Where’s 2018 heading? Michael Wilson takes the elephant in the room for a random walk, taking good care not to step on the cracks
So what are we to make of 2018, then? We’re pretty much a quarter of the way through it now but, to answer the question, it rather depends on who you ask.
It’s the looming trade apocalypse that will put an end to a ten year bull run in equities, say some alarmists. It’s the inflationary jolt that spells the end of the low bank rate era, say others – an event which threatens to pitch the entire over-leveraged world into a wave of credit defaults. It’s the tipping point for fixed interest, which is about to suffer the twin humiliations of rising inflation and a fatally undermined high yield corporate sector. And blah blah blah.
Honestly, it must be true, that’s what it says in the financial press, dammit. Warren Buffett says he’s running out of ideas because he can’t find any value anywhere. Neil Woodford, who has his back foot neatly wedged in the exit door at the moment, is sounding more like Private Frazer from Dad’s Army every week. (“We’re doomed, Captain Mainwaring, doomed.”) And those cyclically adjusted valuations on the S&P 500 are still running at twice their historical averages. The Wall of Worry is there all right, and we’re halfway up it, and the first one to back down loses his performance bonus.
Inconveniently, though, this just happens to be the healthiest spell of growth that the world has seen in maybe thirty years. The International Monetary Fund says that global output rose by 3.7% in 2017, and its projections for both this year and next year have just been upgraded to 3.9% – with 6.5% growth expected for developing Asia.
Worldwide commodity markets are stable, and the worldwide cyclical upswing is set to continue. And with vast amounts of investor cash waiting on the sidelines, it’s a little hard to take some of this doomy talk seriously. Either the right people are reading the wrong reports, or the reports themselves are skewed by their short-term perspective. So which is it to be?
Synthesis, dear boy, synthesis
Well, I’m not sure that I know. But I’ll tell you this much. The 36 years since I joined the Financial Times haven’t been completely wasted. Along the wibbly-wobbly way since before Big Bang, it has been my privilege to collect an entire scrapbook of truisms, and all they really need is for somebody to put them together and give them a bit of a spin, and then the world’s worries will be sorted. No, don’t thank me. But a Nobel economics nomination would be nice.
Let’s start with the value of experience. As everyone knows, those who don’t learn from the mistakes of the past are doomed to repeat them. Except, of course, for those generals who are still trying to fight the battles of the last war, and the economists who correctly predicted 30 of the last 17 recessions, and everyone who thought that the new paradigm was a real thing.
Or shall we look at the market’s behaviour? As Ben Graham told us, Mr Market is illogical and it’s pointless to look for clues from the fundamentals – instead, he said, you just have to take the opportunities when they present themselves. (That may have been why Mr Graham got wiped out in 1929, of course, but hey, everyone makes mistakes.) Always bearing mind, of course, that Keynes told us that the markets can remain illogical for longer than I can remain insolent. At least, I think that’s what he said?
Not to mention all the black swans, blindfolded chimpanzees and random-walking elephants in the room who have been setting fire to our fevered imaginations over the last thirty years or so. If this is what a trampling herd looks like, I’m going to pack my tranquilliser darts.
The sharp-eyed among you will have spotted an interloper among that list of nonsenses that I’ve just reeled off. So help yourself to my last Rolo if you saw that the new paradigm of the late nineties wasn’t a nonsense at all.
Why not? Because it referred to a real change that was really happening, that’s why. The arrival of computer algorithms and integrated accounts and real-time stock and futures trading wasn’t just a flash in the pan, however glitzy it might have seemed.
And nor were the online haulage databases that allowed a trucker from Poland to deliver to Somerset and then nip over to Plymouth to pick up a load that could be exchanged in London for something that needed to go to Berlin. Instead of returning with an empty lorry. It was proper progress. And the only mistake the markets made at the time was to think that the productivity increase from technology could be extended year by year, whereas it was a one-off step change.
A checklist for Mr Trump
And my point is?
Simply this. That before we try to extrapolate from the past into the future, we ought to stop and think about whether our assumptions still hold. Are we trying to fight the last war’s battles?
I don’t know. But, until we’ve taken stock of the following questions, we can’t honestly look ourselves in the mirror and say that we’ve got a firm grip on the realities of 2018.
So, without further ado, here’s my checklist. I’m going to take 1987 as my baseline, because it was the last time we had a proper stock market rout. But if you’d rather reset the odometer to 2008, be my guest.
- The World Has Changed its Shape
Back in the good old 1980s, before Deng XiaoPing declared that to get rich was glorious, China was just about the last place you’d go to get a computer built, or a car, or even a decent pair of jeans. With a chaotic manufacturing structure, starving peasants moving off the land, and three-storey cities with bad roads and no airports, it was at best a niche player.
Now it’s the world’s biggest steel producer, it owns Volvo and half the mining capacity in Africa and South America (and a few American steel mills!), and its economy has trebled since 2007. China is set to overtake the United States by 2025. Oh, and did we mention that it also bankrolls America’s booming federal debt?
That’s not all good news, of course. China’s own debt ratio has also trebled since 2007, its air is foul and its banks are loaded with bad debts which are being kept well hidden. But you get my point
2. Those Pesky Europeans Are Everywhere
No need to labour this point, is there? The twelve European Community nations of 1987 are now 28, of which one might be about to leave, and the group’s collective GDP is neck-and-neck with America’s. Now and then, the EU’s trade relationship with its eastern neighbour Russia puts it at odds with Washington. Just saying.
