Reading the bull

I see the world's central banks as the drivers in the bull market that took off after the global financial crisis. The Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of China and other national central banks have pumped money into the global economy to head off the potential collapse of the world's financial system and to stimulate the world's economies.

They've done this by driving interest rates to historic lows near zero in the United States and Japan and by pumping money into global economies through programs of bond buying that effectively created money. To take just two examples, the Federal Reserve's balance sheet expanded to $2.92 trillion in the week ended Jan. 10. That's roughly three times the size of the balance sheet before the financial crisis. The European Central Bank's balance sheet hit a 2012 high in June at $4.15 trillion (at recent dollar/euro exchange rates).

Even in normal times, creating that much money would have increased the value of financial assets. Some of that created money would flow into the real economy in the form of investment in things like new factories. Some, however, would have flowed into purchases of stocks and bonds -- and into real estate, as well.

But these haven't been normal times. With companies often reluctant to invest and banks often reluctant to lend, a larger-than-usual portion of this created money has flowed into financial assets. And some of that was absolutely intentional as central banks tried to reinflate collapsed real-estate markets, recapitalize damaged banks and prop up the government bonds of troubled countries in the eurozone. Add in the effect of low interest rates on asset prices -- when new bonds pay just 0.25%, older bonds with higher return rates and stocks with higher dividends rise in price -- and the central banks have provided considerable fuel for a bull market.

Of course, central banks were glad to see stock and bond markets moving up, since the wealth effect created by rising markets led to an increase in consumer confidence and a pickup in spending.

But you should be asking, "Now what?"

The Federal Reserve is committed to a program of asset purchases of $85 billion a month through the end of 2013 (probably). But that's not an increase.

The European Central Bank proudly noted at President Mario Draghi's most recent news conference that it begun to shrink its balance sheet (although a new flare-up of the eurozone debt crisis would quickly reverse that shrinkage).

The Bank of China still seems committed to stimulating China's economy, but it has moved relatively carefully, holding off longer than expected on interest-rate cuts, for example. An increase in inflation in December to 2.5%, while still below the government's 4% target, certainly won't make the bank less cautious.

Will the banks keep it up?

Of the world's major central banks, only the Bank of Japan is still increasing its program of monetary stimulus. The Bank of Japan is expected to increase its inflation target to 2% on Jan. 22, which would commit the bank to a big increase in bond buying and to other measures that would weaken the yen.

I look at the argument about secular bull/secular bear through the prism of global central bank policy. The central banks have fueled the bull market that began in 2009 by creating trillions in cash, much of which flowed into financial assets. I don't see the banks releasing another flood of cash on the global economy, absent a new global crisis (which would not be good for asset prices, of course).

Does that mean global financial markets will tumble?

No. Increasing corporate earnings could prop up stock prices at current levels or even move them higher in the months ahead. Wall Street optimists seem to be counting on this for the second half of 2013. But with the eurozone economy in recession and U.S. growth looking weaker, at least in the first half of the year, I find it hard to make a strong argument that U.S. stock prices should end the year markedly higher than they are now based on profits.

Why the bear will be back

I think that leaves the decision on secular bull/secular bear up to two other factors.

First, can a recovery in economic growth in China and increased economic growth in the rest of Asia power global financial markets in those countries absent support from U.S. or European markets? This would require that emerging financial markets decouple from developed-world markets (or that they advance strongly enough that they drag developed markets behind them).

That's not out of the question, since valuations in emerging markets are relatively low and growth prospects are relatively high. But it would require that problems in Europe, Japan and the United States not rise to the level that in 2011 and 2012 prompted global investors to shun any markets with a whiff of risk. If investors wind up buying U.S., Japanese and German bonds with negative real yields again because they're willing to pay anything for safety, then emerging markets certainly won't outperform. I think that the current outperformance of emerging markets makes them attractive enough to overweight in the first half of 2013 and into the second half. After that, it will be time to re-evaluate.

Second, can the world's central banks begin shrinking their balance sheets -- a necessity to keep the faith of the financial markets -- without throwing the global economy (and global financial markets) into reverse?

If there's one thing that makes me pessimistic about financial markets during the next half-decade or more, and that makes me give high odds to an end to the cyclical bull market and a continuation of a secular bear market, this is it. Shrinking a $3 trillion or $4 trillion balance sheet without slowing an economy is horrendously difficult -- so difficult I'm not sure it can be done. Looking out over the next decade, I see a combination of rising interest rates and slowly shrinking balance sheets eating into growth rates at a time when national governments are facing rising costs from aging populations.

It's hard to see that as a recipe for a secular bull market. Rather, it seems to describe the combination of low returns and high volatility that Pimco's Bill Gross has called the "new normal" and that I've called the paranormal market. I think there are strategies for wringing a profit out of a market like this, and I've described some of them in a series of posts on the paranormal market. You can begin that series with this post at Links in that post will take you to earlier parts in the series.

What I don't think will work for investors in this period are strategies that are built on a hope that we'll be going back to the great secular bull market of 1982 to 2000 anytime soon.

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Jim Jubak's column has run on MSN Money since 1997. He is the author of the book "The Jubak Picks," based on his market-beating Jubak's Picks portfolio; the writer of the Jubak's Picks blog; and the senior markets editor at Get a free 60-day trial subscription to JAM, his premium investment letter, by using this code: MSN60 when you register at the Jubak Asset Management website.

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