The “trade” these days is very simple. Just follow what the central banks around the world say and you are pretty much guaranteed to make money. As long as they announce they are printing more paper money or lowering interest rates, then just buy stocks. This requires no thinking whatsoever and the fundamentals, like economic data and corporate earnings, don’t really matter.
Look at the chart below of the Dow Jones Industrial Average over the past few months and pay attention to the green arrows.
Chart courtesy of www.StockCharts.com
On October 16 (green arrow at the bottom of the chart), we heard from the president of the Federal Reserve Bank of St. Louis, James Bullard, that the easy monetary policies of the Fed should be reconsidered. In respect to deflation, he said, “We are watching and we’re ready and we are willing to do things to defend our inflation target.” (Source: “Bullard Says Fed Should Consider Delay in Ending QE,” Bloomberg, October 16, 2014.) In other words, the Federal Reserve will print more paper money if required to boost inflation.
These comments by Mr. Bullard came at a time when key stock indices, like the S&P 500 and the Dow Jones Industrial Average, were in the midst of one of the worst market sell-offs in two years. Maybe it is a coincidence, but the markets turned after Mr. Bullard’s comments. On the economic front, there wasn’t anything major that would justify the turn back upwards for the markets.
Then, on October 31 (green arrow in the middle of the chart), the Bank of Japan said it would print more paper money to jumpstart its economy. North American stock markets rallied and showed significant gains following that announcement.
The Bank of Japan has been printing paper money for much longer than the Federal Reserve. But the country is now back in a recession—its second in just two years.
Lastly, and most recently, we heard from the People’s Bank of China on November 21 (green arrow at the top of the chart). It lowered its one-year lending rate by 40 basis points to 5.6%. Why? The Chinese economy has been struggling for some time and this year, it’s on pace to post its slowest economic growth since 2009. There are many other troubles brewing in China, too, including the housing market and bad loans to name just a couple. (Source: The Globe and Mail, November 21, 2014.)
The stock market’s reaction to the People’s Bank of China was the same; it closed at its highest level ever.
Central banks are the only force driving the key stock indices higher. Fundamentals aren’t really at play here no matter how you look at it. Long-term, blindly trusting central bank policies to move asset prices higher will be very risky.