Rise in equity prices in US on lower than normal trading volumes and flight from Europe and Japan to the safety of the relatively higher yielding US bond markets, US index funds and China’s financial markets has become salient to the global financial markets. Japanese equity markets would join the equity bubble because of the quantitative easing by the Bank of Japan.
Corporate profits – reflecting economic recovery since 2009 Quarter III in the US and the attendant significant monetary and fiscal easing – are higher, and will seek new avenues for investment. Meanwhile, the monetary easing, which is laying the groundwork for long term fiscal discipline beginning now, is creating asset price inflation in equities.
Fed’s purchases of long-dated Treasury securities at the rate of $45-billion a month (or two-thirds of all new issuances) is raising prices and lowering yields. The yield seeking markets are leaving bonds and investing in stocks raising the prices of equities and, hence, Dow Jones Industrial Average (DJIA) and other indices.
Any semblance of good economic or corporate news is triggering a rally while bad news is met with a muted or shallow response. Stock market swings, on net, are favoring ever higher indices. Fed liquidity and crisis intervention have ensured insulating the markets from steep falls, though only a persistently weak economy exacerbated by credit bubbles can shift investor sentiment from stocks to the safety of cash and bonds.
In the real sector, economic indicators are mixed everywhere except in Europe and on balance in positive territory in April.
While large businesses and the financial markets are experiencing robust growth, small businesses which employ most Americans are still feeling uncertain about the US economy because of the fiscal outlook and the injured ties since the Great Recession between the many privately-held small businesses and the publicly-held large businesses in the economic ecosystem. Capital is flowing into the publicly-held large businesses.
Globally inflation is falling, gold and extractive industries are down, and energy prices are also pointing down signaling a global slowdown guided by 2% inflation targets in the G8 countries which are pacing structural change to more efficient economies with higher food supply, better food distribution, lower energy prices and more efficient use of natural resources to structurally contain inflation. In the long run the expectation is for both inflation and unemployment to be low.
In the short run also, however, given the persistence of recessionary outlook and GDP volatility, in US and Japan it would be beneficial if the returns in the equities markets are commensurate with the real growth rates of their respective economies. In the United States that relationship has been incoherent indicative of trouble with conventional monetary transmission and Japan has only begun to see growth sprout once again. Both US and Japan are mired in a liquidity trap, constrained by conventional monetary policies including quantitative easings.
The composition of real growth is the best indicator of the economic structure objectives of the G8 central banks which can only be achieved unconventionally by making industrial policy through monetary policy supported by fiscal policy through public-private partnerships and tax incentives.
It is time for private domestic real investment in agriculture, water, clean coal, natural gas, alternative energy and transportation to rise.
After all, the long run is but a series of short runs.