Which triggers are driving the action? What's next?
Recorded last week as the market was in full melt-down mode, Chris and Wolf Richter decode the underlying drivers of the sudden reversal, and peer into the future to predict what is most likely to happen next. Both agree that, whether stocks are briefly 'rescued' in the ensuing days, the long-awaited downward re-pricing of the 'Everything Bubble' is nigh.
As Wolf puts it:
The emerging market stock index is down 22% from January. So they have gotten hit pretty hard. There’s this trend from the outside toward the core. So when something deteriorates, it starts at the outside and moves toward the core, the core being the higher quality US financial instruments. So that’s probably a dynamic that has already started. And I agree with you. The central banks removing liquidity is a big thing, and it has a big impact.
And people have said, for years, well, QE didn’t cause stocks to go up. So when that goes away, it’s not going to cause stocks to go down. But that’s just not true. The purpose of QE, as Bernanke himself explained it in a Washington Post editorial in 2010, is to create the wealth effect, to bring asset prices up so that the wealthy feel wealthier and spend more money and then this someone trickles down. So this was an explicit central bank policy that other central banks, especially the ECB and the Bank of Japan, imitated. So now, this is being unwound.
We’re in a new era, I think, and the financial markets have to come to grips with it. And the central banks have expressed concerns about high asset prices, repeatedly, for two years now, and especially at the Fed. Including high-end commercial real estate prices, there’s some problems in the housing market.
They occasionally mention the stock market. They have fretted publicly about the leveraged loan market and some parts of the bond market. So they’re purposefully trying to bring down those asset prices. That’s something that investors will have to keep in mind. It’s not that the Fed has stepped away from supporting the markets. The Fed is actually trying to tamp down on asset prices because that’s gone too far and because these leveraged assets are putting the financial system at risk when the prices are too inflated.
So they’re trying to drain some of the risk out of the market. This is a big recognition. Once market players realize that this is going on I would imagine that they are somehow preparing for this.