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The real player behind the global stock markets right now is the Federal Reserve Bank (FRB). The chairman of FRB is the biggest fund manager of all. Last week, Janet Yellen, the nominee to become the next chairman of the FRB, the central bank of the U.S., stated before the Senate Banking Committee hearing that “the mission of FRB is to support the economy,” hinting that she will continue on with the quantitative easing. Stock markets everywhere in the world cheered.
Yellen, like Bernanke, said that she will not hesitate to unload money into the market. Like Harry Potter who flies in the sky on a broomstick, she is going to wave a magic wand engraved, ‘Key Currency.’ Ultra-low interest rate, added with unlimited injection of liquidity – it is the blessing (?) of quantitative easing. Yellen, the nominee to head the FRB, said, “It is too dangerous to conclude quantitative easing too soon.” Thanks to that, the anxiety of market that the tapering may happen before the end of the year disappeared like a magic.
The message is clear - the political leaders and financial regulators of the U.S. do not not want to get out of the ‘swimming pool of Dollar liquidity.’ Looked at the relationship between the GDP and the debt in America, when the debt rose by one unit, the GDP quadrupled in the 70s, but now, even if you raise the debt by one unit, the GDP will not rise even close to one unit. While it is so obvious that the increase of debt doesn’t move the GDP even close to the increase of debt, the Americans are ‘going to the end.’ Those who would do anything to woo their constituents will lie through their teeth, because the future of their country comes after their seats in the office.
The U.S. stock price goes alongside the asset size of FRB, and the bubble is created again somewhere in the meantime. They clamor that the recovering U.S. economy is a sign of the return of U.S. manufacturing industry, but honestly, in a country of which per capital income is somewhere around USD 50,000, hardly anybody wants to go back to the times of working in production lines in blue-collared uniforms.
What the U.S. can do now is to keep the Dollar Printer running and make money by the internet services, in which the Americans are still the world’s No. 1. As long as the Americans run their Dollar printer and print Dollars endlessly, the market will never get out of the volatility game, until the American Dollar domination is over, and the money will have to run through the circle endlessly, chasing the next bubble.
Global economy under the ultra-low interest rate – who is going to benefit from it?
PMI is a leading indicator of the global economy, and those of the U.S., Japan, China and Europe are all showing signs of recovery. When counted the number of countries with a PMI index at or above 50, it is the highest in the past two years. It is the result of the whole world simultaneously cutting their rates, which, since the financial crisis, was an unprecedented event, coordinating their policies of quantitative easing, and the U.S. poured some 3.6 trillion Dollars into the market.
When you pour unlimited liquidity at zero-rate, the ‘curse of zero-rate’ appears in the end. Especially in times of fast-moving information such as we have now, the information disparity enlarges inequality of wealth. The zero-rate takes away the wealth from the mediocre and enriches only the giant investors, such as the institutional investors.
The characteristics of an information-oriented society can be summarized by ‘the rule of first-mover advantage,’ where the no. 1 takes 90%, the no. 2 takes 10% and the rest takes none. Even though an astronomically large liquidity was poured into the market and the stock price shot through the historically highest roof, for ordinary people, who came third place, they took home only a pittance as do other small companies. Only a couple of multinational conglomerates made the big bucks, the rest are still struggling.
The wealth in the present world is moving in the direction suggested by the monetary policies of the U.S. The wave of American-style finance, which is so accustomed to the speculative nature of stocks rather than the bonds and the derivatives, never hits the shore gently. The America treads well on the water of information disparity, because it is so good at gathering intelligence. The reason why Asia and Korea are weak in the arena of financial investment is because their strengths are in creating things only, not so much in the games of intelligence and finance.
Figure 1. Comparison of net interest income per economic entity in major countries under the ultra-low interest rate environment
Anyway, who would be the winners during the recovering economy? In the past 10 economic cycles, when the new order of PMI was 60 or above, the stocks in technology, energy, finance, materials, and healthcare sectors showed high rates of net profit increase, in order. Even now such trends are still valid in the U.S. and in Korea.
