Saturday, February 10, 2018

Share Market Decline

Uncertainty has returned to the US share market. How it will end is not clear.

In the old days, the sharemarket was thought of as a market for capital assets (factories, machinery, etc). A rise in the price of shares reflected improved business profits or increased business confidence. This understanding is no longer true.

Share prices are now influenced much more by the decisions in the political and financial sectors. The American economy looks strong, with unemployment at low levels, but the financial sector and the real economy are increasingly disconnected.

  • The current boom in share prices have not been driven by corporate profits, but by the low interest rates imposed by the Fed since the GFC. Debt funded share buy-back schemes have also pushed up share prices for the benefit of managers paid in stocks or stock options. Price to earnings ratios are at very high.

  • After nearly a decade of close to zero interest rates, the Fed is raising interest rates. The cheap money that has sustained share prices might disappear.

  • To support their quantitative easing policies, central banks bought a third of all securities, including debt and shares (socialisation of the means of production by stealth). They have now stopped buying. As the securities are maturing, they are disappearing from their balance sheets. Some central banks are actively selling.

  • The bond and share markets no longer stand alone. A huge mix of financial derivatives and financial products sit on top of these markets. The value of this financial superstructure is exponentially greater than the capital assets controlled by public companies. These products are an uncertain mix of leverage, risk and debt.

  • The US Congress has just agreed to a budget that involves a huge spending increase, following from tax cuts passed last month. The massive budget deficit that inevitably follows will have to be financed with borrowing. This is likely to push up interests and attract money out of shares.

  • The Chinese have stopped putting most of their spare money into US Treasuries and are placing more of their surplus into One Belt One Road investments in Asia and Africa.

This is different from what has gone before. How these different pressures will work out is anyone's guess.

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