No safety net for equities with interest rates already too low

Usually when bond markets are weak then stock markets become strong. But weaker markets for certain government bonds are not helping equities at the moment. Expect another big sell off around the world this week in stock markets.

Last week it was the mounting public debt in Greece, Spain, Italy, Ireland and Portugal that rattled financial markets. There were also a few rumblings about France and Belgium. But as Deutsche Bank noted this may just be a dress rehearsal for the bigger bond crises to come in the US and UK.

US municipal bonds

In the US the $2.8 trillion municipal bond market looks likely to be the first government borrowing bubble to burst. Money manager Michael Aronstein ranks it next in the bubble series of the Nasdaq and housing, and his Marketfield Fund has got it right before.

He sees the biggest risk coming when the credit cycle starts to tighten and people start trying to withdraw money from municipal bonds. His other big concern is emerging market funds, another bubble asset class.

Yet for the time being faith in US treasury bonds is holding. Bonds rose for the fifth straight week last week as US equities trimmed another 0.5 per cent in value.

However, this is the biggest bubble of them all. But it looks like getting even bigger before it unwinds or implodes. Stock markets look to be heading much lower. Last week the Dow dipped back below 10,000, down seven per cent on its closing peak on January 19th.

The mood of investors has shifted from overwhelming optimism to mounting pessimism. Canny commentators saw the very high optimism at the New Year as a sell signal.

Correction overdue

Indeed, there has to be a correction to move the market back into line with something closer to economic reality. A 20,000 rise in unemployment in January was still a fall in employment, and not a rise which might be expected in an economic recovery, for example.

So fragile investor sentiment is being hit by unpleasant news. But markets are also pricing in very strong profit recoveries, with very high price-to-earnings ratios, and that leaves a lot of room to the downside for stock valuations at this point.

The traditional safety net of slashing interest rates is also not available to policy makers because rates are already at rock bottom. Usually the Fed will cut rates at the first sign of a correction but cannot do so now. Printing money might not be as effective.

Uncertain safety nets make global stock markets a dangerous environment right now. Certain bonds are comparatively safe but it will shortly be time to exit this bubble too. Gold and silver are the final and ultimate bubbles and for now a safe haven asset class, whatever their short-term ups and downs.