Equity markets globally continue on their merry journey unabated. Markets have moved well ahead of fundamentals riding on the liquidity influx by various central banks.
After nearly a decade, economies have finally started showing some signs of growth. But the entire rally over the last decade has been liquidity-driven. This liquidity is now under threat and there are signs visible in various data points that suggest that if the current pace continues, the risks for markets might build up.
Here are 5 signs that equity markets might be heading for trouble:
- Liquidity soaking: After the 2008 financial crisis, central banks, mostly in the developed world, kept on pumping in liquidity in the hope of reviving the economy. The benefits of this largesse are still debatable but the money did flow into financial assets globally and bloated asset prices. The move, known as quantitative easing, also resulted in interest rates falling to near zero levels in the developed world.
Powered by liquidity, world equity markets continued on their path irrespective of negative news flows, economic hurdles, a complete change in the political landscape and social disruptions.
As economies revive they need money to grow and provide employment. After the United States closed its liquidity tap, other economies in Europe and Japan are moving in to crimp the flow as well. The fuel supply that drove the markets is expected to be hit going forward, as the liquidity is diverted into the manufacturing economy.
2. Interest rates: Liquidity has a direct relation to interest rates. Legendary bond market investor Bill Gross, along with other bond market fund managers, has been on record saying that the 35-year bull-run in the bond market is over. Tweeting his view, Gross said that the bear market in bonds was confirmed after the 10-year US bond crossed the 2.5 percent mark.
US Federal Reserve has been raising interest rates as the economy posted strong growth. Market experts feel the US Fed might raise interest rates as the economy picks up. The higher interest rate in the bond market results in money being diverted from equities to debt.
3. Weak dollar: The US economy is facing dual headwinds. First is the higher interest rate as Federal Reserve increases rates to cool inflation and second is because China has publicly hesitated on its US bond-buying program. China is the biggest buyer of US bonds and any slowdown in its purchase would mean high bond yields and a weaker dollar. A Weak dollar can result in the flight of capital to safety. This would hit the world’s biggest stock market.
4. Gold prices: A sign of risk building up in the system can be seen in gold prices that have touched a 19-week high. A weakening dollar results in gold prices moving higher.5. Crude oil
: Oil prices continue to move higher as the production cut being carried on by the oil cartel tightens supply in the market. Brent crude has touched the $70 per barrel mark and is considered as one of the biggest factors in increasing inflation and interest rates globally. Higher inflation and interest rates slow earnings of companies, which, in turn, will impact markets.