Economics editor Stephen Hill, who predicted the current Chinese rout, on what comes next
Two weeks ago I warned about the Shanghai and Shenzhen markets that ‘there could well be further large falls based on these crazy numbers: when a market goes OTT and cracks, the drop comes fast and furious, like with the hangman’s noose. The simple stock market rule is that stock prices go up if there are more buyers than sellers, and down if there are more sellers than buyers.’
This inevitability began two weeks later, last Monday, and will continue lower, much lower, until average p/es are down from their high of 61 to twenty or under. Anything above this is essentially a false market.
I said that ‘the second rule is that governments shouldn’t ever play the market themselves or encourage the market up to bring in other investors, or try and support it. The Chinese government has done both, going up and now coming down, after the suckers had been duly sucked in.’ Black Monday, however, spread globally to all stock markets, for the same reason.
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I repeat: ‘Governments shouldn’t ever play the market themselves or encourage the market up to bring in other investors, or try and support it.’ But that’s exactly what QE has done in the US, UK and currently the EU, whose stock markets all collapsed too.
QE started in 2009 to save the world’s financial system, which was successful. QE2 and QE3 were to try and boost the real economy, but there were no conduits to connect to it, other than the markets. So, a huge amount of liquidity slopped into stock and commodity markets globally – dubbed the Bernanke Put – but also into the unquoted housing markets.
The latter are the next shoe to fall, however, as house prices are too high in China and the US, and far too high in the UK. The markets are false as new buyers who drive these markets cannot afford to buy. The unquoted housing markets haven’t fallen yet because interest rates, which govern their level, are far too low, but will have to rise soon. Why? Because there is a slow recovery emerging in the G7 economies.
There was always going to be a heavy cost to pay from the abuse of QE2 and QE3. (Apologies, Your Majesty, we’re not talking about you.) Now we are seeing it in these falling stock and commodity markets, but there is another gremlin in the works as well.
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The Fed’s balance sheet is stuffed with bonds from its $3,500,000,000,000 – that’s meant to be $3.5 trillion! – QE programme, but when interest rates rise, these bonds will fall in value, the financial equivalent of an own goal. There will be a bond market sell-off, along with falling house prices, when interest rates rise.
So, whither interest rates? Janet Yellen at the Fed saw her unemployment benchmark passed last year, but was fearful of tightening monetary policy too early, as the US recovery was still sluggish. Now a growing realisation that we are in the ‘New Normal’ of just 2 per cent growth may mean Yellen is behind the curve, as I have argued for some time.
She is fixated on the timing of her first rate rise decision, and the Fed’s first in ten years, but is she keeping her eye on the long end of the yield curve? If she loses control here, interest rates will have to rise faster in the recovery. You have been warned.
