MARKET OBSERVER – N° 119

The sudden reversal in monetary policy implemented by the FED at the beginning of January, followed in recent days by a similar statement by the ECB Directorate, leaves little doubt that, at the end of the 1990s what the legendary Governor Greenspan had called his worst nightmare, the “Japanese Syndrome”, has been punctually realized.

In fact, the constant deterioration of the international economic situation that led to the stock market crash at the end of 2018 forced the monetary authorities to finally acknowledge that the structural deflation induced by globalization and amplified by technological progress made the zero-cost of cash normal; said policy introduced in 2009 to tackle the serious recession following the banking crisis.

Therefore, the prevailing working hypothesis starting in 2016, which indicated the return to moderately positive base rates as probable, has occurred only partially in the USA; in the light of recent developments is has been set aside, probably for several years. The same FED, upon review of recent economic data and the negative stock market reaction to recent increases in the base rate, may have already exhausted the credit tightening phase initiated at the end of 2015. So, we are faced with a new phase of monetary stimulus, that maybe will not be called Q5, but, in essence, follows the script already seen in the last 10 years. In effect, from the standpoint of economic theory, what is happening respects logic, in the sense that to achieve the utopian 2% level of inflation, it is necessary to reflate the economies through the introduction of surplus liquidity. However, experience shows that mere monetary stimulus is of little use if it is not accompanied by other structural measures to support the economic situation such as appropriate fiscal policies, which today are not available because of budgetary constraints on public finances.

Therefore, the main beneficiary of the renewed stimulus phase will once again be the securities markets, given the persistence of the “liquidity trap” which sees the real economy unwilling to use available credit.

The stock market dynamics of this first part of the year, characterized by generalized gains that allowed us to recover a good part of the losses at the end of 2018, can be explained by the belief that investors are in the presence of a sort of option of support of the central banks, ready to intervene at the first sign of weakness of the stock exchanges, exactly as they did in January. But we forget that stock prices depend mainly on economic fundamentals, which currently indicate a picture of general economic cooling that in some cases has already turned into a technical recession. Due to the temporal deviation between the implementation of monetary stimulus policies and their effect on the economic situation, the cooling will continue for several months. Without the support of growth in corporate profits, the stock market indices seem destined to regress from recent gains, perhaps having already initiated a correction aimed at retracing at least one third of this years’ rebound. In order to quantify, the S&P 500 index which has recently failed at the 2800 level, appears oriented to fall close to the level of 2650 points, while the EuroStoxx 50 index, after topping 3300 points, seems to be correcting towards the support area between 3100 and 3150 points. At these levels, the European banking sector, thanks to the recent decision by the ECB to re-propose a two-year TLTRO funding starting in September, could represent an interesting investment opportunity. In any case, thanks to the change in the respective monetary policies, the working hypothesis prevailing at the end of December, that the indexes could test shortly the lows at the end of 2018, is temporarily shelved and in any case greatly shifted temporally. On the Asian market front, the Chinese stock market deserves attention, recovering from a sharp correction after the marked gains since the beginning of the year, caused by disappointing economic data, on which however, the government and the PBOC can easily intervene, making the current decline a medium-term buying opportunity.

Nicola Bravetti Data Source: Bloomberg