When central bankers talk, investors listen.
World stock markets rallied last week on a Reuters report which said major central banks were prepared to take coordinated action if the results of the Greek elections led to market turmoil.
On top of that, later reports said the
European Central Bank was hinting at an interest-rate cut and Britain jumped in
with a pledge to flood its banks with cash if needed, according to Reuters.
This global show of force suggests the world’s political leaders will do
whatever they can to keep the financial markets stable.
Interestingly, last week’s economic news in the U.S. and
Europe pointed to continued sluggish growth, according to MarketWatch.
Normally, you might expect the stock market to drop on weak economic news as it
could lead to lower corporate profits. However, investors seemed to interpret
the “bad” news as “good” news for the market because the worse things get, the
more likely government may step in with more stimulus.
There’s an old Wall Street adage that says, “Don’t fight the
Fed.” This means when the Federal Reserve starts firing its bullets to
stimulate the economy, it tends to spark a rally in the stock market – even if
the economic news continues to look weak, according to MarketWatch. The Federal
Reserve, along with other central banks, have already fired $6 trillion worth
of bullets in the form of money printing since 2008 and, as a result, many of the
world’s financial markets have risen sharply since the early 2009 lows,
according to CNBC.
While further stimulus might support the financial markets
in the short term, there are two things to consider:
1.
Additional stimulus is subject to
the law of diminishing returns. Just like one chocolate chip cookie tastes
great, but 10 may make you sick, too much stimulus may eventually backfire.
2.
Additional stimulus improves
liquidity, but does not address the solvency issue. Europe and the U.S. still have
a solvency problem of too much debt and this debt needs to either be written
off or paid off. Solvency is the harder issue to solve.
Source: Hussman Funds, June 18, 2012
We’ll know the financial markets are “back to normal” when
they can stand on their own without any hint of support from central banks.
IS THERE A BUBBLE IN THE
BOND MARKET?
As you know, interest rates are near record lows and that
hurts savers who were used to receiving relatively high and mostly risk-free
income on their savings. For example, back in 2007, 10-year Treasuries yielded
about 5 percent, according to the U.S. Department of the Treasury. Last week,
the yield was down to about 1.6 percent. Since bond prices move inversely to
yield, this means as yields moved to near record lows, bond prices moved to
near record highs. And, now, some analysts are asking if bond prices have
reached bubble territory, according to Bloomberg.
One of the most recent clear-cut cases of a bubble was the
technology boom of the late 1990s. Unfortunately, that was followed by the
technology stock bust of the early 2000s. You may recall that bubble was based
on greed as investors clamored to get in on the internet frenzy and make some
“easy” money.
But, today’s peak in the bond market is just the opposite.
It’s based on fear, not greed. Due to economic uncertainty, investors have
jumped into bonds to preserve their money and this fear-based demand for bonds has pushed prices up and yields down,
according to Bloomberg.
So, can a bubble be based on fear or are bubbles just reserved
for greed-driven extremes? In reality, we’re not as concerned about the
definition of the bubble as we are about the possible unwinding of the bubble.
The technology bubble of the late 1990s and the strong bond market
of today are great examples of two things that can drive markets to extremes – greed
and fear. In the end, whether driven by greed or fear, extreme movements in the
financial market tend to eventually reverse themselves and revert back to the
mean. Our job as your financial advisor is to acknowledge these emotions, but
not get caught up in them. We do our best to remain rationale and analytical in
the face of greed and fear so we can do the best job possible in securing your
financial future.
Weekly Focus – Think About It…
“Individuals who cannot master their emotions are ill-suited
to profit from the investment process.”
--Benjamin Graham, investment manager, author, Warren Buffett mentor
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