The stock market rally is just another bubble – and it’s set to burst

From John Stepek, across the river from the City

Dear Money Morning Reader,

Stock markets continue to expect the best of all worlds.

There will be a V-shaped recovery. Everything is headed back to normal. At least, that’s what you’d believe if you just look at the way stocks have surged.

But the ‘real’ economy is telling a different story. And it’s one that could spell a very sticky ending for the current rally...

We're in a brand new bubble

Money printing by the Bank of England and other central banks across the world has worked. Sort of.

The free and easy money being dished out by the world’s central banks is finding its way into assets, particularly financial assets such as stocks and bonds. That’s great for asset prices, as the surge in stock market since March has demonstrated.

But so far, it’s not having much impact on the ‘real’ economy. In other words, the money is being pumped into financial assets, but it’s not being loaned out to businesses and individuals to fund business expansion and investment, or increased consumption. In fact, businesses and individuals are still in cutback mode, and show no real sign of coming out.

So it seems we’re having a surge in financial assets that has no backing in economic reality. There’s a name for that – a bubble. “Instead of getting consumer inflation from all this central bank liquidity, we are seeing asset price inflation and we all know that usually does not end well for investors,” Steven Ricchiuto of Mizuho Securities told the Financial Times this weekend.

What this means for property

It’s interesting to look at the property market with this in mind. On the one hand, the property market benefits at the very top from the renewed boom in asset prices. You get bankers getting all excitable again, and foreign investors and people with cash looking for returns and getting fed up with the “dull” sub-5% or less return they’re getting on their savings. So top-end homes in the South particularly look attractive again.

But as the latest Rightmove survey points out, at the bottom end, things are a lot tougher. “This recession appears to have hit prices harder in the North, and this is compounded by lenders’ more conservative attitude to risk. Lenders quite naturally prefer to lend to lower-risk borrowers in better locations, with better job security, larger deposits and more resilient property values,” says Rightmove’s Miles Shipside.

In other words, there’s plenty of demand for now for high-end homes that can be bought with cash or big chunky deposits. For sellers who depend on buyers who actually need home loans, the outlook is far less upbeat.

Oil traders are worried about the oil price

This disconnect between the bubble in financial assets at one level, and the reality of rising unemployment and restrictive lending on another, can only continue for so long. Elsewhere in the financial markets, one group of traders certainly seems sceptical about the notion of a ‘real’ economic recovery. Oil traders are paying more than ever for options to protect against falling crude prices.

As Bloomberg puts it: “The gap between prices of options betting is on a decline and those that would profit from a rise in oil [has] widened to a record 10 percentage points,” according to Banc of America Securities-Merrill Lynch.

The more scared you are that an event will occur, the more you’ll pay to insure against it. In other words, oil traders are increasingly worried that the oil price is heading for a fall. And looking at the evidence, it’s little wonder.

US stockpiles are up 14% year on year, while oil cartel Opec is pumping 600,000 barrels a day more than the world currently needs, says the International Energy Agency. Apparently, oil inventories at the 30 countries within the Organisation for Economic Co-operation and Development are now equal to 62 days of demand, about 5% higher than last year. “Stockpiles are brimming on both sides of the Atlantic,” reports Bloomberg, while “more than 60 million barrels of fuel is stored on tankers offshore.”

In short, “if there was ever going to be a retreat below $60 a barrel, it is now,” says Stephen Schork of Schork Group. That makes sense to us. As we noted on Friday (How to profit from the alternative energy boom), a high and spiking oil price is likely to be a part of our investment future. But before then, we’re likely to see oil sliding back from here as investors realise that the global recovery isn’t going to be strong enough to use up all that spare crude any time soon.

And as a side issue, that’ll mean no shortage of demand for places to store all that oil.

Until next time,

John Stepek

Editor, MoneyWeek UK

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Turning to the markets...

The JSE all share index gained 0.46% yesterday. The gold mining index grew 1.06%. Resources added 0.43%. Banks and financials both bounced 1.06%. Industrials inched up 0.17% and the platinum mining index collected 0.37%.

London's FTSE100 climbed 0.16%. The Dow Jones jumped 0.52% and the Nasdaq gained 0.39%.

Tokyo's Nikkei lost 0.7%. Hong Kong's Hang Seng slipped 0.43%.

Brent crude is currently trading at $70.22 per barrel.

Spot gold's trading at $1,016.65 and platinum was last quoted at $1,339.00.

And here's how the rand is performing against the major currencies:
R/$7.36
R/₤12.07
R/€10.90