The markets are on fire, but don’t ask why

Markets out of sync with reality.

 
 (Photo by Ramin Talaie/Getty Images)
(Photo by Ramin Talaie/Getty Images)

“May you live in interesting times,” so the story goes, is a Chinese proverb that reads like a blessing but is actually a curse. It certainly seems to apply to the markets right now. As you’ve no doubt heard, the Dow Jones industrial average recently hit a new high, and at press time the S&P 500 was surging toward a new record too. It’s time to celebrate, many suggest, and join the market party before it’s too late.

The problem is there’s something off about this party. The punch is spiked with a mighty strange liquor, and everyone knows it. It’s great to see the markets soar to new highs. But there’s a niggling doubt at the back of my head: Why are the markets on fire when the rest of the economy is so sluggish?

It doesn’t make sense. The U.S. economy is showing signs of improvement, but it hasn’t recovered from the great recession, not even close. Wages are still dropping, unemployment—at just under 8%—is still high, and the American housing market is still scraping along near the bottom. Here in Canada, things are better, but not great. The Bank of Canada predicted a paltry 1.9% growth in Canada’s gross domestic product in 2012, but we didn’t even hit that. In fact, growth in the second half of last year reflected the poorest economic performance the country has seen since the market crash.

So what’s going on? Why are the markets exuberant when the larger economy most definitely is not?

A lot of the disconnect is due to the massive global economic-engineering project the central banks have launched. Interest rates have been held at artificially low levels for years now, while at the same time the banks have injected some $6 trillion into the global economy. The idea is to fix the world’s financial woes, but it’s not working out exactly as planned.

What seems to be happening is that most of the stimulus spending now fattens the stockpiles of major corporations. Meanwhile those same corporations have been able to cut wages and continue globalizing their workforces, and that, along with the kick from ultra-cheap financing, has produced strong profits, especially in the financial sector.

High profits are great news, and those profits, in turn, have led to rising markets, as they should. But if the idea of growing corporate profits in a stagnating economy makes you nervous, well, it should.

I’m not against central banks stimulating the corporate sector to help get the economy back on its feet, but I am worried about how long we can keep it up. Usually, a strong economy leads to strong corporate profits, not the other way round. In a healthy economy, consumers make more money, they feel more confident, and they spend more, so corporations benefit. In this case, we’re skipping the middle man. The companies are making more money, even though (unless they borrow) consumers don’t really have the means to buy more stuff.

That sets off alarm bells for me. I’m not saying the rally won’t continue—as long as the central banks keep injecting that stimulus money, the market’s pulse will continue to race. But if the rest of the economy doesn’t catch up soon, this could end in disaster. Eventually, the stimulus has to end, and the rates have to go up. With rates this low, lenders are not being properly compensated for risk, so fundamental financial laws are being violated. Given all that, I don’t think I’ll go on an investing bender just yet. I think I’ll sit this party out. The bankers and some large corporations are having fun, but I’m going to wait until everyone is invited.

Duncan Hood is editor of Canadian Business

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