cent chosen rate) is seemingly certain in many countries. I continue to think there is no reason why that should continue and, therefore, no action is required to address this. Those desperate to prove that central banking still exists and still has a purpose (both of which are in considerable doubt) argue rates must rise.
Now, it is true that the supposed corollary of increasing interest rates is that shares increase in price because bond prices fall. But we have not seen inflation for a long time and that driven by real economic woes in the underlying economy is much rarer still. In that case the assumption that this relationship holds is dubious: rates can fall and share prices can take a simultaneous hit when monetary policy is inappropriately used to squeeze demand when all the problems in the economy are already on the supply side and hitting life's essentials rather than the demand for supposedly vainglorious fripperies that rising interest rates target. It's possible, in other words, for there to be a hit in both financial markets if monetary policy is used to make life generally worse for people.
An increase in interest rates now, which central bankers so clearly want, would make life worse for most people in the UK. What is more, there are few for whom it might improve anything much, not least as there is no guarantee that any increase would be translated into improved saver rates, and so it is entirely plausible that the Bank of England could trigger a financial meltdown. The best chance of avoiding them doing that might be if savers rumble the risk first, and start off loading shares anyway.
Why would they do that? Because the reality is that stock markets are very likely considerably over-valued. So far no one seems to be talking about a change in that value to reflect the mood of the moment. That's because that might give the Bank of England what they would think to be justification for even greater (but still inappropriate) intervention. But just give it time. There is every chance for those in charge of our economy to make things much worse yet.
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Clearly there are current economic risks which should make us nervous about the winter, whether you are measuring the health of the economy in terms of FTSE, inflation, employment rates, or whatever. But I am puzzled – no doubt because of my lack of knowledge – why those risks would be greatly changed by the sort of interest rate change that the Bank of England is almost certainly thinking of: going from 0.1% to 0.25% and then waiting to see what the impact is.
“Now, it is true that the supposed corollary of increasing interest rates is that shares increase in price. “
Apart from the banking sector this is clearly not the case!! Either this is a typo or you are woefully off the mark..
That is not a typo
That is what is thought to be the case
I am simply summarising what is commonly said
If rates are rising in response to the economy (and corporate profits) going gangbusters then rates and stock prices CAN go up together.
If we are in a highly inflationary period we could also see higher rates and higher (nominal) stock prices.
But, for a given level of economic activity higher interest rates will deliver lower stock prices.
My bet is that the run up in stocks we have seen over the last year or so has everything to do with low rates…. so it is highly likely that higher rates will depress share prices…. particularly if you believe the BoE is going to hike.
Maybe…
Surely it is two effects linked to one cause. When inflation increases, on the one hand central banks increase interest rates, on the other hand transactions are at the new higher prices, leading to profits at the new higher prices. A lot of other things can happen, but I would expect a weak positive correlation.
From Business Insider …….
(https://markets.businessinsider.com/news/stocks/stock-market-outlook-overvalued-equities-sharp-correction-sp500-earnings-growth-2021-9)
Stocks look dangerously overvalued and are at risk of a sharp correction as investors misjudge the sustainability of explosive earnings growth, DB says
On nearly every valuation metric, US stocks are trading at “historically extreme” levels, according to the bank. Trailing and forward price to earnings, enterprise value to EBITDA, and cash flow valuation metrics are well into the 90th percentile, Deutsche Bank highlighted.
Historical data shows that when valuations have gotten to such high levels in the past, five-year forward returns were on average negative. And with expectations high for continued strong earnings growth, investors could soon be let down as results potentially disappoint, the note said.
“We are skeptical the 85-year trend in earnings has changed,” Deutsche Bank said. The bank highlighted that analysts may soon be done playing catch-up in revising their earnings estimates to the upside.
“We look for earnings beats and upgrades to slow, diminishing if not ending what has been a key driver of equity upside, particularly year to date and supported multiples,” Deutsche Bank explained. The bank thinks confusion over where the market is in its current recovery cycle can explain a bulk of the recent gains, and is also one of the main risks going forward.
“At a fundamental level, we believe the key reason multiples are high is market confusion over where we are in the earnings cycle, in part reflecting the speed and surprise with which the economic recovery has unfolded and the large persistent beats this generated,” Deutsche Bank explained.
“So the cycle is much more advanced and the risk is that activity begins to slow, while the market is priced for most of the recovery as yet to come and large beats to continue,” the bank added. Weaker-than-expected economic data has slowly been materializing, most recently illustrated by the miss in August’s jobs report.
“With the current cycle advancing very quickly, the risk that the correction is hard is growing,” Deutsche Bank concluded.
All I see is executive box economics from this Government – they’re playing to the exclusive upper floor seats of the house where they get their funding whilst leaving those in the stalls to fend for themselves.
It’s disgusting.
Richard …You might have followed the decision to dedicate Jersey’s economy to a deal over a new £800 millions hospital – if you have seen the details your analysis would be helpful. Its the largest project ever undertaken here and could break this small “state”. Is it a micro example for the future of larger economies in our changing world?
Mike
I have seen that the black hole has very definitely appeared
I have also not had time to examine it in depth (pun intended)
Sorry
Richard
I have no doubt now that the bank of UK are going to increase rates. They believe people were expecting high inflation, so are doing their very best to lower inflation expectations.
Of course visitors to this blog are familiar that central bank monetary policy is not wealth neutral. This was one of the key defenses in the 1940s of classical economics against the Keynesian critique. The whole idea is that a wealth effect will rebalance the economy, meaning that government spending is unnecessary. This sounds very similar to the current government’s policy. According to Pigou a wealth rebalance can resolve a liquidity trap.
However, what Pigou leaves out is a detailed explanation in the direction of this wealth rebalance. And from a political position it is an easy sell, wealth rebalance. Sounds a lot like wealth distribution which is a popular policy. However, wealth rebalance does not specify who are the victims. And those victims are going to be precisely those who most need wealth redistribution. It will cause further asset price increases, higher real value of debt and more bankruptcy.
Instead of reducing financial risk, this kind of monetary targeting causes financial risk. Just a thought, could be wrong.
Yeah, about that 2% inflation target… https://www.nytimes.com/2014/12/21/upshot/of-kiwis-and-currencies-how-a-2-inflation-target-became-global-economic-gospel.html
You are no doubt aware that reports today explain the IFS view that the Chancellor will ‘run out of money’ for public services despite tax hikes. When this level of economic illiteracy emanates so brazenly from one of the ‘respected think tanks’, with no conceivable possibility, and certainly no fear, that it might dent credibility, you really have to ask whether the ‘experts’ actually do not understand that they are spouting vacuous neo lib propaganda and actually believe they are making economic analyses. Of course they are aware that it will all pass unchallenged at the public media level, but I believe that the success of the neo lib agenda since the 1970s has produced economists across the globe who simply have no idea that MMT actually exists, from which must follow total ignorance. Those who are aware regard it in much the same way as Marxism, something just too awful to even give a public airing, let alone to debate. Running out of money is an idea designed to induce fear, of course, but it signifies total acceptance of the Thatcher purse analogy, meaning that there really is a tax receipts account somewhere that limits the cash available to the state. In turn, this means public acceptance because of course the government cannot control the weather! This must surely underline your point that the government is intent on crashing the economy? My only question from this is whether it is intentional or merely the inevitable consequence of economic illiteracy?
Intentional I think
But the other option is certainly arguable as well