Several factors have been inflating economic expectations. Four key issues in play are the tailwinds from China's massive liquidity injection during the first part of the year, rising oil prices, technical factors indicating a breakout on the charts, and Janet Yellen's recent rollback of when interest rates would increase. In truth, all these issues are double-edged swords that could cut either way rather than a solid guarantee of stronger markets. An argument exists that each of these factors is a warning that risk is on the rise, and together, they scream "caveat emptor," or in plain English, let the buyer beware.
It is now known that in the first quarter of 2016, China opened the floodgates of liquidity in what some economists view as an almost panic reaction to its deteriorating internal economic conditions. This explains a great deal as to why housing prices are again on the rise in China, and office space is being built even though vacancy rates remain high. This recent boost in money supply occurred at the same time money has continued to leak out of China, fueling prices in several global markets and increasing speculation. This boost in markets has reassured those touting a bullish scenario and lends credence to the false illusion that all is well.
Due to the fact that China shares strong economic ties with Japan, it is possible this wave of money also had a role in the announcement overnight that Japan's economy has grown slightly more than the government initially reported. A revision in private consumption and business investment that dropped less than originally thought during the first quarter was given as the reason. According to revised data, gross domestic product expanded by an annualized 1.9 percent in the three months ending March 31, a slight bit more than the initial reading of 1.7 percent. It should be noted this is not a great performance on the part of Japan, but it does keep the country out of a recession.
Money leaking out of China and working its way into commodities also helps to explain a jump in oil and even copper, while it is clear that more than ample stocks of both exist to fill somewhat weak demand. While many people had predicted oil to come back a bit off its bottom, the speed of its rise has surprised even some bulls and caused bears to cover their positions in panic and horror. If this China boost has indeed been the big driver of recent markets and its force is about to weaken, we might see prices soon reverse and head lower again. If this happens, predictions of a breakout to the upside by the chart-loving nerds may prove just another market disappointment. These have been experienced on more than one occasion.
As for Janet Yellen and her flipflop, dovish comments on an interest rate hike followed a heartbreaking jobs report. Shocking many, the report showed that only 38,000 jobs were created in May, and revisions lowered the number of jobs thought to have been created in prior months. Yellen's move was seen as an effort to prop up and halt a market fall. The idea that "bad news is good news" is based on skewed logic and can be countered with the argument the positive effects garnered from lower interest rates are largely behind us. This has proven true across the world, as the central banks have raced to the bottom, only to find little relief from the slow economic growth that has haunted their economies for years.
Near the end of May as the Group of 7 finance leaders gathered in Japan, warnings of a coming global financial crisis were voiced, but in the end, concerns were ignored and brushed aside. If indeed the above factors have, for the moment, put a little lipstick on our tired old pig of a market, do not expect her to sprout wings and fly. And it is wings she might need when you stand back and look at the fact that this economy and market sits upon a pile of debt, piled upon a pile of debt. To say it may be time for caution and prudence is an understatement.