Figure 5 Comparison of relative profit increase rate per industry segment when the new order of PMI is at or above 60
A word on current stock prices
They say that a person walking a dog is the relationship between the fundamental and stock prices, but stock prices in the U.S. seems to have stretched its leash from its economic recovery too far already. Quantitative easing during a lackluster recovery of the fundamental makes the liquidity spin faster, and flow of money reaches its climax. The economies of Europe and the U.S. may be getting better, but their stock prices have already peaked.
Considering the amount of liquidity that has been poured into the market, the only right thing to do for any country is to stop the bubble from growing and collecting the money back from the market. Considering that the economy is recovering and the increase of debt is not working its wonder in the U.S., it will be for the long-term benefit of its economy to appoint a hawk figure as the head of the Fed, not Yellen the dove. However, no one in the U.S. wants to stop the train as it is headed over a cliff.
The stock price supported by leveraged buying does not last long. As U.S. stock prices have replaced their previous records, the weight of margin debt, buying stocks with borrowed money, hit a record-high level since 2007. But from the perspective of Q-Ratio, U.S. stock prices still has some room left. Seen from the degree of disparity between the long-term moving average line at the time of the highest point in the short-term and stock price, it is still lower than the historical peaks.
Figure 9. Disparity between S&P 500 index and long-term moving average in the time of rising stock price
The Global economy is clearly recovering, but for stock prices that have already reached a historic high to climb even higher, there must be a new innovation. Without it, one must bear in mind the inevitability of downside correction. 2014 is the second year of incumbent administrations in the U.S., China and Korea. Usually the second year of any new administration had been most favorable to both the economy and stock price.
It is time to take a close look at the new policies of governments that will control the real economy of next year, not the cliché of nominee to the head of Fed. We need to pay special attention to what new growth strategy the U.S. government will proclaim, while it is bogged down in Obamacare. For China, we need to keep a close eye on the results from the Third Plenary Session of the 18th Central Committee of the Communist Party of China, which will make or break the coming 10 years. For Korean stock market, we will have to look at the liquidity situation in the U.S. to predict the direction of overall market and Chinese economy to pinpoint the leading stock and to select which horse you want to bet your money on.
For the last 10 years, Korea did well to make its ends meet by selling Intermediary goods to the world’s workshop, China. However, the table has turned now, and the growth model of China has become a big risk for Korea, the powerhouse of intermediary goods. China started restructuring the 19 traditional manufacturing industries while shifting its focus of growth to domestic consumption and plans to complete the shift by the end of next year. This is why Korea’s export of intermediary goods to China this year became sluggish.
The innovation plan drafted by a team headed by Xi Jinping, the General Secretary and deputy team heads, Liu Yunshan, the principle of CPC Central Party School and Zhang Gaoli, the Vice Premier, over seven months of collecting expert opinion and two Political bureau of the CPC Central Committee meetings was revealed during the Third Plenary Session of the 18th Central Committee of the Communist Party of China. Total of 14 reforms, 6 in the area of economy, 3 in politics, 2 in society and one each in culture, environment, and defense will be implemented in the six areas of economy, politics, society, culture, environment, and defense.
The major reform plans in the area of economy include allowing private banks and making a large-scale investment related to the issue of the environment. For the 260 million laborers from rural areas, the Party has to allow them to sell their land back home and to register as the residents of cities. The 260 million new city-dwellers will become the mega-consumers of culture, education, and medical services. If one of the couple is the only child, the couple will be allowed to have up to two children, and it immediately allowed the projection of 15 to 20 million newborns. 30% of the profit generated by state-run companies will be channeled to social welfare and used for the national welfare and elderly care projects, to strengthen the purchasing power of the people.
Finance, environment, culture, education, medical care, and the silver industries are the six benefited businesses of the most recent reform plan for the coming 10 years. Unless Korea quickly converts its current Chinese export structure focused on steel, chemical, machinery, automobile, and semiconductors, the Chinese domestic market is expected to grow into the world’s largest one during the Xi administration will become a pie in the sky to Korea.