The line actually derives from a Victorian melodrama by Leopold Davis Lewis about the ghostly sleigh bells of a murder victim. Notre Dame’s sufferer of kyphosis though was famously deafened by said bells, a fate which is tenuously in danger of befalling financial markets. The volume of short term noise during October has become deafening and the markets have bats in their belfry.
Hands up everyone who thought that the month would end with the S&P 500 and Dow Jones Indices at new record highs? Or that this could happen in the week in which the Federal Reserve ended quantitative easing? No, neither did we. We did say though that the forces driving equity prices and bond yields down through most of the month were an unfortunate coincidence and were unlikely to last. We lay no pretense to having predicted how quickly equity markets would rise nor that the trigger would be another gargantuan bout of Japanese quantitative easing.
It is now an instantly accepted wisdom that Japanese QE has solved all the problems of the global economy and everything is suddenly wonderful. It hasn’t and no it isn’t. Let us have a superficial scout through the history of Japanese quantitative easing. Japan has been easing its quantities since March 2001. Its success, or absence thereof, can be gauged by Friday’s announcement. The expansion in bond purchases from the existing target of Y60tr – Y70tr per annum to Y80tr is admission that the policy is yet again failing. It is akin to a cut in base rate from 0.25% to zero: if the former is not working, nor will the latter.
It is arguably even worse than Einstein’s definition of madness; it is not just repeating the same action hoping it will work, it is doing even more of it.
We are approaching the 14th anniversary of the start of Japanese QE. Still each increment to this multidecade policy failure is greeted by markets as being the move that will finally make it all work. And eventually it transpires that it was not. This time will not be different. I am indebted to my erstwhile colleague and long-time mentor Professor Tim Congdon for many things. Amongst these, he has spent much of the past decade arguing that Japanese QE will never work as the Bank of Japan does not understand monetary economics. Simply (or not) it seemingly cannot differentiate between the monetary base and the quantity of money; in erroneously targeting the former it is doomed to perpetual failure. The evidence of the past 14 years is that the prof is right.
No matter though, in the short term the yen has tanked and markets are enamoured. Just as the rationale for the rebound in equities may be wrong, so the world was never as gloomy as the mid-month picture indicated. Remember that last week’s first guess at America’s growth rate in the third quarter was a much higher than expected 3.5%.
This week the two ISM Surveys and the non-farm payrolls will show that the US economy on average is still growing nicely. This morning Chinese manufacturing growth has been reported exactly as expected while Ireland (an oft forgotten small island just off Europe) is still going gangbusters. Indian manufacturing is also reported to have improved in October, accompanied by the weakest rise in input costs in the past 17 months.
Almost three quarters of the S&P 500 Index have released their earnings for the third quarter. The reported growth rate thus far is 7.3%, significantly better than the pre-report consensus of 4.5%. The percentage of companies beating expectations is the best since the second quarter of 2010 (data sourced from FactSet). The naysayers are highlighting that fourth quarter earnings are being cut, but this ignores the concentration of downgrades in the energy and materials sectors, reflecting the same lower commodity costs that will drive up margins in the rest of the economy.
We do not wish to overegg this pudding. The global outlook is patchy and uncertain, but broadly not too bad. That markets are at long last over-reacting to good and bad news is, as we have argued before, to be welcomed with open arms and wallets. Sentimental irrationality is the mother of opportunity, not a pied piper.