In the realm of modern finance, one of the most bewildering actions of central banks is the creation of digital monetary credits from thin air, which are then used to purchase equities. While this might sound surreal, it has become standard practice in several economies today.
Take Japan, for instance, where the central bank’s intervention in the stock market operates with the same routine as a dairy farmer milking cows. This process resembles an art form more than a science; any interruption, even for a single day, can lead to noticeable discomfort.
In late April, a Bloomberg report revealed that the Bank of Japan (BOJ) had become one of the top ten shareholders in nearly 90% of the companies listed on the Nikkei 225 through its purchasing of exchange-traded funds (ETFs). At that point, estimates suggested that the BOJ was acquiring approximately 3 trillion yen ($27.2 billion) worth of ETFs annually, a figure that has likely increased since then.
Furthermore, recent reports from ZeroHedge, citing Citibank’s Matt King, indicate that global central bank asset purchases have reached their highest levels since 2013. This surge helps explain why stock markets are achieving all-time highs, despite investors withdrawing money from equity funds for 17 consecutive weeks, suggesting a cautious flight to safety.
In essence, central banks are infusing “liquidity” into stock markets at a rate that exceeds investors’ withdrawals. Currently, the primary players in this dynamic are the BOJ and the European Central Bank (ECB), with similar measures potentially coming from other central banks soon.
Wealth Effect Redux
Other than trying to bolster the economy by inflating the stock market, the purpose of this direct intervention remains somewhat unclear. There is a prevailing belief that the “wealth effect” resulting from inflated asset prices will foster economic demand. The theory suggests that as investors see their stock portfolios rise, they feel more financially secure, prompting some to make purchases — whether it be a new television or wearable fitness devices. In turn, this increased spending could lead to rising GDP, higher wages, and lower unemployment, ultimately triggering an economic boom.
For those skeptical of this narrative, there are even abstract concepts — such as liquidity trap graphs — that lend academic justification for central banks pumping liquidity into ETFs. These theories suggest that traditional methods like buying government debts no longer yield the desired stimulus, leading to the justification of inflating stock prices in pursuit of the elusive wealth effect.
However, there are significant concerns regarding the side effects and unintended consequences of such policies. What transpires in a market when central banks become the predominant shareholders of stocks?
Shingo Ide, chief equity strategist at NLI Research Institute in Tokyo, provides insight: “For those who want shares to appreciate no matter the cost, it’s fantastic that the BOJ—or any central bank—is buying so much. However, this clearly distorts the realities of the stock market.”
Destination Mars
The asset purchases by the BOJ and ECB are not only warping their own markets; today’s financial markets are more interconnected than ever. Liquidity infused into one market can ripple through others. Presently, U.S. blue-chip stocks, particularly dividend-paying ones, are in high demand.
Recently, the S&P 500 reached a new all-time high, despite clear signals that stocks should have already plummeted. They are currently overvalued by numerous metrics.
The S&P 500’s Shiller price-to-earnings ratio was recorded at 26.92 at the market’s close, significantly exceeding its long-term average of 16.68. Moreover, the Buffett indicator, which compares market capitalization to gross national product, closed the day at 122.9%, indicating a “significantly overvalued” market.
A market correction seems inevitable, but the question remains: is it on the horizon?
Over the past decade, we’ve frequently underestimated how far the consequences of radical central banking measures can stretch. Whether observing the residential property market during the mid-2000s or current government debt yields, we continue to be astonished by the capacity for prices to detach from economic fundamentals. This applies to the current state of the U.S. stock market as well.
Ultimately, we must confront the reality that global central banks appear to be on a perilous course. Their belief in printing money and accumulating stocks as a means of salvation can lead to an eventual plunge—but not before we witness the dramatic spectacle of an extraordinary price surge, illustrating the folly of central bankers.
While we find this unsettling, it is crucial to recognize the unconventional financial universe we inhabit. Any reservations must be set aside.
Stocks may not only soar dramatically but could reach unprecedented heights—perhaps even to Mars or beyond—before the inevitable conclusion of this cycle is reached.
Sincerely,
MN Gordon
for Economic Prism
