Macroscan. The raging bull markets worldwide are running on empty

The S&P 500 index of US stocks rose cumulatively by more than 300 per cent when compared with its post-crisis low value on March 9, 2009, and did not fall by a cumulative 20 per cent anytime in between.

This signalled that the US stock market had recorded its longest bull run ever (Chart 1). Though the magnitude of the rise has fallen short of previous records, a bull run of 3,453 days is a remarkable record in itself. All the more so, because over much of this period, the US economy was performing poorly and struggling to recover from the depths of the recession created by the financial crisis.

However, because the record breaking moment in the stock market’s run came when the GDP numbers for the second quarter of 2018 pointed to the US economy growing at an annualised rate of 4.1 per cent, and because the magnitude of the overall rise in the US stock index has been significantly higher than that of indices in Japan and the main European markets, the bull run is being linked to the promise of better corporate performance.

Robust US recovery

US stocks have been favoured, it is argued, because the recovery in that country came sooner than elsewhere and has now turned robust, with creditable GDP growth, a steep fall in unemployment and relatively low inflation. Moreover, the fact that the US is the original home of some of the world’s leading technology companies is seen to have helped.

Technology companies account for more than a fifth of the gains registered by the S&P 500 in the ongoing bull run, and most of the recent gains have been due to Amazon, Apple and Google (or its parent Alphabet).

Facebook and Netflix had been major contributors earlier, but slipped recently because of the privacy violation challenges the former has faced recently and disappointing results for the latter.

But these explanations miss a number of factors that could change the interpretation of this long-term rise in US stock indices.

To start with, we seem to live in an age of long bull runs. Going by the S&P 500’s track record, the immediately preceding bull run which lasted 3,452 days, ended in March 2000 with the tech stock bust.

The cumulative rise in the index during that run was 417 per cent.

So there seem to be factors favouring long bull runs in the macroeconomic environment.

Second, while it is true that the US stock market has outperformed many markets in Europe and Japan, those markets too have displayed considerable buoyancy in recent years, and the German DAX appears to have kept pace with the US’s S&P.

This comes through in Chart 2, which shows the increase in the value of the relevant index relative to its value on March 9, 2009, when the US bull run began.

Overall, while between that date and August 22, 2018, the S&P 500 for the US rose by 322 per cent, the DAX increased by 234 per cent and the Japanese Nikkei by 216 per cent.

These are significant increases over a close to 10-year period, even if lower than that in the US. It is only the French CAX that seems to have lagged behind with a rise of 115 per cent.

But that speaks more for France’s economic performance that made it different, than it does of the performance of the other three economies.

Tech drive

Third, while it is true that technology stocks of US-headquartered companies have done very well, they currently stand at levels that are not warranted by estimates of potential earnings. The price to earnings ratios of these stocks are way above their long period averages.

Amazon was trading at a price that is 85 times expected future earnings (down from 115 times), according to an estimate quoted by the Wall Street Journal , while on average stocks in the S&P 500 were priced at around 16 times earnings.

When confidence falters, such euphoric valuations can quickly unwind. In July, Facebook’s stock price fell by 19 per cent on a single day and lost about $120 billion in market capitalisation because of declining revenues and slower than expected user growth.

For similar reasons, the value of Netflix stock fell by 14 per cent in after-hours trading on the day the results were revealed.

Finally, index movements in some emerging markets are similar to that in the US. With interest rates low and the investors having whet their appetite for high returns in equity markets, emerging markets have been buoyant for a part of the period when the US market experienced its bull run.

Some like India have seen the local index track the S&P index closely, though others like Thailand have been less “fortunate” (Chart 3). This synchronisation across global markets does suggest that there are common drivers pushing stock indices to levels where the bull run appears speculative.

Cheap liquidity

One such common driver recognised by all, but conveniently ignored in market-friendly assessments of such phenomena, is the long-term reliance on a policy of infusing large volumes of cheap liquidity as a means of pulling economies out of the recession they fell into after the financial crisis of 2007.

Central bank balance sheets in the US, UK, Europe and Japan have seen their asset values rise by trillions of dollars.

That cheap liquidity found its way to equity markets, rendering them buoyant even real economies were doing badly.

A significant proportion of that liquidity also flowed to emerging markets, where too equity markets turned buoyant.

Speculative fever

This phenomenon of excess liquidity in search of a relatively few actively traded stocks leading to buoyancy is nothing but a signal of speculative fever — an unintended consequence of the use of monetary policy to address the crisis.

Central banks and governments realise that this cannot go on, so the emphasis now is on unwinding the policy of “quantitative easing” and raising interest rates.

But that can only be done gradually, for fear of unravelling the speculative spiral too fast with economy-wide adverse consequences.

Meanwhile, the unsustainable bull run continues.

COMMENT NOW