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Central bank liquidity and markets

Hi Cullen, this is my first post on your website so I'm kind of fumbling my way.

I (think I) have uploaded a chart of G3 central bank balance sheets vs ACWI (from topdowncharts.com), which echoes an oft' repeated theme that markets are being driven by liquidity. I'd be interested in your views on that.

I've browsed your site to see if you've written on the topic already but couldn't find an article, though I could easily have missed it (there was an impressively large library of material - you appear to be a prolific writer).

Cheers, James

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Hi @JAMES-W,

Thanks for the comment.

I've written a bit about this idea (see links below). I call it "assflation". Basically, everyone who predicated hyperinflation following QE was wrong and then pivoted to saying all the "inflation" went into stocks. I actually used to think there was some merit to this idea and I once thought that it could cause commodities to rise in value, but the evidence has been clear - this thing does not make commodities go up. So I've had to revisit the whole concept over the years and I've concluded that there's no empirically sound explanation for why the stock market should rise just because Central Banks expand their balance sheets.

One core assumption here is it assumes the stock market is hyper hyper inefficient. That is, that there's no underlying fundamental reason for the improvement. And we just know that's wrong. For instance, US corporate profits and EPS have boomed in recent decades. We don't need conspiracy theories to try to explain why they've gone up. I'm not an efficient market guy, but I also don't think the stock market goes up because a bunch of dopes buy stocks because the Fed said they'd buy stocks. I mean, at some point the rubber meets the road, right and the stock market would sniff that out and the traders who got burned would avoid getting burned again? Right?

As to this chart specifically - I'm not sure. Seems like there are lots of way to cherry pick a preferred narrative around it. For instance, stocks seem to rise as the balance sheet slows in growth. Then, at times when it turns negative the stock market seems to still do well (like in 2013 and 2015).

Honestly, I think a lot of it is a misunderstanding by people who don't know what the term "inflation" means and have this conspiracy theory in their minds that the whole financial system is a scam being operated by a cabal of secretive bankers at the Fed. But who knows. Maybe I am the crazy person????

https://www.pragcap.com/lets-talk-qe-asset-price-inflation/

https://www.pragcap.com/forum-2/topic/assflation-and-fed-derangement-syndrome/

 

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

It isn't either one or the other. Not a planned conspiracy, but still bad stuff going on. The Fed didn't want the market to crash in response to the pandemic. There is also a "plunge protection team" that works to prevent crashes.

The Fed can inflate the stock market by shooting off dollars to foreign central banks, and asking them to invest in US stocks. That's one way. The Fed also can, or soon will be able to, invest in equities.

The stock market is increasingly an illusion divorced from American business.

Hi Cullen, thanks for taking the time with such a thoughtful reply. I must say I'm pleased you came to the same conclusion I did, that the evidence doesn't support the notion that share markets are dependent on CB liquidity injections. I think a great confirmation of that was in an article Ben Carlson wrote last year pointing out that, using Bogle's formula, earnings growth + dividends accounted for 97% of the S&P 500's rise in the 10 years to end September 2019.

It also occurred to me that, if the Fed's BS increased by (what was it?) $3-4 trillion post 2008, but the US market has gone from $13 trillion to $39, that would have to be one hell of a multiplier effect. Maybe that's a naive way of looking at it?

I'll have a look at your articles.

Thanks again, James