Is equities bull market exhausting itself?

Can monetary stimulus provide a lasting effect for equities and the global economy? More interest rate cuts and further quantitative easing (QE) seemed the chief upshot of "Vote Leave" on 23 June, reinforcing a sense to "buy the dips" whenever they happen.

Central banks and governments in Europe and Asia have responded, with Deutsche Bank estimating a combined asset buying programme worth £137 billion from the European Central Bank and Bank of Japan. This compares to the £97 trillion of estimated assets under management around the globe; hence the trend towards negative interest rates makes for a desperate search for yield.

Moreover, an aspect of central banks' bond repurchases for cash may simply end up recycled back into the system, boosting equities as "the yield of last resort". Reassuring it may be, a month after the EU referendum, but the underlying fundamentals need constant check when financial assets are boosted like this.

Goldilocks story reads well, for now

As I've explained in previous macro pieces, when the US economy is neither too hot nor too cold, consumer spending holds up pretty well but the Federal Reserve keeps interest rates low - mainly out of concern for employment. Capital therefore prioritises equities for return.

If US earnings reports continue well enough, capital will stay in the game.Occasional news jolts this story, e.g. US durable goods orders for June fell by 4.0%, the greatest since August 2014, versus expectations of a 1.4% slip. Other gauges of manufacturing have been more positive though and stocks rose, despite the weak durable good number, as traders put more emphasis on the Federal Reserve keeping interest rates low.

But mind how the Fed is reacting to news like any of us - after the latest meeting it has left rates unchanged but opened up the possibility of a September hike by saying "near-term risks to the economic outlook have diminished". Given their high multiples, US stocks can easily consolidate, but if earnings reports continue well enough then capital will stay in the game.

Borrow from the future?

Then there is Stanley Druckenmiller, the hedge fund manager who achieved a 30% average annual return from 1986 to 2010, when he wound up his fund citing the challenge to find value deploying big money. Over a year ago he conceded that all the stimulus meant stocks could have further to run, but more recently he warned that the equities bull market is exhausting itself. Best take refuge in cash and gold.

Addressing an investment conference in May, he argued that central banks have borrowed from future consumption more than ever before; that cheap debt has encouraged financial engineering more than productive investment; and it all bakes in lower future returns.

Helped by share buybacks, you might see company earnings progress against low productivity and historically high-rated equities. Hard to be sure exactly when, but markets will eventually force an endgame.

Druckenmiller's thesis is interesting because unlike money managers with a vested interest in stocks going up - who are committed by way of their career - he's given up all that. However, he is 63 and any of us can get stranded in a new world if our past assumptions no longer apply. History doesn't necessarily repeat itself; the question is to what extent does it chime?

That's a lot more subtle than the bold pronouncements made by Druckenmiller and other equity bears. A guy worth £3.3 billion can also indulge bold ideas and enjoy the limelight; he can amply afford to be out of the market, while others need its dividend income.

Chinese progress

While there is spare capacity, neo-Keynesians will say stimulus makes sense and is manifestly low/non-inflationary. Worse would be to let low growth fester versus high levels of debt.

US money supply is growing at its fastest rate for four yearsIn China at least, such macro-management tricks are having "positive" effects: the second quarter of 2016 saw 6.7% growth aided by credit expansion and government spending. The snag is this deriving from another infrastructure boom that needed a rebalancing of the Chinese economy.

It helps explain why metal prices have recovered from early 2016 fears of a Chinese slump, whereas the rollercoaster in oil prices has resulted from off/on US shale supply. Latest indications from China show GDP up 6.7% like-for-like in the second quarter, which should support Asia if not more widely.

US money supply is growing at its fastest rate for four years, up 5.9% in June against 2.8% a year ago, the global measure up a startling 10.5%. This ought to help the economy on a six-nine months view, and the markets also.

Will there be a UK recession?

Markets had a brief panic after the Brexit vote but it was more a release of pent-up fear, followed by a resumption of the status quo after being reminded that stimulus is always at hand. Moreover, profits warnings are not breaking out as yet.

The real test will come this autumn following a drop in the UK Purchasing Manager Index (PMI) from 52.4 in June to 47.7 in July, i.e. negative below 50. Both services and manufacturing were affected, although it's still possible this is more a culmination of much scaremongering over Brexit, which abates.

An August rate cut would be nothing special for borrowers, further loss for saversThere has also been a Confederation of British Industry (CBI) industrial trends survey implying manufacturing will slow over the next three months, with expectations for total new orders growth at their lowest since January 2012. The chief worry is this impacting on firms' investment decisions alongside consumer caution, recessions being caused mainly by a drop in spending.

Meanwhile the evidence by way of Gross Domestic Product rose by 0.6% during April to June, versus 0.4% for first-quarter 2016 and beating expectations of 0.5%. There was significant variation, however, with services up 0.5% and production 2.1%, while construction slipped by 0.4% and agriculture 1.0%.

The Bank of England governor has quite staked policy raising expectations of an August rate cut, the PMI drop appears to support. Quite how net positive that would be is uncertain: nothing special for borrowers, while savers would lose out further - however, it would strengthen the attraction of equity dividend yields.

Marketing services firms are usually a good forward indicator and a latest update from AIM-listed Cello Group cites "no noticeable impact on client spending behaviour as a result of the EU referendum vote and income pipelines remain robust".

However this one is quite focused on pharmaceuticals and healthcare, relatively defensive sectors compared, say, with retail.

Will oil slump again?

After a sharp turnaround from February's $26 a barrel low, back up to $53, crude prices have lately eased near $43. The issue is mainly supply: with enough US shale oil operators profitable around $35 oil, the active US oil-rig count has risen.

The crux issue is marginal cost of production i.e. the cost of producing additional oil from any field, not "sunk" investment costs to date. Bearish observers such as Gary Shilling have maintained a $10 target, given this is Saudi Arabia's marginal cost of production and it's allegedly seeking to keep the US shale industry at bay (so it can later raise prices).

A repeat of oil prices going below $30 looks unlikelyBut US shale operators have proven more adaptive and supply interruptions (due to political risk or operating "outages") weigh significantly too. Also hedge fund and commodity traders are very active in oil, with a herd-effect to any trend. Lately short positions have come to dominate again, hence oil & gas exploration/production stocks typically being sold off.

Latest interims from Tullow Oil exemplify the cost-cutting firms are taking, to achieve respectable results.

Analysts generally re-iterate 'buy' with a sense for medium-term value. Yet the stock has continued to sell off, a good example how it is hard to buck any lurch down in oil prices. Unless the Chinese economy suddenly de-rails then traders will probably be wary not to pile on shorts like in early 2016; moreover the South China Sea is increasingly becoming a political flash point able to spike oil's downtrend.

So a repeat of prices going below $30 looks unlikely and the latest drop provides modest economic help if lower energy costs beckon. A chief reason oil's New Year plunge hit stockmarkets was fear it reflected wider deflation. But the Chinese economy has so far proved robust and excess oil price volatility down to traders.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.