Westpac: Central Bank Liquidity Injections Won't Work Forever

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The Bank of Japan and Europe’s ECB have stepped into the breach to fill the liquidity vacuum in markets that could have resulted as the Fed ended it’s QE program last month.

These actions have helped propel global stock markets higher as investors bet that the free money must flow into stocks and drive prices even higher.

But Westpac’s New York based strategist Richard Franulovich has warned that, “longer term trends in risk appetite will be shaped by more than just liquidity conditions.”

Franulovich says that he has identified “useful long term leading indicators warn that we may be at the multi-year low point for volatility with 2015 and beyond likely to be a much more rockier environment.”

Franulovich has identified US bank lending standards, corporate profits and M1 money supply which he has dubbed his “four-star generals…so named for accurately flagging the four major turning points in equities over the last 15 years.”

While he says the lead provided by these three indicators is “long and variable” after “an exhaustive study of many data points we found that just three indicators, money supply, lending standards and profits consistently turned ahead of the last four major turning points in equity values”.

With US money supply growth slowing as the Fed has exited QE, corporate profits of 10.5% of GDP at 60 year highs and the improvement in lending standards slowing the outlook becomes more clouded in the year ahead as the “constructive momentum” of these indicators flattens out.

If October is a window into the future then the implications of this increase in volatility are likely to be lower global stock prices, a lower Aussie dollar, a stronger US dollar against everything but the Yen and pressure on commodity prices.

We’ve all been warned.

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