Equity markets have made a significant recovery from their lows of four weeks ago. They seem determined to take the combination of visibility of the peak of virus infections and the economic stimulus packages as their signal for a new bull phase. We are concerned that the degree of economic damage is yet unquantified and profits uncertainty remains huge.
In financial markets, we often focus on certain numbers, such as GDP, interest rates, leading indicators, and so on. In doing so, we often forget that the real economy is actually a collection of people and their business activities. The measurements matter, of course, but what drives them arises from the real world.
We have for many years recognised that the era of globalisation is over and the world is becoming more local and regional. The trade dispute between the US and China is one of many pieces of evidence to support the thesis that “globalism”, in all its forms, is a spent force.
It’s become an obsession in financial markets to talk about yield curve inversions and the predictive power of forecasting future recessions. However, with the bond market as distorted as it is by ultra-low interest rates and quantitative easing, perhaps the yield curve no longer gives helpful signals.
We see risk in three key measurables: volatility, correlation and liquidity. Liquidity is often ignored, as it’s harder to measure, but it can often prove the most important risk.
A way of considering the financial system in the post-quantitative easing (QE) era has been to understand that everything has become increasingly dependent on confidence in central bankers.
So long as markets believed debt levels no longer mattered, and countries could grow their outstanding debt without consequence, the show could be kept on the road.
Many years ago, we described quantitative easing as battlefield medicine, quite necessary at the time, but with a real danger of addiction if not exited early. Ten years after its introduction, attempts to exit QE are proving more problematic for the US than policymakers may have expected.
For many years, financial markets have had a very benign backdrop. The era of quantitative easing put a floor under bond markets, forward guidance provided certainty over future US interest rates, and we had a relatively predictable political order.
These factors, combined with a growing economy and ultra-cheap money, may have given rise to a huge degree of complacency in financial markets, or irrational exuberance as it was once termed.
In all big stories, the reality is often more nuanced than headlines suggest and the growth versus value debate is no different. It’s true that growth stocks have recently outperformed by a considerable degree and this had led to a degree of comparison with the tech bubble in the late nineties, as relative performance has reached these heights. Back then, the reason for growth’s outperformance was a high level of speculation in a narrow area, which had little or no earnings.
The global economy is transitioning from a long period of falling inflation and interest rates to one of gradually rising inflation and interest rates. While we don’t think we’ll see this shift occurring rapidly, we do think the disinflationary forces of the past few decades are now fading or even reversing.