- Currencies: We Now Have a Choice
It’s a hard reality for President Trump to swallow, but the euro (which didn’t exist until 1999) is now at least as important as the dollar when it comes to international bond issuance. That’s important because it means America can no longer claim to be the world’s only viable refuge currency, or the only solid basis for a bond issue. That fact affects government borrowing and investment decisions around the world, and many are opting to float bonds in their own small currencies as the dollar becomes semi-detached.
And we haven’t even mentioned cryptocurrencies. Luckily, there isn’t enough space here, or we’d be arguing till next month…
4. The Quantitative Easing Detox is Starting
The world is currently “detoxing” after ten years of QE, mainly in the UK, the US, the EU and Japan – and nobody has the slightest idea how it will impact on debt markets. Was it “free money” with no consequences, as some claimed at the time? Or will it have to be repaid by our grandchildren? Nobody really knows. That’s a factor we shouldn’t ignore.
- Rising Bank Rates, Weak Dollar
This is a bit of an oddity, historically. In the past, a much stronger level of US government borrowing has generally fed straight through to a stronger dollar, which has generally increased America’s influence on the global markets. And this year it isn’t working that way. Why is that?
Could it be that the expected surge in bond issuance hasn’t attracted investors from abroad? Or is it that everybody knows that China will buy a large chunk of it, so as to stabilise its own currency? Wiser heads than mine are puzzled. Whatever can it mean?
6. Super-Low Interest and Inflation Rates Distorting the Market
The last decade has seen a surge of investor interest in bonds that might once have been labelled sub-investment grade, and yields have tightened. Why are investors seeking out higher risks in search of returns, and how will it unwind if the business world stumbles?
- Clever New Technologies
Clever new technologies were, of course, blamed for the 1987 stock market panic, but they’ve come a long way since then. On the one hand, high speed algorithm trading forces efficiencies on the market – but only (pace, MiFID II) if the transactions are openly declared. And the easy availability of derivatives puts another safety net under portfolios.
And to think, we haven’t even mentioned exchange traded funds yet.
8. Cash on the Sidelines
Nobody knows how much investor cash is sitting on the global sidelines at the moment, waiting for a suitable investment opportunity – Blackrock was being quoted in late 2016 as guessing $50 trillion, which if true would equate to about half the value of the world’s official stock markets.
What we do know is that there’s a lot of it. And that it ought to provide a safety net in the event of any major market crisis.
- Any More Issues?
Dozens of them. Spend a few moments compiling your own list of things that have changed in ways that will make the lessons of the past seem – if not irrelevant – at least subject to qualification. It’s only by getting back to grips with these past issues that we can hope to see through the deceptions, and the self-deceptions, of the present.
Should we be worried? Well, the best way not to be worried is to be aware. We can all do something about that.
The demographic imperative
One factor that really can’t be dismissed quite so lightly is the very reliable prediction that people are getting older. Yes, you read it here first.
Every ten years, the UK population’s expected lifespan at 65 increases by two and a half years (for both sexes) – with men currently expected to average 84 years and women 86 years. That would be significant even if the statistical balance between working-age and over-65 age groups were stationary, but it isn’t, of course, because the boomer generation is forcing its unstoppable way through the labour statistics. And the murmurs are growing about how (and even whether) a stagnant working age population is going to pay for it all?
The implication, inevitably, is that everyone is going to need to make better provision for old age, and that portfolios will need to adapt as a result. Younger workers with long time horizons don’t find it easy to invest, but at least they can embrace risk more confidently than their elders. The over-50s, on the other hand, face a growing need to adapt their investments toward greater security – which, for most, means income investing of one sort or another, or in some countries, cash deposits.
In short, it’s arguable that the wrinklies and the middle-aged are keeping the global fixed interest scene in liquidity during a time when yields have become painfully strained. And that their increased need for balance and security is not going to disappear in a hurry. The challenge for advisers and investment managers, then, is to judge their sector allocations correctly. And for investment groups to generate products that will cater specifically for risk-averse investors. The impact of pension freedoms is significant as it places responsibility for key decisions on individuals who may or may not be sufficiently well-informed to consider all the factors involved – especially the risks. The need for sound professional advice has never been more important.
The Pensions Policy Institute forecast in 2015 that – even allowing for the increase in the State Pension age, especially for women – the numbers of women reaching SPA by 2040 would grow from 6.51 million in 2020 to 8.92 million. While males of State Pension age would swell from 5.48 million to 7.73 million. That would leave the SPA group equating to 37% of the working age population, up from 28% in 2020.
Let’s also remember that Britain or (especially) the United States, with large migrant working-age populations, have relatively young workforces compared with Germany or Japan or China, where the problem of working-age balance is far more severe than it is over here.
We could try to insist that those countries’ issues don’t really need to impact a UK investor’s retirement portfolio, but that would be to ignore the fact that the UK accounts for only 6% of the world’s financial markets, and that the kinds of income producers we buy in London may be buoyed up by the demand from retirees in other parts of the globe as well. The big picture is getting bigger all the time. And that’s another thing that isn’t going to change any time soon.