October 29, 2012
Stock markets and the financial repression effect
ALEX CARRICK
Chief Economist, CanaData
North America’s stock markets have turned in remarkable performances over the past three-and-a-half years. All three major U.S. indices recorded their most recent trough levels in February 2009. Since then, the NASDAQ index is up a stunning 126% (more than double), the Standard & Poor’s index is +96.1% (double) and the Dow Jones Industrials index is +90.2% (nearly double).
Even the laggard of the group, the Toronto Stock Exchange (TSX), is +51.6%. The TSX was doing fine until early 2011 when it became apparent global growth was about to slow and commodity prices would be coming off their highs.
A new phrase — “financial repression” — has come to the fore lately and gained media attention. It has particular relevance for why share prices have been doing so well.
“Financial repression” might better be called “creditor repression”, since it’s the people and agencies who lend money who are being held back.
It’s not an official policy. Rather it’s more a description of what has been taking place.
It results from current government policies that embrace very low interest rates and the printing of money.
Keeping interest rates as low as they have been for the past four years brings about several key events. It lowers the return to creditors, it devalues the currency and it makes it easier for government to handle deficits and debt.
Let’s stick to point one — lowering the return to creditors — for the moment. I’ll have more to say about the currency effect towards the end of this article.
When the return on fixed assets such as government bonds is low (i.e., currently close to 0.00%), investors look for other opportunities to earn a higher return. In effect, they’re encouraged to take on more risk.
One option investors have seized on with a vengeance has been corporate shares.
This has been especially true in the United States due to a unique circumstance. Usually real estate offers an attractive alternative to stocks. But until the last couple of months, home prices in the U.S. have done nothing but decline over many years.
The “financial repression” effect is not the whole story for why U.S. stock markets have been doing so well, however.
Strong profit levels have also been driving up equity prices. Certain sectors of the economy have recovered faster than others.
From 2010 through early 2012, high-profile U.S. manufacturers of machinery and equipment (e.g., John Deere and Caterpillar Inc.) made large export sales gains to nations wishing to pump up their infrastructure construction projects and expand their agricultural output.
Many companies have been participating in an energy boom that is underway across the U.S., as new oil and natural gas reserves from shale rock are brought to the surface.
Also, many high-tech firms learned how to survive from the great “dot.com collapse of 2001 and steered their ways through the latest recession with hardly a course correction. Apple Corp. has by far the largest representation in the NASDAQ index and it has been moving from one successful product launch to another.
To add icing to the cake, the statistics on the general economy are now taking a turn for the better. Employment, housing starts, auto sales, capacity utilization rates and retail sales have all become decidedly more upbeat.
U.S. retail sales in September were +1.1% month to month and +5.4% year over year. The motor vehicles and parts dealers sub-component was +8.1% year over year.
Furniture and home furnishing store sales — which are very much tied to both consumer spending and housing — were also +8.1% year over year.
Non-store retailer sales, which are derived from conducting business over the Internet and through catalogue shopping, were a stunning +15.0% year over year.
As suggested earlier, there is an international aspect to the financial repression effect.
The very low interest rate environment in the developed world has not only caused capital to seek out other domestic assets, it has also caused funds to shift to other economies, most notably those in the emerging world.
Some of those nations, most notably Brazil, have become quite vocal in their criticism. As capital flows in and drives up their currencies, they’re finding it harder to sell their exports.
Plus the extra money is boosting real estate prices, potentially giving rise to proverbial bubbles.
It probably goes without saying, but in the world of international dealings between economies, all is not sweetness and light.
For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com
Data sources: NYSE, NASDAQ, TSE and Reuters/Chart: Reed Construction Data - CanaData.
