The stock market has reached new all-time highs, which is generating considerable interest in the media. That, of course, is no surprise. Perhaps the surprise comes from the fact that stocks have been able to get as high as they have. We are, after all, still looking at an economic situation in the US and elsewhere that is anything but robust. And yet, a look at the monthly chart for the major global stock markets shows that the likes of the S&P 500 and German DAX have broken then 2007 peaks. The NIKKEI still has some way to go to catch up to the others, but is already up better than 50% in 2013, so is making ground rapidly.
Quantitative easing in its various forms around the world is being given quite a bit of credit (or blame) for stocks being able to carrying on rallying despite the headwinds which remain at work. Europe, for example, still faces significant issues in the Euro Zone, and nobody is going to say Japan doesn’t still have a ways to go to get as healthy as it should be.
The interesting part of all this is that the new highs in the stock market are coming in conjunction with a higher dollar. Unlike earlier in the year when it was just a weak euro holding the USD Index up, the latest push that saw the greenback break the 2012 high came on across-the-board strength.
What makes this unusual is the fact that the dollar generally doesn’t do well during good economic conditions because imports tend to rise relative to exports. This is particularly noteworthy at this juncture given that the US has been ahead of many others in terms of getting things pointed in the right direction. We would expect to see import demand boosted as export demand continued to struggle because of weak conditions elsewhere.
So what’s going on?
Well, decreased imports of crude oil (lowest level in 17 years in March) are helping keep the US trade deficit contained. Still, the US continues to run a deficit, which tends to weaken the value of the dollar. The USD must be getting strength from capital flows rather than anything trade related. Certainly that shows in the Treasury market where there was a sharp drop in 10yr Note yields after they peaked in Q1, indicating a considerable increase in demand (similar moves were seen in German and UK rates, it should be noted, but “internal” demand is a bigger factor there than in the Treasury market).
That has reversed of late, though, with yields moving back up in line with higher stock prices. This is the sort of thing we’d expect to see if gains in the equity markets were being driven by expectations for higher economic growth.
So is it quantitative easing? Or is it an improved economic outlook?
The truth is probably a bit of both. There’s no doubt that the increased money supply created by QE in its various incarnations around the world provides a boost to asset prices. It’s simple supply/demand figuring. More money chasing the same (or fewer) securities produces higher prices. At the same time, though, stock prices have risen of late more rapidly than new money is being created by the world’s central banks. Also not supporting the QE impact case very much is the stagnation in oil prices and the persistent weakness in gold, both of which should be pointed higher if QE were a major influence on prices.
Does that mean stocks will keep going even after the money supply taps are turned off? Maybe so. Right now there isn’t a lot to suggest they are due for a major reversal.
The two concerns technicians will point to in the above SPY chart, however, is the market getting extended beyond the upper Bollinger Band of late and the unimpressive volume. The former suggests a market that has perhaps gotten a bit ahead of itself and is therefore due a pause or retracement. The latter is a bit more uncertain. We’d ideally like to see increased volume on a new high, but we’re just not getting it.
This may not be a bad thing, though. Before 2007 the markets moved steadily higher without a lot of volume improvement. We could be seeing something similar again, in which case the worry would be if we saw volume and volatility start to tick up together as we did six years ago.