Global Stock Markets in Self-Perpetuating Denial

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MoneyMorning.com Michael E. Lewitt writes: The central bank circus was on full display this week as the Federal Reserve's Open Market Committee held a two-day meeting only to emerge with another mind-numbing series­­­­­ of excuses for keeping interest rates at zero when the economy is not in crisis.

One such claim was that inflation (as measured by economists) is insufficiently high, despite the fact that the price of real-world goods and services (including gasoline again) are steadily rising. The Fed stated that it's afraid raising interest rates – for the first time in nine years and by all of 25 basis points – could send the economy into a tailspin. That isn't only bad policy, it is pathetic.

Perhaps it's time we learned that the last person we should ask about the economy is an economist (or worse, a group of economists). The Fed lowered its economic forecast for 2015 to 1.8%-2.0%. This continues a steady deterioration in its economic outlook. In March, it forecast growth at 2.3-2.7% and last December, it was looking for 2.6-3.0% growth.

The Fed has consistently overestimated growth throughout the post-crisis recovery. It then maintains that its zero interest rate policy and bond buying programs will produce faster growth. When that doesn't happen, it uses slower growth as an excuse to extend the very policies that aren't working in the first place. Einstein said the working definition of insanity is doing the same thing over and over again and expecting a different result. In this case, that may be too kind – here it may be the definition of stupidity.

Nonetheless, this was precisely what equity markets wanted to hear, which is probably why the Fed said it in the first place. On Thursday – the day after the Fed's announcement – stocks enjoyed their best gains in weeks and, even after giving some gains back on Friday, ended the week back near all-time highs.

The Dow Jones Industrial Average gained 117 points (or 0.7%) on the week to 18,015.95 while the S&P 500 added 16 points (or 0.8%), to 2109.99. The Nasdaq Composite Index traded at new all-time highs before closing the week up 66 points (or 1.3%) at 5117. Ten-year Treasury yields also liked what the Fed had to say and dropped by 11 basis points on the week, to 2.27%, while the Fed-sensitive two-year note yield fell by 14% (10 basis points) to 0.62%.

While most people still expect the Fed to raise rates by 25 basis points in September, they could easily be disappointed. Whatever courage the Fed demonstrated during the financial crisis has long ago given way to cowardice and fear that it might upset the market by doing its job.

The Greeks' Drawn-Out Drama

Over in Europe, the Greek tragedy continued to play itself out as farce. As the standoff between Greece and its creditors (which includes practically anybody it has done business with since the inception of the European Union) has dragged on. Greeks have been pulling money out of their bank accounts at an increasing rate. Last week, the ECB had to extend a second emergency loan of €1.8 billion to the banks to cover these withdrawals.

Anyone who thinks this money is going to flow back in, even if a deal is reached, is delusional. Greeks saw their Cypriot cousins have significant chunks of their bank accounts confiscated a couple of years ago and are not going to sit around and have the same thing happen to them.

Greece remains a bankrupt country, on a bankrupt continent, in a bankrupt world. Whether or not it reaches a short-term deal with the EU now, it will have to be bailed out again. Sooner or later, Greece should exit the Euro since it cannot possibly compete within the single currency regime. The question is how long Germany wants to keep paying Greece's bills.

The Slow Leaks in the China Bubble

China's stock market bubble deflated slightly last week as the Shanghai Composite Index dropped 13% on the week, including a 6.4% decline on Friday. But those who want to ultimately lose money by investing in this market should not be discouraged – it is still up 122% from a year earlier.

While some have tried to make the argument that this market is not expensive, The Economist has pointed out that the median price/earnings ratio on the Shanghai index is 75x. Furthermore, 85% of stocks today have higher valuations than they did at the height of China's 2007 stock market bubble, which did not end well. Those looking to lose all of their money, rather than just some, can invest in the ChiNext market, home to start-up companies – the average price/earnings ratio of this market is 140x.

Here's what's really going on in China…Speculation has shifted from the housing market to the stock market. Farmers are the new day traders and millions of new brokerage accounts have been opened by people with little or no education and absolutely no business investing in stocks.

If this is how the Chinese government thinks capitalism should work, or how they are going to manage a smooth landing, they are going to be sorely disappointed.

Source :http://moneymorning.com/2015/06/21/global-markets-in-self-perpetuating-denial/

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