The stock paradox

Strange world we live in now. Over in the US the Bureau of Labor Statistics reported here the non-farm payroll data:

"Nonfarm payroll employment increased by 175,000 in May, and the unemployment
rate was essentially unchanged at 7.6 percent".

So the US continues to add jobs. Here's the seasonally adjusted chart:

Source: Bureau of Labor Statistics

The participation rate was also fairly steady, ticking up 10bps to 63.4%. Not too shabby overall. "Decent enough" one might say.

Here's the chart of the US unemployment rate:

Source: Bureau of Labor Statistics

The unusual thing about the interpretation of the data is that stock market analysts and institutional investors had feared that a drop in the unemployment rate could see an end to the Fed's stimulus program.

Christopher Joye over at the AFR, who always has a nice way with words, refers to 

"Ben Bernanke’s  tautological statement that the Federal Reserve will have to wind back its 
$85  billion a  month money printing program if US conditions continue to improve."

A moderate increase in the headline rate of unemployment to 7.6% ensures that, for now at least, this won't be the case. The Bureau calls this "essentially unchanged" and they are probably right, as the trend still appears to be down.

The US markets went on a field day, with the Dow adding more than 200 points in the trade.

Bad news can be good news: the strange new world of quantitative easing we live in.

In Japan the Nikkei 225 Index ran all the way up from 8,328 to 15,942 in the past 12 months, before investors got scared and triggered a correction.

The tremendous shot in the arm for stock valuations was Japan's own stimulus program. The economy has been in the doldrums for so long that drastic action was taken, and investors fearful of raging inflation piled into stocks with valuations doubling accordingly in just one year.

Note that, just as in the US where stock valuations have roared up well over 100% since 2009, there is very little emphasis here on fundamentals or the strength of the economy. Moreover, hot money seeking returns simply flies into the market.

The upshot of this phenomenon will likely be volatility. That is, sharply rising stock valuations where quantitative easing is undertaken followed by sharp corrections when the stimulus is taken away.


In Australia, the stock market has never quite recovered with the same fervour since 2009, perhaps partly hampered by our strong dollar.

We have seen an element of the 'bad news is good news' in property markets though. 

As the world's economies crumbled from 2007-2010, there was something of a feeling of "the worse the world gets, the better Australian property will" and low interest rates fired capital growth up until 2011.

This led some foolish commentators to state that they "can't wait for the next global financial crisis". 

Quite apart from being an unpleasant and facetious thing to say, this is also hopelessly naive. The mistaken attitude showed itself again in late 2012 as the cash rate was cut with plenty of misguided celebration by property investors. 

Yes, lower interest rates are good, but you also need to consider why the cash rate has been cut so low - it corresponds to slower economic growth and thus a heightened risk of recession.

While low interest rates can sometimes cause a property price boom, this is by no means always the case. Just ask people in Britain or the US.

Ultimately, over the long term countries need a strong economy and growing wealth to justify higher asset prices.

Mark Bouris of Yellow Brick Road stated this week that "over the next 5 years Australian property will be the hottest asset class you can possibly think of".

Is he right? That will be the subject of my blog post later today...

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