Oct 10, 2019

The end of stock market corrections

Dion Rabouin, author of Markets

Illustration: Eniola Odetunde/Axios

Normally the health of business drives a country's asset prices, but that's not what's happening at the moment, according to Deutsche Bank Securities chief economist Torsten Slok.

What's happening: The S&P 500 has risen by around 20% so far this year, despite weakening U.S. economic data and a slowing labor market. Earnings growth, typically the bread and butter of equity market returns, was negative in the second quarter and is expected to be negative in the third and fourth quarters as well.

  • U.S. GDP growth is expected to be lower in the second half of the year than in the first and lower still in 2020, a negative picture for the country's growth outlook and that of its public companies.

What we're hearing: Slok, a typically even-handed economist, expressed his disbelief at the decoupling of asset prices from fundamentals in a recent note to clients.

  • "Perhaps the answer is that equity and credit markets are no longer driven by fundamentals, but instead by Fed and ECB promises of lower rates, more dovish forward guidance, and QEternity."
  • "In short, because of unlimited central bank safety nets — including in the new MMT form of aggressive fiscal policy — S&P500 may not decline, and credit spreads may not widen next time we enter a recession."

Why it matters: This isn't the way public markets are supposed to function.

The big picture: In an email exchange, Slok asserted that there were 3 reasons "this time is different" from other Fed "puts," or bets by investors that central banks will step in to lower rates if stock prices get too low.

  1. The Fed is actively responding to asset prices. "This shows that the Fed is directly trying to ease financial conditions" and "trying to limit declines in the stock market and widenings of credit spreads."
  2. The ECB has re-started quantitative easiing, which is also aimed at boosting prices of risky assets.
  3. Central banks are not effectively "promising" fiscal expansion, which is "a whole new narrative" in markets. "This has introduced a new safety net under risky assets. Put differently, why would I sell equities today if governments and central banks are about to do a big fiscal expansion financed partly by the central bank balance sheet."

The bottom line: Asset managers and economists have long suggested the Fed and other central banks are overly concerned with stock prices. But, as the chief economist at a major investment bank, Slok is one of the first in his position to allege stock prices could be this influenced by central bank policies.

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