Monday, July 31, 2017

What's Keeping the Stock Market UP?

Central banks are buying stocks. As you probably know, when the Federal Reserve buys bonds from the U.S. Treasury, it creates—out of thin air—a corresponding deposit in one of the large commercial banks where the Treasury has an account. The money from that deposit gets into circulation when the government spends it by buying something with it, for which the seller makes a deposit in his own account. The seller then spends the money from his account to buy something else, and the process of sales and deposits is repeated as the money is circulated in accounts throughout the economy.

The Fed is not the only central bank increasing its money supply in this manner. Other central banks are doing the same thing with their national currencies in the hope of stimulating growth in their economies. Japan is a prime example, having employed this and other “stimulative” policies for more than two decades with poor results. Those decades are called the “lost decades.” From 1991 to 2011 Japan's annual economic growth averaged less than one percent. It now has a debt-to-GDP ratio of 250 %, the highest in the world, and more than three times what it was (65 %) in 1990 when the first of its ten stimulus programs began. But that hasn't stopped Japan from trying larger doses of the same failed policies.

Shinzo Abe was elected prime minister of Japan in large measure on his campaign for monetary easing. In 2013 he said, “Countries around the world are printing more money to boost their competitiveness. Japan must do so too.” He called for more aggressive action along the lines of the Fed and the European Central Bank. That was his prescription for a degree of “needed” inflation to bring Japan out of two decades of economic stagnation and avoid the growing fear that deflation was now a greater threat than inflation. Whereas the Fed buys only U.S. Treasury securities, the central bank of Japan would henceforth buy at the market more than twice the amount of new bonds issued by its government, and it would buy not just government bonds but stocks, ETF's (exchange traded funds), and real estate funds.

Other central banks also broadened the scope of their buying, particularly for common stocks. After all, with near zero interest rates on government securities, buying common stocks at least offered the prospect of higher yield. The chart below shows how the five largest central banks raised their financial assets in ten years from less than $4 trillion to $14.6 trillion. This includes adding a record $1 trillion in just the first four months of 2017. Annualized, that would be $3.6 trillion for the year.


The bank of Japan is already a top-five owner of 81 companies in Japan’s Nikkei Stock Average and is on course to become the No. 1 shareholder in 55 of them by the end of next year, according to Bloomberg. And it owns 62 percent of the domestic ETF market.

Swiss National Bank purchased a record $17 billion in US equities in just the first quarter 2017, bringing its total US equity holdings to an all time high above $80 billion, 29% more than at the end of 2016.

Have you wondered why stocks like Apple, Microsoft and Google continue to make big gains in the U.S. indexes such as the Dow-Jones Industrials? These are the kind of big, successful companies that central banks favor. The Swiss National Bank bought almost 4 million shares of Apple in the first three months of this year. It owns more publicly-owned shares of Facebook than founder Mark Zuckerberg, whose holding is worth almost $24 billion. SNB also has over $1 billion each in Exxon Mobile and Johnson & Johnson stocks. SNB is the world's eighth largest public investor.

Until 1996 the Swiss constitution required the Swiss Franc to be 40% backed by gold. In 1992 Switzerland joined the International Monetary Fund. In 1996 an amendment to the Swiss constitution ended the Swiss Franc's gold backing, with the Swiss Parliament stating, “gold no longer has any meaning for monetary policy.”

Switzerland began selling its gold in 2000 when gold was just beginning a powerful 12-year price surge. Since 2000, the SNB has sold about 60% of Swiss gold reserves, about 1,500 tons. It is, therefore, perhaps surprising that in 2013 the SNB began quietly assembling a portfolio of gold and silver mining stocks, which in 2016 consisted of $1 billion of stocks in 32 mining companies. As of August 5, 2016, its two largest holdings were $186,092,033 in Newmont Mining and $157,318,092 in Goldcorp.

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