Barry Riley IN FT-- WALL STREET: Blowing bubbles again
We can call it rational exuberance. On Monday, Wall Street celebrated its complete recovery from the late summer crisis, with the Dow Jones Industrial Average hitting a new high after rising 24 per cent from its low at the end of August, when forced selling by hedge funds and other leveraged players was at its peak.
Is what is good for Wall Street good for America? It seems US investors can now rely on the Federal Reserve to bail them out of any mess they get themselves into. They can leverage the risks again.
Without looking at the securities markets, it is impossible to make any sense of the Fed's recent decisions. On the basis of the economic numbers, it is hard to see that the Fed should be afraid of anything except overheating.
Yesterday's upwards revision of third-quarter gross domestic product shows that the US economy has been powering on at a near 4 per cent year-on-year growth rate at least up to September, in spite of a collapse in export growth.
Broad money growth has recently accelerated to 15 per cent annualised, a phenomenal expansion rate in real terms which easily explains the reinflation of Wall Street's bubble.
True, the credit surge is partly the result of the hiatus in corporate bond issuance, which is more or less over but which for several months caused US companies to draw unusually heavily on their bank credit lines.
Nevertheless, extreme strength in the housing market shows that the credit-based boom is having a broad economic impact.
Meanwhile, consumer spending has been growing at 5 per cent as the US heroically strives to head off a global economic slump and in the process the personal saving rate has gone negative.
Any threat that weakness on Wall Street might undermine consumer confidence has been removed. The "wealth effect" has been restored.
Is there still a hidden problem in the financial system that the Fed is trying to address? It seems unlikely. Although the hits that certain of the banks took in Russia and other emerging markets will have done some permanent damage to their capital bases, talk of any sort of credit crunch seems misplaced.
Stresses certainly persist in the corporate bond market, however. In relieving the problems here through a general monetary loosening, the Fed has set off explosive growth in credit and in equity prices without yet satisfactorily curing the problem on which it has apparently been focusing.
High yield spreads remain 250 basis points above their levels earlier in the year, and spreads generally have narrowed only modestly from their peaks. Even the US Treasury market is softish, and one significant external indicator is that the normally higher-yielding UK gilts market is moving lower in terms of the 10-year benchmark yield.
This may reflect a cooling of the enthusiasm of foreigners for the US bond markets, perhaps because of their strategic diversification into the euro, perhaps because of a fundamental suspicion of the dollar.
The US securities markets are in apparent contradiction. The corporate bond market seems to be discounting a rise in credit risks because of imminent profit weakness. Equities, however, have bounded ahead, and stock market investors are clearly optimistic about corporate prospects.
But how would profit declines affect a market now valued at 33 times trailing earnings?
One historical precedent could be 1987, when many central banks were misled by a stock market crash into preparing for a 1988 recession that somehow never happened.
Alternatively, it is increasingly tempting to compare the Wall Street phenomenon with the Japanese bubble economy of the late 1980s. Eventually the Bank of Japan called a halt as the party got out of control.
The US Federal Reserve, however, for as long as it is relieved of worries about inflation, is happy to let the celebrations run on. Until Thanksgiving Day, anyway.
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