Crashing markets don’t herald a descent into global recession
So the FTSE 100 has joined a wide range of global equity indices now in a bear market. Having peaked in excess of 7,100 in April 2015, the rout in commodities has dragged the index of the UK’s 100 leading shares steadily down over the last nine months. To date there have been three notable episodes of acute stress.
First, in August, the unexpected devaluation of the Chinese yuan spooked investors. While the absence of forward guidance from the People’s Bank of China continues to spread concern, the shock factor of altering the dollar peg has since faded.
Then, in December, the traditional “Santa Rally” in equities was put on ice ahead of the first increase in US interest rates in almost 10 years. Stabilisation followed, however, as Fed chair Janet Yellen guided markets to expect very gradual increases in US rates.
Now investors are rightly asking questions about the basis for the current bout of market jitters. Is this the advent of a global recession made in China, leading to a wave of sovereign defaults and capital flight from emerging markets? Or worse still a deflationary supercycle, as countries jostle to debase their currencies and launch waves of protectionist industrial policy?
These questions have been further fuelled by a stellar line-up of grim reapers, ranging from the permabears at Societe Generale to RBS, Mark Carney, George Osborne, and most recently the International Monetary Fund. Each has warned of the risks facing the global economy in 2016. To cap it all, there are also gloomy voices echoing in the valleys of the Swiss Alps this week.
But the paradox for investors and for economists is that growth in the global economy is not stalling – it is, in fact, slowly accelerating, at least according to the IMF. The Fund’s latest estimate of 3.4 per cent GDP growth in 2016 comes despite an ageing population, the ongoing headwind of elevated household indebtedness, public sector deleveraging, and the flux produced by the recent rapid declines in input costs. All the same, it is growth that is 0.3 per cent higher than the 3.1 per cent achieved in 2015.
Amid the doom and gloom in the global economy are bright spots, and quite a few of them. These include households that have seen cuts in their energy bills, falling debt servicing costs, and stronger labour markets. Though yesterday was a day of huge market volatility, it was also a microcosm of these positive trends in the UK. We saw E.On cut gas prices by 5.1 per cent and UK employment hit a new record high, beating records going back to 1971. Real wage growth of 2 per cent, while not spectacular, has the pleasant upside of enabling the Monetary Policy Committee to continue delivering super-accommodative monetary policy.
With these conflicting signals in play, how are market participants to interpret the longer-term impact? One must start with the diagnosis. For me, we are looking at the next stage of the commodity bust that now sits third in the ranking of sector routs – after the dot-com bust and the financial crisis. Vast parts of the globe, from the Urals to the Fjords, from the Amazon to the Arabian Peninsula, are dealing with commodity-related revenues that are falling short of expectations. Many of the governments in these regions are having to dispose of assets, including global equities, that were accrued during the good times. This selling pressure is now weighing on equity markets as 2016 budgets struggle to adjust to the reality of sub-$30 oil.
Asset sales by sovereign wealth funds – the top 10 sovereign wealth funds have assets under management equivalent to 8 per cent of all global equities – are difficult to verify as much of their market activity is opaque. But redemptions on this scale are rarely achieved amid calm market conditions and the scale of current selling pressure suggests the activity is widespread. Against this backdrop, investors have every right to take a cautious approach – but are the macroeconomic fundamentals proportionate to a 10 per cent fall in global equities since the start of 2016? For me they are not. I believe this to be a technical reassessment of valuations that have doubled since their 2009 lows, coupled with a rational liquidation of assets by some of the market’s largest players.
“Be greedy when others are fearful” is Warren Buffett’s sage advice at times of market turbulence. That remains as relevant this morning as at any point since the financial crisis.