Who Let the Bears Out?

New skyscrapers tend to correlate with market peaks. Construction of the Empire State and Chrysler buildings marked a top in equities back in the 1920s, just as the completion of the World Trade Center pegged the top in the 1970s, as behavioral economist Peter Atwater recently pointed out to me. So will the current proliferation of luxury skyscrapers correspond to the end of a multiyear bull market in the U.S.? Quite possibly, yes. In the short run, that could complicate the lives of average investors, but at root it really shows how scrambled the world of international finance has become.

Savvy investors everywhere have been chattering for some time about the arrival of a new bear market. Recently, those worries have reached a fever pitch. It’s not the nosebleed buildings that have them spooked but the machinations of the world’s central bankers. Since the financial crisis of 2008, the trillions of dollars they’ve poured into markets in an attempt to buoy the global economy have basically dictated the direction of stocks–up.

No single actor has done more to bolster markets than the U.S.’s Federal Reserve bank. But in October, the Fed ended its $4.5 trillion bond-buying program, and a strengthening U.S. economy means it is mulling an interest-rate hike, probably by September. Higher rates will mean lower stock prices. In Europe, where the European Central Bank just began a similar bond-buying program, the opposite is true: stocks are going up.

What’s amazing is that the real economy in the U.S. is getting stronger (recent payroll numbers were the best since 2006), even as the European economy is plunging into another episode of the telenovela that is its debt crisis. It’s a bizarro world that makes sense only if you try to understand how central banks work. Central bankers pump money into the market when they perceive their home economies as being weak. They pull back when they sense a sustainable recovery is in hand. The end result is a complete divergence between the real economy and the markets.

This problem has been brewing for decades, as loose monetary policy has become the fallback position for governments that don’t want to do the hard work of training a 21st century workforce, paying for new infrastructure or coming up with smarter, less consumption-based means of growth.

Certainly this was the case post-2008, and the results have been mixed. Many will rightly argue that quantitative easing in the U.S. helped the rich more than the poor, since they hold the majority of stocks. But particularly in the early days, it also greased the wheels of a weak recovery that has benefited everyone, even if unequally. It certainly kept unemployment lower than it would have otherwise been. In lieu of more political action to address the root causes of slower growth, central bankers felt they had no choice but to keep the money spigots on. Fed Chair Janet Yellen, a Keynesian, told me as much when she took up her position last year.

For politicians, it’s always easier to let the central bankers of the world keep the sugar high of easy money going rather than tell this or that vested interest group that things are going to be tough for a while. But what happens when the sugar is metabolized? A market correction, no doubt. The only question is how long and how deep.

The ramifications aren’t likely to be pretty. The Bank for International Settlements, a bank for central banks, based in Switzerland, has warned that the coming Fed pullback in the U.S. could have “significant” consequences. “The disconnect today between the markets and the real economy has never been bigger,” explains Mohamed El-Erian, chief economic adviser at Allianz and chairman of President Obama’s Global Development Council, who is working on a book about how central bankers have distorted the market in pursuit of better economic outcomes. “It scares me to think what happens if we reach the end of this policy road and the economic results are disappointing,” he adds. That leaves average consumers with few good options aside from buying and holding an index fund.

Already we’re seeing more market volatility this year than we saw all of last year, as investors begin to jitter. The U.S. markets may not be the prettiest house on the ugly block that is the global economy anymore. Now that European markets have been sprinkled with central-bank fairy dust, look for money to rush there, despite slower real economic growth. Investors aren’t outright panicking–yet. From the world’s penthouses, it can be hard to see what’s happening on the ground.