Until the music is playing, investors will dancing

It is 10 years, almost to the day, that Chuck Prince, then chief executive of Citigroup, told the Financial Times: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Those fateful words bear thinking about, especially when looking at today’s equity market where investors are dancing furiously despite the Federal Reserve, the European Central Bank and the Bank of England adopting increasingly hawkish rhetoric about tightening policy. While the bond markets have been rattled, the party in equities continues with a swing. And quite a party it has been.

According to Harry Colvin of Longview Economics, the US equity bull market is now the second longest since 1896. It is also the third largest, delivering a cumulative 328 per cent total return to early July.

There are anyway good grounds for thinking that equities might yet become more expensive. Despite the central bankers’ tough rhetoric, money remains cheap, or “accommodative” in the jargon. The political background has become less threatening in the US and Europe with the Trump administration confronting benign gridlock on Capitol Hill and Emmanuel Macron bringing some stability to a European Union where populism is in retreat.

Since the financial crisis, public sector debt in the developed world has spiraled. And latterly global debt has been driven upwards by households and the non-financial corporate sector. According to the Institute of International Finance it hit a record $217tn in the first quarter of this year, equivalent to 327 per cent of global gross domestic product. By historic standards this is a colossal number. Anything remotely approaching a normalization of policy interest rates could cause a spike in bond market yields, which could in turn spur financial fragility, especially in the eurozone where bank balance sheets are overloaded with sovereign debt and still undercapitalised.

The marked lack of volatility in the markets in the first half of this year suggests that investors are placing enormous faith in the capacity of central banks to tighten policy without precipitating a recession.

Source: Bloomberg Pro Terminal

Trader Bozhidar Arabadzhiev

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