Managed financial markets? The upside-down world in art and financial markets

We try to analyse the financial markets against the background of the massive stimuli provided by central banks and the huge government rescue packages. You will also learn what central bank policy might have to do with Pieter Bruegel and Hieronymus Bosch.


Sharp recession is being fought with the most aggressive rescue packages and most aggressive central bank policy ever

The biggest crash in recent history and the dramatic recession that was to be expected as a result led to the biggest bail-out rescue attempts ever.

It could be that the dominant influence on the financial markets in the future will no longer be the economic and profit cycle, but central bank policy and financial policy. For some time now, the central banks have been succeeding in turning bad news into good news by “doing everything they can to ensure that bonds and equities rise, or at least do not fall”, while accepting the most terrible collateral damage. This was already discussed in the Aquila blog post “The Pavlovian Investor“.


Central banks create an upside-down world that can also be depicted artistically

If this were to happen, certain economic market rules would not only be broken, but would be exactly the opposite. The worse the economic news, the stronger the intervention of central banks and fiscal policy, the higher stock prices, the higher junk bond prices, etc.

In a sense, the economic and profit cycle would then remain the dominant influence on the financial markets, but with a reversed sign.

A twisted world can also be represented artistically. An example: “The house upside down“.

In the author’s opinion, however, the “upside-down world” by Hieronymus Bosch and Pieter Bruegel best characterizes current central bank policy.


Redistribution in favor of the present generation at the expense of the unborn

The massive interventions by central banks can be interpreted as a “distribution policy battle”. The manipulation of interest rates downwards against market forces (subsidisation of debtors, taxation of creditors) leads to the following “moral hazard” problems, among others: Incentive to run up debt over both ears, to pursue an aggressive investment strategy (frontrunning the central banks; buy before the central banks buy, don’t fight the FED), inefficient capital allocation, redistribution in favour of large, stock market capitalised companies and at the expense of small, unlisted companies.

Such an anti-market economy system is characterized by a massive build-up of debt, which will become more dramatic with every crisis and the resulting bail-outs. All financial market variables that are supposed to indicate scarcity are not only overridden but turned into their opposite. The system is highly inefficient and self-destructive. In the short term, the winners will be those who have invested large sums of money at risk today (how old are the decision-makers in monetary and fiscal policy?). In the long term, all those who have invested little in risky assets and future generations will lose (can the unborn somehow influence the monetary and fiscal policies of today from which they will suffer in the future?).

Therefore, let yourself be inspired by The Battle about Money (Pieter Bruegel, after 1570).


Chance or risk of a melt-up, a central bank orchestrated overvaluation bubble high

The risk that the suppression of investment risks, the subsidisation of debtors at the expense of creditors in the middle of a sharp recession will create a gigantic overvaluation bubble is very high.

Chart 1 shows the Shiller price-earnings ratio for the S&P500 relative to the index level 2823 as of 04.05.2020. With a price-earnings ratio of around 26.5, equities are historically rather expensive compared to their own history, especially considering that the US economy is currently in recession. However, if one looks at equities relative to bonds, one can conclude that bonds are “overvalued” compared to equities.

Chart 1: Shiller price-earnings ratio S&P500 since 1880

Shiller price-earnings ratio S&P500 since 1880
Source: Homepage Robert Shiller and own calculations

Is it still possible to make forecasts for the stock markets?

How long will the central banks succeed in reversing economic laws? How strong is the will of the Administration Trumps and the FED to keep the NASDAQ and S&P500 rising? Does President Trump have an even higher price target in mind for himself and his constituents? It is difficult for us to answer these questions.

As long as the central banks are not stopped in their “whatever it takes” policy by “counter powers”, the central banks’ willingness to centrally plan to rescue whatever it takes cannot be stopped.

“The market” or economic laws can only stop the central banks if either the money created by the central banks to buy up “of everything” is no longer accepted because of an inflation problem, or the instability of the financial system is so high that investors flee into extreme safety, ultimately into debt-free real assets (such as real estate) or gold.

The COVID-19 shock is likely to have a deflationary effect in the short and medium term and inflationary effects only in the long term. The central banks’ fight against the instability of the financial system can thus presumably succeed until a serious inflation problem emerges. Thus, the future development of the stock markets will probably depend primarily on the will of the central banks. This is not known to the author. However, it seems plausible that they are “not yet satisfied”.


Perhaps the only thing that can be said…

For equities to remain at current levels or rise further, central banks’ balance sheet expansion must be maintained, market manipulation must be continued or probably implemented much more aggressively. For this reason, only intervention and equity forecasts can currently be made in combination.

At the end of this article, one last question comes to mind:

Was Hieronymus Bosch, the creator of the upside-down worlds, on drugs?


This post was automatically translated

Thomas Härter
Chief Investment Officer Aquila