The outperformance of risk assets over the past year suggests investors appear to believe that all credit problems have been solved – but nothing could be further from the truth, says Leigh Skene at Lombard Street Research.
“Rising stock markets and narrowing credit spreads depend on buyers being more anxious to buy than the sellers are to sell,” he says. “So who are the enthusiastic buyers of risk assets?”
Surprisingly, says Mr Skene, surveys show that the usual investors in major rallies – pension funds, hedge funds and retail investors – have not been net buyers of equities. And he says the most likely explanation for this anomaly in the biggest stock market rally since the 1930s is that major investment banks are the anxious buyers.
“Their buying would appear to be for one of two reasons. Firstly because they think the authorities will prevail in their (so far unsuccessful) efforts to inflate their way out of debt liquidation; or secondly because they are too big to fail and so can afford to take a huge gamble that enough buying will convince others to rush in and buy their inventory of risk assets at even higher prices.
“Huge economic slack in most developed nations and falling money supplies in the two biggest currency areas indicate that government efforts to inflate will continue to be unsuccessful – so reason number one is bearish for risk assets; number two is catastrophic.”