Central Bank Analysts Say Stocks Are In 'Euphoric' Territory And We're Screwed When The Recession Hits


The Bank for International Settlements - the Swiss-based financial institution that acts as a counterparty to national central banks - has declared that stock markets are currently in a "euphoric" state and has urged central banks globally to begin tightening interest rate policies now while economies are growing rather than wait for another recession, when it will be too late.


Those are scary words, coming from a set of economists whose job it is to monitor how capable central banks are of responding to economic conditions with flexible monetary policy. The subtext (and not-so-subtext) of BIS's annual report is that because many central banks have reduced interest rates to zero - the U.S. and Japan included - they are currently without weapons to boost the economy should another crisis hit. You can't go lower than zero, basically. These words from the BIS ought to terrify anyone who thought central banks were unprepared for the last recession in 2007, when U.S. interest rates were "high" at about 5.3%:

Financial markets are euphoric, but progress in strengthening banks' balance sheets has been uneven and private debt keeps growing. Macroeconomic policy has little room for manoeuvre to deal with any untoward surprises that might be sprung, including a normal recession.

And that crisis looks set to arrive any day now because stocks are at a peak. Bloomberg underlined the point at the weekend:

One thing making people nervous about stocks these days is the fact the U.S. market has gone more than two years without a correction, or a 10 percent drop.


It just doesn't feel right. Sort of like going two years without changing a car's oil, or two days without brushing your teeth, or two paragraphs into a column without a good metaphor.

The last major dip for the Standard & Poor's 500 Index (SPX) was an 11 percent drop from its intraday high on April 2, 2012, through its low on June 4, 2012. This year, the closest it's come was a 6.1 percent slide from the middle of January to early February and a 4.4 percent decline in April.

On top of that, the M&A market hit new records this year. The Financial Times reports:

Deal frenzy, animal spirits, merger mania - call it what you like, it is back. The value of global mergers and acquisitions hit $1.75tn in the first six months of the year, a 75 per cent rise on the same period last year and the highest since 2007.

The FT also cites these frothy stats about the value of the M&A market:

  • The value of U.S. M&A this year hit $748.5 billion, up almost 75%.
  • In Asia-Pacific, the number hit $327.8 billion, up 85 per cent - a record since 1980, The FT says.
  • In Europe, the $509 billion in deals was doubling over the year before.

Alberto Gallo, head of macro credit research at RBS in London, believes investors are asleep at the wheel:

The worry is that a combination of complacency and illiquidity could turn a snowball into an avalanche when "low-for-long" interest rates come to an end. With US unemployment falling and the Fed's asset purchase "tapering" ending in the fourth quarter, this moment is getting closer. Markets are unprepared.

Get out now, in other words, because the Fed won't be able to rescue stocks with more liquidity should the market begin a secular slide.