I watch the markets like a hawk, and here’s what I’m seeing right now: Falling long-term bond yields … incredibly small price differences between riskier bonds and equivalent U.S. Treasuries … rising stock prices … huge buyout deals … and elevated gold and energy prices.
In short, almost every investment and asset under the sun is soaring. That’s odd. Usually some go up, while others go down. What’s happening right now defies common sense.
I blame it all on one simple phenomena — money, money everywhere. Let me explain …
Money Supply Is Soaring
Around the World
I don’t want to get too technical, so here’s the basic idea: Governments keep tabs on how much of their countries’ money is out there floating around. Right now, these measures are soaring.
For example, the U.K.’s broadest measure of money supply surged at an annual rate of 14.5% last month. Not only was that up from 11.4% a year earlier, it was also the fastest rate of growth since 1990.
Meanwhile, money supply in the 12-nation Eurozone climbed at an 8.5% year-over-year rate. In the past, the European Central Bank has called a rate of 4.5% risky!
In China, money is pouring out of every nook and cranny. That country’s broad money supply measure jumped 17.1% in October, up from 16.8% a month earlier.
I could go on and on, too — Australia saw an 11.3% increase, vs. 8.8% a year earlier, while Canada’s money supply growth hit a nine-month high.
Our Federal Reserve stopped publishing its measure a year ago, claiming the data wasn’t that important. I’ll leave it up to you to decide whether that’s pure Fed incompetence or something more sinister. But suffice it to say there are clear signs that lots of excess money is coursing through our economy, too.
Here’s the really troubling part …
Global Rate Hikes Have
Not Stopped This Easy Money
The Fed has hiked short-term interest rates 17 times — pushing the federal funds rate from a multi-decade low of 1% to 5.25%.
Other central banks have made similar moves:
- The Reserve Bank of Australia just increased its benchmark interest rate to 6.25%, the third hike this year.
- The European Central Bank has raised rates five times in the past year. It also strongly hinted at more increases down the road.
- And the Bank of England has resumed its rate-hiking campaign after being on hold for a year. Rates climbed to 4.75% in August and 5% this month.
Yet money is still piling up in vaults around the world. Want proof?
China’s foreign reserves just crossed the $1 trillion mark. They’re accumulating at the astonishing rate of $30 million per hour!
Reserves in the Middle East and North Africa (key oil producing regions) jumped $43 billion in 2003, $60 billion in 2004, and a whopping $126 billion in 2005.
Russia’s reserves have expanded an eye-popping 57% so far this year, hitting $274 billion.
It’s piling up in private hands, too. Banks, brokers, and pension funds are all swimming in a pool of dollars that they need to invest.
That’s fueling a massive wave of deals that make the leveraged buyouts of the 1980s look like child’s play. In fact, private equity funds are on track to raise $400 billion this year, up 41% from a year ago, according to Private Equity Intelligence.
All of this money is getting shoveled into anything with yield – bonds, stocks, commercial real estate, whatever. [Editor’s note: For more on how this is affecting Real Estate Investment Trusts (REITs) shares, see “Apartment REITs Ready for a Fall?” and “Commercial Real Estate Binge”]
What This Means for Interest
Rates and Your Investments
The latest inflation figures aren’t reflecting the impact of all this excess liquidity right now. The Producer Price Index tanked in October due to the recent decline in oil prices, falling truck prices, and other factors. The Consumer Price Index also dropped due to falling energy prices, while the “core” CPI gained just 0.1%.
But asset inflation is everywhere. Stock prices have been rising virtually every day. The difference between yields on high-risk and low-risk debt remains extremely tight. And yields on all kinds of income investments are falling.
This has some policy makers worried. The ones who “get it” realize that asset inflation can be every bit as dangerous as inflation in the price of goods and services. Here’s what European Central Bank council member Christian Noyer had to say:
“When financial imbalances build up in the economy which are fueled by excess money or liquidity growth, unwinding of those imbalances can be brutal and discontinuous [and] very destabilizing.”
Indeed, the U.S. housing market exemplifies the risks Noyer is talking about: Too much easy money fueled too much reckless mortgage lending and too much residential real estate activity. Now, we’re going to be dealing with the fallout for years to come.
The European Central Bank, the Bank of Japan, and the Bank of England all pay lots of attention to money supply because they know how important it is.
But Fed Chairman Ben Bernanke has basically taken a pass on the whole subject. He called money supply an “unstable” indicator in a key policy address a few days ago in Frankfurt, and said it doesn’t matter much here in the U.S.
I think Bernanke’s ignoring a big force in the markets. Don’t make the same mistake. Here are three things to know about the effects of increased money supply …
First, it’s supportive of asset prices. Gold and other commodities should continue to do well as a result.
Second, it’s preventing the market from making “normal” adjustments. It’s keeping long-term interest rates lower than they should be. It’s allowing junk bond issuers to pay less interest when they raise money. And it’s pushing up the price of every two-bit, piece-of-junk stock out there.
In the short term, this “party on” atmosphere may continue. But remember, the fundamentals will win out in the long term. If you want to thrive, you need to be in the right sectors and stocks. That’s exactly why we’re using sector rotation strageties in our ETF Power Trader and LEAPS Power Trader services.
Third, it’s forcing a lot of people to take big risks. Investors are extremely complacent right now, so things can get ugly fast. I wouldn’t rule out a “credit event” — something that forces people to radically rethink their excess leverage, derivatives, and debt exposure.
If that happens, it will come out of the blue like a cold slap in the face. And it will drain a lot of excess money right out of investors’ portfolios. So keep a chunk of your money in safe investments, such as short-term Treasury bonds.
Until next time,
Mike
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