The "central bank of central banks" warns asset prices are disconnected from reality

The Bank for International Settlements issued another warning about the detachment of U.S. equity prices from the real economy in its latest quarterly review.

Why it matters: The so-called central bank of central banks continues to warn that the gravity-defying stock market is also defying reason.

• “We are moving from the liquidity to the solvency phase of the crisis,” Claudio Borio, head of the BIS Monetary and Economic Department, said on a call with reporters.
• “We should be expecting more bankruptcies going forward yet credit spreads are quite low by historical standards, and indeed while banks are pricing risk more carefully we don’t see the same in capital markets.”

In the latest review, BIS researchers flagged concerns about "the daylight between valuations, which are still above or near their already stretched pre-pandemic levels, and economic prospects, which are still uncertain."

Flashback: This is not the first time BIS has warned about the disconnect of equity prices and economic fundamentals.

• In its last quarterly review, titled "Markets rose despite subdued economic recovery," the organization said the Fed's accommodative monetary policy was responsible for “close to a half" of the runup in U.S. stock prices and "a fifth of the rebound" in European equities.
• In September 2019, BIS warned that the extreme growth in central bank balance sheets since the financial crisis had negatively impacted the way financial markets function.
• That report also found that negative impacts have been more prevalent when central banks hold a larger share of assets.

On another note: The December review also unveiled a study on the long-time correlation between stock and fixed income returns that drive the traditional 60/40 portfolio.

• "Signs have emerged that the effectiveness of US Treasuries as a hedge to large equity losses may have declined in recent years."
• "The response of 10-year yields to S&P 500 sell-offs has become more muted since 2018, possibly reflecting the Federal Reserve's limited easing space."
• "As Fed officials have consistently communicated their reluctance to introduce negative interest rates, this not only puts a floor under short-term rates but also limits the potential decline of long-term nominal yields, regardless of any additional easing measures considered."