Take a look around the globe.
There’s something fishy going on.
No. I’m not talking about that nagging feeling of always being watched.
I’m talking about the divergence between stocks and gross domestic product (GDP).
If GDP (economic output) is strong and growing, then it means good things for stocks.
Growing economic output generally means higher corporate profits. And higher corporate profits translates into higher stock prices.
Sometimes, or should I say often, stocks tend to over and undershoot actual figures. If we were to construct a sophisticated and extremely complex graph of stocks and GDP, it might look something like this…
Source: Money Morning
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That’s human emotion for you. GDP is the steady rise. Stocks on the other hand zig and zag, as investors try to predict what will come next.
But are investors ignoring the data in 2019?
In Australia and Europe, GDP is surprisingly on the downside.
Shouldn’t stocks be falling instead of rising?
THIS is what the market expects…
Yesterday, you’ll remember I talked about the problems in Europe.
Not only are lagging GDP figures terrible, especially since interest rates are so low, the future outlook for economic growth is even worse.
In Oz, we’re seeing a similar situation play out.
In the fourth quarter, GDP growth was not only low, it disappointed central bankers who thought their low interest rates would kick economic growth into high gear.
Household spending in particular was terribly low. Not as low as it was in 2009. But below its 10-year trend.
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Is this Aussie economic turnaround, which the Reserve Bank of Australia (RBA) predicts, ever going to happen?
It matters little really. That’s how investors feel, anyway.
If the market was expecting current GDP trends to continue, then stock should be falling. GDP is simply businesses producing goods and services at the end of the day. If GDP drops it means businesses are producing less, likely a sign of lower corporate profits.
But stocks are not falling. The largest 500 Aussie stocks are up double digits this year. Are investors expecting the RBA to lower rates even further?
Some believe they might. News.com.au writes:
‘Financial markets are generally more bearish and some retail banks are factoring in the prospect of at least one interest rate cut this year. The RBA’s key cash interest rate remains at a historic low of 1.5 per cent, where it has been since August 2016.
‘Westpac economists think the central bank will cut the key cash interest rate as many as two times this year by a total of 50 basis points, which would bring it down to one per cent.
‘This scenario is based on a much softer pace of growth this year of about 2.2 per cent, compared to the RBA’s forecast of three per cent.’
An interest rate cut might also help out house prices, and in turn household spending, as the banks start tightening up their lending. From Bloomberg:
‘While property investors were first to feel the pinch of the tougher borrowing environment after regulators cracked down on risky lending, banks are now winding back on owner-occupier loans, which are generally considered to be the more stable segment of the market.
‘…Banks are also demanding borrowers have bigger downpayments, pulling back on lending to would-be homebuyers who haven’t been able to save a deposit of at least 20 percent. That’s forcing some to lower their sights to a cheaper property, or give up house-hunting altogether.
‘…Mortgage growth at Australia’s largest lenders is expected to slow to 2.2 percent in fiscal 2019 and 2 percent in fiscal 2020, with “risk to the downside given scrutiny around responsible lending,’’ Morgan Stanley analysts led by Richard Wiles wrote in a Feb. 28 note.’
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[Speaking of which, we’ve just finished another video. In this one, Selva talks about whether Aussie property is finally a buy or not. You can find out by clicking the picture below.]
But if a cut is on the cards, it won’t help what ails our economy. It will just fuel asset bubbles like many other low interest rates environments have done before.
THIS is what the RBA should do…
It’s not interest rates (the price of money) that’s the factor here.
What matters more is the quantity of money being created and where in the economy it’s being pushed.
For the Big Four banks, any newly created money is bound to find its way into the housing market. These loans are relatively safe, which will increase their capital ratios. There’s also plenty of demand for it.
If everyone was trying to get into housing in 2017, when prices were screaming higher, why wouldn’t those same buyers jump at the chance to buy property at steep discounts?
Or maybe even more money will flow into pumped up financial assets. If the RBA resorts to the measures of Europe, Japan and the US, stock and bond prices will surely rise.
I’m talking about quantitative easing (QE), where central bankers enter financial markets and trade newly created money for bonds and stocks.
But answer this. What happens when prices rise?
Everyone starts getting optimistic. No one wants to miss out. They newly create money and then some gets pumped back into financial markets. And that’s where it stays.
It doesn’t grow the economy. It doesn’t help businesses produce more goods or services. It creates asset bubbles, which requires more QE when they burst.
Clearly the problem here is where money is being created, not the price at which it’s being lent out. What the RBA needs to do is not lower rates, but encourage banks to lend to sectors of the economy that will lead to economic growth.
Dial back loans for consumption. Start incentivising value-added lending. That way, you create debt to produce more goods and services, which turns into GDP growth.
Editor, Money Morning
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