|Investment Research Group|
The big question now is whether recent gains can be sustained. Economic figures out recently show the NZ economy is out of recession (assuming a quarterly rise of 0.1% is outside the margin of error in the imprecise world of statistical analysis) and there are many other indicators that things are on the mend both here and overseas.
What has not yet been revealed is whether this recovery is based on solid economic activity or merely is a reaction to massive government and central bank stimulus efforts.
One important number on the Dow Jones Industrial Average index (the main measure of the US market) that is worth keeping an eye on is 10,300. Currently the Dow is at 9773, having bounced back from as low as 6440 back in March. This number marks the 50% point between the market's highest and lowest points and traditionally is an effective measure of investors' expectations.
A 50% bounce-back during a bear market is not an uncommon occurrence, nor is a subsequent decline that often is longer and stronger than the previous correction.
In the Great Depression of the 1930s, the markets initially recovered strongly from the collapse of 1929 but eventually that gave way to more bad news that took decades to recover from and saw the share market hit rock bottom at 90% below its high point.
On the other hand, a sustained recovery above 10,300 offers more evidence that the worst may be over. A third scenario is that the markets will rise, but represent a false signal about good times to come.
This is the view of US commentator Sean Brodrick, who points out that the massive interventions in the markets and economies of the past couple of years have no historical comparison.
His view: share markets will rise by up to a further 50%. Unfortunately, he does not see this as necessarily a good thing in the long-term. That's because the markets are reacting to all the new liquidity being injected into economies to stave off recession.
He points out the US markets have risen in line with a programme by the Federal Reserve to 'monetise' US government debt by purchasing US Treasuries. "The fact that both stocks and Fed debt monetisation are going up at the same time is no coincidence. Just in the United States alone, the Fed has purchased US$1.24 TRILLION in Treasury and Agency securities.
“Fed plans to buy at least another $507 million in debt over the next couple of months. At the same time, the Fed is holding its key interest rate at essentially zero. Result: Banks are getting to trade nearly worthless securities for cash while at the same time they are able to borrow money at very low rates.
"Of course they invest that money in stocks and bonds … and hard assets, like gold and oil and silver and copper," he says. "Meanwhile, there is $3.5 trillion sitting in U.S. money market funds, according to recent data from the Investment Company Institute.
That's down from a March peak of $3.9 trillion, but it is still HUGE.
"Fund managers and individual investors are sitting on that cash, nervously watching stocks go higher. Will they buy in? Of course they will! As that money gets put to work, stocks, bonds and precious metals will probably go even higher."