Here, There Be Monsters...

Financial markets in the United States have staged an enormous recovery since the depths of the Global Financial Crisis of 2008. So much so that it almost seems miraculous.

It's no miracle though - and it's not due to economic growth, government spending, or even the pro-business policies of President Donald Trump. It's down to one factor alone: the actions of the Federal Reserve.

The Federal Reserve is America's Central Bank - and they're responsible for determining monetary policy in the world's largest economy. Monetary policy includes things like the stability of the US Dollar and that all-important factor for asset prices: interest rates. Monetary policy has also taken on an unorthodox new face over the past 12 years, in the form of Quantitative Easing.

Quantitative Easing is what most commentators are referring to when they talk about central banks printing money. What gets less attention though, is what happens to the money once it's been 'printed' - and that is where things get interesting. This money, which has been created out of thin air, isn't just handed out to people. It's used to purchase assets, such as bonds, from large institutional investors and Exchange Traded Funds (ETFs). This puts more money in the pockets of these funds, which in-turn drives them into buying riskier assets, like stocks.

Since 2009, the supply of money in the US has increased by a staggering 300%. This means that 75% of all the US Dollars in existence today have been 'printed' in the past 12 years alone. That money has been used to purchase assets, like bonds, which are all sitting on the Federal Reserve's balance sheet.

And that brings us to the chart below. If you filter out the influence of money printing and the corresponding asset purchases, US stocks (as expressed by S&P 500 index) have done basically nothing in the past 12 years. The question now is whether the Federal Reserve can keep printing money and buying assets at such a rate (globally, central banks are printing  around US$1.4 billion per hour) - and if so - how long will it be until something breaks? In terms of the economics, we are well and truly into that part of the map labeled 'Here, there be monsters'.
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The big risk facing all investors, including the Federal Reserve, is inflation in the real economy. We've already seen inflation in asset prices, but what if that spills over? If we arrive at a point at which the Federal Reserve and others can no longer maintain their breakneck pace of money printing due to inflationary concerns, all bets could instantly be off. How likely that is, or when it might occur, is very difficult to say. What's much easier to say is that the current state of play appears very, very unsustainable.

When we meet the monsters beyond the edge of the map, we can only hope that they're friendly...

- Richard

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