With Greenspan emerging from his crypt to confirm that he is now as clueless about everything as he was 15 years ago (although the absolutely zero reaction out of "stocks" to his statement that stocks are "very undervalued" is perhaps indicative that SkyNet may just be learning), it is appropriate to remind readers that this thing known as the "market" died some four years ago. What we have now is a vehicle with a "role in the policy fight to support spending" while "today’s stock market has arguably lost some of its ability to reflect underlying economic trends." Not our words - those of Bank of America's Ethan Harris, who, four years after the fringe blogs, finally "gets it."
From Bank of America's "A Market With A Mission"
Equity prices in the US and Europe have been hovering at multi-year highs. To the extent that this reflects powerful policy easing, equity markets may have lost some of its ability to reflect economic trends in exchange for an important role in the policy fight to support spending.
The ongoing climb in stocks does not look like a traditional reflation trade. US long rates remain well-behaved in face of brightening data. Equity prices thus seem to be benefiting from a diet of steadfast monetary support from G-4 central banks as well as expectations that global growth and inflation will remain tepid enough to avoid early policy exits.
A contribution exercise indeed suggests that earnings growth expectations have yet to become a key driver of US and European stock prices. Rather, improved confidence and diminished risk perceptions explain, to a significant extent, the equity price pickup in recent months. This is particular true for the euro area, where firms are still feeling the brunt of a long-lived recession.
Risk assets breathed a sigh of relief back in September, when both the Fed and the ECB reaffirmed their commitments to fight downside risks. Six months on, and risk perceptions still seem to be receding. As Chart 2 shows, equity risk premia (ERP) have been edging down in recent months. Altogether, the ERP has shed 1pp in the US since June. In the euro area, however, the ERP has dipped by 2pp during the same time period.
The key contributors to US and European markets are likely to be major drivers of stock prices elsewhere. Equity returns are usually found to be even more highly correlated than bond returns. Moreover, to the extent that the predominant role of lower risk premia in driving equities has been induced by G-4 policy easing, global stocks may be acting as a transmission channel.
Fed Vice-Chair Janet Yellen recently noted that, even if the interest rate channel is less powerful in these QE days, the central bank is counting on wealth channels to support consumption spending. In other words, today’s stock market has arguably lost some of its ability to reflect underlying economic trends in exchange for an important role in the policy fight. That said, we see more no change to this trade-off on the horizon: the Fed will likely keep purchasing assets into next year.
So there it is: the "market" is now anything but. The only question is whose "consumption spending" is being supported.
Can we please stop pretending as if there is any causal relationship between news from the real world, and what the Fed's wealth transmissions mechanism does. In fact, can the Fed just give everyone its closing price target for 4pm today, a month from today, and for 2013 just so everyone can fast forward to that point, and "discount" their newly diluted wealth?