When asked about the job of the Federal Reserve, William McChesney Martin was once quoted saying that their job was to "take away the punch bowl just as the party gets going."
Since 2008, we have seen successive rounds of stimulus from central banks all around the world. It is up for debate whether or not these stimulus measures have been coordinated, coincident or in competition with one another, but to a large extent these easing measures have benefited equity markets. In particular, over the last three and a half years, the S&P 500 has nearly doubled. So, the question becomes, when will central banks take the punch bowl away?
Spiking the Punch
In the last couple months of 2012, we are likely to see increased global stimulus efforts, not a withdrawal from stimulus. Some of these measures will be outside the precise purview of central banks, but they will probably have similar economic effects.
The first of these potential stimulative actions is a Spanish bailout as early as November. As with everything in the EU, this is tenuous at best, but reasonable projections indicate that a bailout could very well occur before year-end, and thereby bolster Spanish bonds and the eurozone as a whole.
The next stimulative action could be more direct market intervention from the Bank of England through more asset purchases. Although the BOE's October minutes demonstrate a split over this policy move, the strength of the GBP and projected 0% growth in the British economy indicate that unless the Funding for Lending scheme becomes dramatically more successful, the BOE is likely headed for more QE.
Adding fuel to the stimulative fire, weakening growth in Asia is likely to force Japan toward monetary easing and possibly even fiscal stimulus to bolster the export sectors of their economy. Furthermore, even China is weighing major new economic reforms. With the change in Chinese leadership fueling new economic stimulus ideas in the world's second largest economy, November 8 could be the beginning of a very turbulent but fruitful period of growth on the heels of several new stimulus policies.
And what does the Fed have to say about this global stimulus? Not much. Instead of fearing rising inflation expectations, several former Fed officials have noted that Fed policymakers seem much more comfortable with elevated inflation right now. These policymakers consistently claim that this focus has more to do with domestic job growth than international currency pressures, but the central banking incentives to weaken the U.S. dollar can't be ignored. So, the Fed is unlikely to halt its stimulative measures anytime soon.
Diluting the Punch
Despite all of these stimulative policy steps from the world's largest economies, several economic indicators suggest that it is time to dilute the punch, if not take it away altogether. Among these indicators is rising inflation in both the UK and India. This could cause the BOE to take pause and not initiate further QE in the near future. However, this could be a dangerous move from a currency standpoint, since the GBP might rapidly strengthen against its primary trade partners who are all still actively easing.
The bigger surprise in recent data has actually been from Germany. Despite all of the eurozone turmoil, its biggest economy somehow managed to show significant signs of life in the third quarter. This positive signal might be enough to convince some policymakers that Europe is on the mend, even without issuing an actual bailout to Spain. However, as with everything in Europe these days, this positive sentiment is likely to fade rapidly, and the need for a Spanish bailout will once again be obvious within the next few months.
Despite a few positive signals that will give pause to central bankers around the world, the signs overwhelmingly indicate that central bankers are not taking away the punch bowl anytime soon. If anything, central banks around the world seem to be spiking their respective punch bowls in hopes of making the party a little bit better. Investors can continue to gorge themselves for a while and have a great time, but eventually the punch will catch up with you, so you better hope that someone takes the punch bowl away in time.
Essentially, when we ride stimulus driven growth, asset prices will eventually be too mismatched from the fundamentals to continue rising in value. So equity investors should look for the party to keep going through the rest of 2012, and if Europe moves to shore-up Spain, and China starts new stimulus initiatives, this party could continue well into 2013. The question will be whether the party can keep going as stronger economies begin taking away the punch bowl while weaker ones continue spiking it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.