Index Jun12.pngThe blog’s Boom/Gloom Index (blue column) reaches its 3rd anniversary this month.

It was introduced to help monitor sentiment in financial markets, on the basis that “many markets are clearly being ruled by sentiment”. It has since done a good job in identifying peaks and troughs:

• Peaks have been focused on periods when central banks have rushed to provide liquidity via quantitative easing and other stimulus programmes
• Thus the Index was strong from June 2009-June 2010, and from September 2010-June 2011
• The main trough has been seen since August 2011. This highlights the key flaw in the central banks’ thinking
• Their Quantitative Easing and bank lending programmes wrongly assume that markets face liquidity problems, rather than solvency risks

The Austerity measure (red line) in the chart highlights this issue. It shows how governments are increasingly being forced to abandon stimulus programmes, due to lack of cash. Investors increasingly worry that countries such as the PIIGS (Portugal, Ireland, Italy, Greece, Spain) will never repay their debts.

Thus June sees a sharp jump in the Austerity reading, back to levels last seen in May/June 2010 when the Eurozone crisis first properly erupted. In turn, this has pushed the Index below its neutral 4.0 reading and back into Gloom territory.

This highlights how the stimulus policies have been able to create short-term economic growth and major asset bubbles (oil/commodities prices, China real estate etc). But they have not created the conditions for sustainable long-term expansion.