As interest rates continue to decline, stock prices have been moving in tandem since last summer, Ryoji Musha, president of Musha Research observes. This correlation gives pessimists “a reason to expect another crisis on the same magnitude as the global financial crisis,” he observed. The logic is that once the interest rate market is normalized, the correlation between bond and stock market returns will work in the reverse. Musha says this logic is entirely false and “pessimists will be completely rejected.” But don’t look at economic statistics, particularly regarding productivity growth. Musha says they “cannot be trusted” as he makes the argument market pessimists have no proper arguments for concern.
Low interest rates are not a sign of trouble, but rather real investors concerned with risk flowing into bonds
Market participants think low interest rates are “a sign of trouble” in the economic world, Musha observes. In his argument, Musha says that low interest rates could be caused by any number of factors and are not necessarily a sign of trouble.
He says weak capital demand gives investors an uneasy feeling. This pessimistic behavior makes them unwilling to take on risk, tipping the supply and demand scale in the bond market towards lower rates.
Separately, this argument makes the assumption that it is natural investors who are tipping market scales. Nowhere in the nine page analysis is there any deep analysis of central bank involvement in intervention being the factor that primarily is leading to lower rates. Further, the analyst says low rates are not a sign of trouble but then points to concern for risk as to why investors are moving into bonds, an apparent contradiction.
Musha does consider in a meaningful way how central bank influences in the market in his four primary reasons that “pessimists will be completely rejected.” Even central bank officials admit this as being a concern, but Musha avoids the meat of this conversation.
When he does mention central banks, Musha calls the notion that central banks are the cause for lower interest rates lacking context. “Falling long-term interest rates caused by excessive central bank monetary easing, is a one-dimensional view,” he wrote. “Without this excessive easing, the global economy would have been even weaker, causing prices of assets to fall. Having nowhere else to go, capital would flow into government bonds, creating more downward pressure on interest rates.” He did not acknowledge the impact central bank quantitative measures have had in keeping global interest rates low.
Musha seems to believe that falling interest rates are due primarily to natural buyers and sellers reacting to the market situation. But context for this notion, the analyst asks his readers not to trust economic numbers being released relative to productivity growth.
Musha: Don’t trust statistics
“Don’t trust statistics that show productivity growth is slowing,” Musha says in a headline. While he acknowledges that slowing productivity growth is “the most reasonable position of pessimists,” he says “there is reason to be suspicious about data indicating that productivity growth is slowing.”
If one just looks at statistics alone, “it is impossible to deny the fact that the pace of productivity improvements has been declining in recent years.” But context is required.
Productivity statistics are a sub category performance driver. The most important issue is corporate earnings. “Companies have been reporting consistently strong earnings for the past decade, even during the darkest days of the global financial crisis,” he wrote, noting a key component in many stock valuation formulas. “This raises serious doubts about the pessimists’ belief that productivity is decreasing” and this will result in lower earnings.
“The time has come to make it clear that statistics are wrong,” he wrote.
Profit margins and interest rates move in different directions
Musha thinks profit margins and interest rates are moving in different directions.
“Normally, strong earnings and historically low interest rates should not occur at the same time,” he notes. Separately, low interest rates are documented to lower the cost of corporate financing, but factoring this didn’t make it into the analysis.
Musha, for his part, points to a new world of productivity:
The new industrial revolution, driven by IT, smartphones, cloud computing and other advances, has converged with globalization to produce a remarkable upturn in productivity. Companies require much less capital and labor as a result. Higher productivity has immediately sparked a big increase in earnings while simultaneously producing capital and labor market slack.
Musha says the key is to create policies that can put surplus capital to work. “If the idle money that companies are hoarding due to their high earnings is in fact exerting downward pressure on long-term interest rates, something must be done to end this problem.”
Not reacting to the situation could result in dire reactions, Musha claims, as he says corporate “hording money” and unused capital “signifies the death of capitalism.”
“If governments do not have the resolve to enact policies aimed at altering the current situation, capitalism could collapse,” he said, leaving unaddressed many of the primary issues economic observers have with the current free market capitalism being light on free markets.