Despite central bank concerns, stocks climb
Despite the Federal Reserve's concern over persistently low economic growth and 7.9 percent unemployment, the American, European and Japanese stock markets have continued to climb, based largely on institutional buying.
Yet, the Dow Jones Industrial Average trading volume has remained low — 43 percent below its normal average — which means all types of investors are not buying into the rising market.
The central banks of Japan, the United Kingdom and the European Union have followed the example of the American Fed's so-called “quantitative easing.” That is, injecting trillions of dollars of synthetic money into their economies by purchasing Treasury bonds and other debt instruments. By doing so, these central banks have kept interest rates low and reaffirmed their deep concern over the health of their economies.
The money injected has been invested mainly in bonds, stocks and bank deposits. Although financial institutions have been the major buyers of bonds and stocks, individuals and corporations have hoarded cash. What's causing these opposing strategies?
Financial institutions are under pressure from customers, investors and shareholders to invest in securities and not hold on to low-yielding cash. Individuals and corporations are independent of such pressures and can invest with a free hand.
Pension funds and insurance companies need to meet huge payment obligations. They cannot sit for long with their funds in bank deposits yielding less than a half-percent interest, while inflation officially remains at 2 percent and “unofficially” at well over 6 percent, according to John Williams, who publishes a financial newsletter, “Shadow Government Statistics.” Therefore, those institutions have to invest in riskier assets to achieve better returns.
Mutual fund managers, including those in 401(k) plans, are paid management fees for their expertise in selecting and investing in securities — not bank deposits. If mutual fund managers remain in cash, their customers soon will withdraw their funds to save management fees and earn better returns.
Trust managers, such as those in large, ‘too-big-to-fail' banks, experience customer pressures similar to those felt by mutual fund mangers.
Financial institutions such as the largest banks have investment managers who are highly sophisticated, familiar with futures markets and have huge funds (including borrowings) at their disposal. Thus, they are able to move markets.
And Wall Street firms such as Goldman Sachs depend on investment and trading of financial instruments to generate rich returns.
Fed Chairman Ben Bernanke has boasted that its massive quantitative-easing program has boosted stock markets.
In a recession, however, asset prices tend to fall, and it appears wise to hoard cash. Financial institutions find it hard to hoard cash for long because they are encouraged by central banks to take greater risks even when facing recession.
This creates a contra-logical bubble in asset prices. Investors should beware of chasing central-bank driven financial markets.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Contact him at firstname.lastname@example.org.