Delinking indicators warn of a fractured system

FT.com

Are the markets going mad? That is a question many investors might have asked in recent weeks, as stocks in the UK, eurozone and US have soared – even as bond spreads decline.

But, if you want another sign of how peculiar market patterns now seem, take a look at a report recently compiled by Matt King, an analyst at Citigroup. For what is most striking about the current market trends, King argues, is not simply those dazzling equity and bond prices; instead the really notable issue is how many long-standing data patterns have broken down.

Take a look at the link between unemployment and equity markets. Between 1997 and 2011 the level of unemployment in the eurozone was always inversely correlated to the Stoxx index. However, since 2011 the eurozone jobless rate has jumped from 10 per cent to 12 per cent – even as the Stoxx has risen 10 per cent.

Corporate earnings are another case in point. In recent decades, US earnings revisions have tracked swings in the stock market. But since the start of 2012 there have been net downward earnings revisions – while US stocks have soared. So too with credit spreads and leverage rates. In the past two decades, spreads on investment grade companies have always widened when corporate debt levels rose. But since 2011 the leverage ratio of eurozone companies has risen from 1.4 times to 1.7 times, while spreads have declined from around 210 basis points towards 120 basis points. A similar pattern is at work in the US.

It is the same story for market measures of economic uncertainty, drawn from business surveys. Indices of uncertainty used to track credit spreads. But while uncertainty has (unsurprisingly) remained elevated since 2011, spreads have tumbled. Or to put it another way, the behaviour of credit and equity markets has moved in the opposite direction from fundamentals – on multiple data points.

It is easy to identify the reason for this: as this data has gone haywire in the past couple of years, western central banks have been unleashing an estimated $7 trillion worth of quantitative easing. This has lowered interest rates on government bonds, forcing investors to search elsewhere for yield. But what has intensified the crunch is that, while central banks have been gobbling up bonds, the supply of assets has declined.

Citi calculates, for example, that net issuance in the US fixed income markets has tumbled from around $2 trillion in 2007 and $1.5 trillion in 2010, to a mere $250 billion in 2012. Little wonder, then, that spreads have been tightening and investors grabbing at equities; in macro-market terms this is tantamount to a giant, two-pronged squeeze.

However the crucial question now is just how much longer these bizarre conditions can continue. Right now the betting among most analysts I have recently spoken with in London and New York is that these distorted conditions will remain in place far longer than most people expect. The markets apparently agree: measures of volatility are currently running at very low levels, suggesting continued calm.

But while that bet of continued peace is probably correct – particularly given that central banks seem unlikely to abandon QE any time soon – there is an important caveat.

Back in 2007, King sometimes used the image of “a ball in a bowl” to explain how markets behaved during the credit bubble. Between 2001 and 2007 there was such a huge volume of liquidity in the system that markets seemed able to weather small(ish) shocks; just as a ball will roll back into the centre of a bowl if gently shaken, the financial system rebounded quickly from blows like the 2005 downgrade of General Motors.

However, this calm was fragile: beneath the surface there lurked profound contradictions and tensions. Thus when a big shock hit in 2007, the markets hit a tipping point and collapsed – just as a ball will fall out of a bowl, not roll back, if shaken violently.

King suspects that metaphor is an apt description of markets now, and I agree. For a while the flood of central bank liquidity is enabling the system to absorb small shocks, it is also masking a host of internal contradictions and fragilities that could surface if a shock hits. Or, to echo a point often made by Nassim Taleb, precisely because central banks are trying to pursue stability at all costs, the potential for a future violent instability is rising apace; 'tail risk', as statisticians say, is growing.

That does not mean a shock will necessarily occur soon; this phoney peace may last months, if not years. But as those equity markets soar, investors would do well to ponder on the data dislocations. Nobody can afford to feel complacent, least of all if they sit in a western finance ministry – or a central bank.

Copyright The Financial Times Limited 2013.

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Meanwhile as the world floats, on its new monetary paradigm, the little man, holding the banner "Jobs for workers", is totally missed.

One of the problems, with living inside a box, is that after a while, we adapt to it. Our explanation of reality becomes retarded.

So, lets look at the cause of retarded growth, energy costs.

The USA was the first country, to recognise, that bankers run banks. Industry runs industry. Whats my point? Give companies cheap energy and they will produce, create jobs, pay taxes and move the economy to a safe place.

Print money and bankers, will do what bankers do, protect it. That results, are cash coagulation and the economy has a heart attack.

Energy is the most abundant substance in the universe, it created everything, Republicans, will never accept this and would prefer Armagedon, than have their faith challenged.

Carbon is the new source of energy, no not burning it, thats primitve. Use supercooled CO2 to collect electrons from carbon sources. That's science, bankers have had their turn, time to give someone else a chance.

Well, no, it won't last. Such calm as has arisen is due to the Damoclesian transfer of enormous risk and debt to public institutions of uncertain standing.

MIT’s Simon Johnson (and former Chief Economist of the International Monetary Fund) believes that fraud – supported by successive administrations, including Obama's - is at the heart of the US financial markets.

Many of the national and international policy reactions appear intended to avoid or at least minimise losses to the moneybags through economic rent taken from the less affluent. Ultra-low-interest lending to banks, near-zero interest rates, and money-printing are all intended to preserve high asset (housing, equity, and commodity) prices for as long as possible, paid for by increasing national debt, austerity, and reducing workers' absolute and/or real incomes. Quantitative easing has been inflationary only in the sense of preventing deflation.

From the time that the Eurozone became a concept, there is and remains an absolute refusal by Europe's ruling classes to accept that a single-currency structure for a Eurozone that includes a wide range of disparate economies without central economic coordination renders both the encouragement of growth (balanced or unbalanced) and prevention of and recovery from economic crises extremely difficult. Linked to that is a complete refusal to restructure Europe's economies to provide a reasonable, if frugal, standard of living for its people in a low-GDP-growth environment, given jobless growth and large movements of economic migrants.

All this simply highlights the suicidal cost of allowing bankster criminals to plunder the real world. Looking to the future, it is clear that there is no meaningful recognition of pressing issues like the impacts of climate change, or increasingly pressing natural resource and ecosystem pressures. But none of those problems will await Europe's convenience!

Finally, any ultimate answer to the financial crisis will have to be a collectivist answer. Any reaction not giving a central role to government, socialism, and government business enterprises will fail.