Macro-econ recovery is all about credit growth-has been since the 1960s. The state of current affairs? Credit growth is meager at best: Loan growth and M2 have rolled over (weekly stats out of the FED) in recent weeks and M1/M2 velocity of money has plunged since 2009. Conclusion: FED policies of low interest rates and QE-which jams liquidity onto bank's balance sheet to get them to make more loans-have only been marginally successful. Of course, simultaneous policies of Dodd/Frank and other bank penalizing regs, sour grapes lawsuit "recoveries" and other growth retarding legislation (Obamacare, EPA, OSHA, lack of tort reform, etc etc) have been tremendously counterproductive. Yet stocks are near all-time highs, while main street still suffers.
What comes next? First of all. It doesn't appear Washington is going to change its colors anytime soon by relieving the economy of cumbersome regulations and pass productivity and pro-growth policies. Without Washington's help, then the "credit engine" is the only game in town. As we know, the FED is doing all it can, but Washington is working against it. With the FED now contemplating taking QE down, it is not a disaster because QE has become less effective as banks are over reserved and Washington policies have been thwarting the FED sine 2009. However, higher interest rates do not lend itself to higher PEs and/or stock prices.
So, what of the "credit engine"?. It has gone negative in the Euro-zone and is about to in China with the PBOC's recent restrictive repo-rate policies. China, has had too much of the wrong kind credit growth, in recent years. Tthat growth has led to over-investment in export industries and infrastructure and more recently to maintain asset prices. Well, with credit growth now restricted in China, and underlying cashlows unable to support asset prices, China is going to have some negative adjustments-bank failures and/or in need of capital infusions, plant closures/industry consolidations-leading to much lower levels of GDP growth. This process is going to be deflationary for the rest of the world-commodity prices should go down and PE ratios should contract. How long and how fast this adjustment occurs is any one's guess-we will just have to live into the answer. Similarly, the Euro-zone is going through this process as their "credit engine" has been broke for years-their banks still have not sufficiently repaired their balance sheets.
This is why I think stocks have to come down, alot, first as credit engines in the US, Euro-zone and China are all: flat, grinding down and going down, respectively-while interest rates are rising is not a backdrop for higher stocks prices in my mind-with the chance that some financial institutions and/or countries are going to "blow up".
However, once we get 3-18 months of poor macro-econ data, and China and the Euro-zone are further along in their restructurings and QE and other "credit engines" policies are ramped up, then I'll be a buyer of stocks in size. In the interim, I think alot of bad news and time needs to come out first.
As for policy responses, I'll be looking for:
1)More QE out of the FED after tapering 1 to 2 times
2)Pro-growth initiatives out of Washington
3)QE out of the ECB, (Portugal is going to need it bad, perhaps France)
4)Pro "credit engine" policies out of PBOC after months of restructurings
A catalyst that would negatively influence the "credit engine" would be Chinese banks having difficulty rollover their WMPs. Wealth Mgt Products are non insured ways for banks in China to collect deposits. Problem is banks have been enticing customers with higher than market average yields and paying off maturing WMPs with money from selling new WMPs-a Ponzi scheme if you will. Eventually, perhaps soon, it will blow up. Late last June, the PBOC made it difficult for banks to rollover maturing WMPs-one day and 7-day Repos went through the roof to 13%+.
That was the "warning shot across the bow" by the PBOC to the banks. However, WMPs sales have taken off so far in July. The end of July could foretell another liquidity squeeze-shaking confidence in WMPs cutting off new supplies of money-Ponzi scheme to then unravel.