Central Banks Worldwide Are Lifting Stocks. Is the Stability Masking Trouble Ahead?

By Randall W. Forsyth 


Central Banks Worldwide Are Lifting Stocks. Is the Stability Masking Trouble Ahead?
Photograph by Peter King/Fox Photos/Getty Images


“Don’t fight the Fed” was a market mantra from another era. If the U.S. central bank was raising interest rates, the stock market would inevitably be fighting an uphill battle. In that case, the better part of valor would be to get out of stocks and other risky assets and take cover in cash.

Now, the Federal Reserve and virtually every other central bank on the planet appear to be keenly watching asset prices, given their increasingly tight connection to the real economy. That may not have been their stated intent, but that has been the effect of a marked shift away from restraint this year.

The Dow Jones Industrial Average notched its ninth straight weekly advance, for a cumulative gain of 16% over the span, the longest winning streak since May 1995, according to our colleagues at Dow Jones Market Data. The rise has put the blue-chip gauge within just 3% of its record close on Oct. 3.

The advance has also been global. The Shanghai Composite Index scored its seventh straight weekly gain, totaling 12.4% during the period. The Nikkei 225 ended its sixth winning week in the past seven and is up nearly 12% from its December low. And the Stoxx Europe 600 had its seventh up week in the past eight, ending up 12.6% from its Dec. 27 low.

Minutes of the Jan. 29-30 meeting of the Federal Open Market Committee confirmed that the U.S. central bank was not oblivious to the growing danger to the economy posed by the slide in risky assets. The policy-setting panel confirmed earlier statements attesting to its patience in raising interest rates and flexibility in shrinking its balance sheet, which is another form of policy tightening.

While the Fed’s shift so far has only been rhetorical, the effect has been to add $5.1 trillion to the wealth of investors in U.S. stocks since the market’s Christmas Eve low, according to Wilshire Associates’ reckoning.

At the same time, the People’s Bank of China has engaged in a number of easing moves. Cornerstone Macro, led by veteran strategist Nancy Lazar, wrote in a client note that the central bank’s actions have boosted shares of U.S. companies with the most sales to China, including A.O. Smith (ticker: AOS), Expeditors International of Washington(EXPD), Boeing(BA), and TransDigm Group (TDG). Reports that U.S. and Chinese trade negotiators are moving toward a deal that would forestall a threatened increase in U.S. tariffs on Chinese goods would clearly be another plus for trade, and continued gains in stock prices.

In essence, central banks have tamped down the risk in the markets, which is evidenced by the decline in volatility measures. As a result, the VIX—the so-called equity fear gauge, measuring the volatility of S&P 500 index options—fell for the ninth straight week, to 13.51, less than half its late 2018 peak before it began its slide into somnolence. Nor has that been confined to equities. The MOVE index of Treasury market volatility has also declined by nearly a third since December as expectations of Fed rate hikes have all but disappeared.

Indeed, traders continue to bet actively on future rate cuts in the market for options on Eurodollar futures, according to Chicago futures brokers R.J. O’Brien & Associates.

The steady rise in stock prices and diminution of risk perceptions make for an opportune time for hot, young companies to make their initial public equity offerings. Last week, Pinterest, the social-media site, submitted a confidential filing to the Securities and Exchange Commission to go public, following ride-sharing company Lyft’s filing in December. Waiting in the wings to go public are other so-called unicorns, notably Uber, the biggest ride-sharing service, and Slack, the messaging service for offices. As with the rush to the debt market noted here last week, the IPO window now seems to be opening.

The nonchalance toward risk oddly has as its backdrop any number of potentially market-moving events. Fed Chairman Jerome Powell is due to testify before Congress on policy and the economic outlook, starting with the Senate Banking Committee on Tuesday and the House Financial Services panel on Wednesday. President Donald Trump also heads to Vietnam to meet North Korea Supreme Leader Kim Jong-un during the week.

The March 1 deadline to work out a trade deal arrives on Friday but is likely to be extended. Also looming is the expected report from special counsel Robert Mueller III’s investigation on Russian influence on the 2016 election. And in case you’ve forgotten, the March 29 deadline for Brexit also looms.

March Madness this year could refer to something other than college basketball, which doesn’t seem priced into the markets.