Stock Bubble Driven by Central Banks to Burst in 2014, Analyst Warns

As Federal Reserve officials pursue the most aggressive monetary policy stimulus campaign in their institution’s history, they are mindful of the unintended consequences their actions can have on financial markets.

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But as it now stands, most remain confident that huge injections of money into the economy haven’t created any bubbles big enough to threaten the overall course of the recovery. That has allowed them to press forward with their aggressive agenda of bond buying, which is aimed at pushing up asset prices in a bid to boost growth and lower unemployment.

Against that confidence, an equities strategist is warning of a major bubble in global stock prices. In a research note, Nomura Securities strategist Bob Janjuah is warning that over the final three quarters of next year and into 2015, there “could be a 25% to 50% sell off in global stock markets.”

Mr. Janjuah, who is co-head of macro strategy research at Nomura, sees a lot to worry about, and he sees central banks, including the Fed, at the center of the factors that eventually will bring woe to stocks.

“The major themes are unchanged–anaemic global growth/mediocre fundamentals, what I consider to be extraordinarily and dangerously loose monetary policy settings, very poor global demographics, excessive debt, an enormous misallocation of capital driven by the state sponsored mispricing of money/capital, and excessive financial market/asset price speculation at the expense of any benefit to the real economy,” the analyst says.

Mr. Janjuah says markets are now priced entirely for good news, leaving them vulnerable to adverse developments. But the main driver of the coming bursting of the stock market bubble, as the Nomura analyst sees it, is a much delayed rebalancing of the global economy as central banks pull back from all of their aggressive stimulus activities.

“The next five years has to be about a rebalancing towards the ‘real economy’ and the bottom 90%, at the expense of the top 10%,” Mr. Janjuah writes. “This shift in policy emphasis will not be a happy time for financial markets and speculators while the transition happens,” he says.

Fed officials don’t offer predictions of future equity price movements. But they do believe that rising asset prices boost the so-called wealth effect. As consumers feel richer, they feel emboldened to spend more, which lifts the broader economy. To that end, they have been pursuing very aggressive bond-buying policies while offering guidance on short-term rates that suggest monetary policy will be very easy for years to come.

Over the course of this year, speculation about the Fed easing back on its bond buying generated considerable market volatility. Some officials welcomed this because they said it helped correct market complacency about future Fed policy while flushing out some pockets of excess in some corners of the bond market. But Fed officials also came to lament the move as they saw higher borrowing costs creating fresh headwinds for an economy that wasn’t growing fast enough to begin with.

In an interview Monday, Federal Reserve Bank of St. Louis President James Bullard said when it comes to market levels, “I think we are at a good place right now.” He put himself in the camp of those who see some value in the rise in bond yields, saying the levels seen at the start of the year were so low that they were a bit worrisome.

That said, the veteran central banker said the bubble issue remains challenging for Fed officials. “I don’t think we’ve come up with a really great answer” when it comes to dealing with markets that have gone out of line with fundamentals, Mr. Bullard said.