So we have been having Quantitative Easing already, and Baruch doesn’t like it. The stockmarket is up (or was), the data seems to be improving; QE has done its work and for all we know it will continue. But there is a special unhealthy quality to it all. It feels like a “wrong” rally, like the cat from Pet Sematary was clearly a wrong kind of cat.
The problem as I see it is this: QE lowers overall interest rates and makes all the stocks go up when they wouldn’t have normally. It raises their valuations, which you can also express by saying it makes for higher PEs. This makes people feel richer. They will go and buy more stuff like LCD TVs, making the companies who make the stuff they buy richer too. They will invest more, and buy more stuff from companies who make stuff not for people, but for other companies. Eventually all the companies grow into their higher stock valuations, and we are all fine.
The key word here however, is “eventually”. What happens in the bit between the 2 points: after all the stocks have gone up, and before the fundamentals improve to justify their new valuations? Because I think that’s where we are if stocks have stopped going up, or where we will soon be.
Now, my tech stocks aren’t exactly expensive. Lots of them are to be had for PE multiples in the low teens, which really isn’t bad. But there has been no fundamental improvement in their businesses since the summer, as far as Baruch can tell, and yet their stocks have absolutely zoomed to levels I frankly have difficulties buying them at, at least on the charts. Baruch was astonished last week to see that the NASDAQ 100 was basically back to its pre-crisis high!! You get that? That index is telling you that things are as good as they were before the Great Unwind.
I can’t short them either, at least not on past form. That’s been a mug’s game; the subtext of QE is “kill all the shorts” — another way of making sure stocks go up. Returns on short books have been pretty brutal, and most long short guys in the past couple of months have learned to be mostly long, or if they have to stay balanced, then long stocks, short indices.
So, now what? If stocks are now disassociated from their fundamental realities, however short a time that disassociation is supposed to last, non-fundamental realities are going to rule, and I have no idea what that means. Will we get stasis, a crunch in volatility and volumes? Will we have vast nauseating unexplainable swings in stocks, huge moves in the VIX? Will we crash? Will we carry on straight up? Will we pause and rally? Who can say? We’re in a period where anything is possible, as I’ve said before, a world of unintended consequences coming down the pipe. Some may be good, and some may be bad.
This is why in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).
The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.
I’m not saying we’re in an undead homicidal zombie market, though we may be. But here’s an example of what the Pet Sematary market is capable of in terms of unintended consequences: QE inflates all asset prices, including commodities. This pressures the Chinese consumer, who we are relying on to pull us all out of this mess, who can suddenly not afford his new LCD TV because his Moo Shu pork is costing 20% more than it used to. Changes in commodity prices have a much greater impact on his consumption than Joe Schmoe in Idaho, with his low cost high fructose corn syrup and processed trans fat diet. The BoC has to raise rates to offset the inflation this is causing, hurting Chinese growth even more, and global GDP growth drops 50bp. Bravo the Bernank. With your Quantitative Easing you just killed off the only good thing in this market which was working naturally without outside interference.
OK, Baruch may be exaggerating, but a big part of today’s selloff is driven by fears of commodity prices in China and a collapsing Shanghai stockmarket. It’ll probably turn out to be nothing, a damp squib. But if it doesn’t, you heard it here first. I feel sure there is a wider point here to make about the bad things that happen when you mess with the signalling mechanism of the stockmarket. After all, the stockmarket does not exist solely to make us richer, does it? But that’s probably for another post.