Why I’m not worried about this market plunge

Are we looking at another 2008?

Another painful day for markets yesterday.

All the major markets saw significant falls. A few hundred points here, a few hundred there, and pretty soon you have yourself a proper correction.

Before Christmas, everyone was talking about melt-ups and how there were no clouds on the horizon. Barely a month later and there’s an emerging markets crisis and investors don’t know where to turn.

So what’s gone wrong?

What’s changed?

2014 has been miserable for most stock market investors so far.

Two main reasons are being thrown up: China is slowing down, and the Fed has stopped printing money. But these aren’t terribly satisfying explanations on their own. China has been slowing down for at least 18 months now, if not more, and the Fed has been threatening to ‘taper’ since last May.

What was the tipping point? What’s got the market so rattled now?

Well, no one rings a bell at the top or the bottom of the market. But if you look at what’s been going up and what’s been going down, I think there’s a pretty clear explanation for why everyone’s suddenly nervous again.

People were clearly too bullish before Christmas, so they had all their bets placed on one outcome – a smooth reflation, driven by the geniuses who run the world’s central banks.

Then, post-Christmas, we ran into some weak economic data that contradicted that happy story. It’s not about China’s weak data; China is a wildcard – its entire financial system could implode. But you could have said that in just about any year in the past five, at least.


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The real problem is the US. The jobless data was awful in January, and manufacturing data yesterday was atrocious. And yet the Fed continued to ‘taper’ cheerfully, without even mentioning a hint of doubt about the process.

Now, a lot of this bad data could be down to the disruptive winter they’ve had in America, so it may not represent anything significant.

But the story investors have been telling themselves is this: it doesn’t matter that the Fed is tightening monetary policy, because the US economy is getting better. Up until now, investors have been betting that the real risk is that the Fed is ‘behind the curve’ – that the recovery will pick up, inflation will leap, and there will be a ‘sweet spot’ where everything jumps in price before the Fed has to take drastic action.

So buy equities, sell bonds, and sell gold (because things are looking up for the financial system). Ditch your ‘safe havens’ and start piling into ‘risk’.

That trade has now reversed. Equities are bombing, while bonds – last year’s big casualty – are rising. Even gold has rallied, along with the gold miners.

You see, if the Fed is tightening monetary policy, but the US isn’t actually in the throes of a spectacular recovery, then that could leave monetary policy too tight.

Now, the idea of the Fed running ‘tight’ monetary policy may make you chuckle cynically – I’m practically giggling at the notion even as I write these words – but you have to remember that investors have grown used to the Fed stepping in the minute there’s a hint of a correction.

With quantitative easing (QE) dropping off, and economic data disappointing, what will prop up equity prices?

In short, this is a market that is worried about deflation. When you’re worrying about deflation, you buy bonds – they pay a fixed income, which will only rise in value in deflation. You buy gold – deflation is very disruptive to a debt-based financial system, and the ‘opportunity cost’ of holding gold during deflation is minimal.

The next crisis is not about deflation

So how long will this last? Is this ‘the big one’? Another 2008?

I have to say, I don’t think so. I can understand why investors are worried about deflation. But I don’t see this being allowed to carry on.

One of two things will stop this rout, I suspect. We could get a run of better data out of the US, which will bolster confidence once again. That may or may not happen – the next big release is on Friday, with the latest US jobless data. That could easily be affected by wintry weather, leaving the markets panicky again.

So the dud data may continue. But if that happens, either the Fed will pause the taper, or the Bank of Japan will decide that it can’t allow the yen to strengthen any further, and so it’ll print more money.

At that point, everything will rally hard, and it’ll be fun and games again.

I might be wrong. But generals are always guilty of fighting the last battle. The deflationary crisis of 2008 was the last battle. I believe that the next crisis will be an inflationary one – and that central banks will do everything in their power to make sure that this is the case.

So I’d stick to drip-feeding your money into your chosen markets, and just enjoy the current opportunity to buy more stocks for your cash.

(If you’re new to building a portfolio, I’d suggest you take a look at my colleague Phil Oakley’s Lifetime Wealth letter. Phil shows you how to build a complete portfolio, designed to withstand most economic conditions, and talks you through key concepts such as rebalancing, keeping costs down, and looking at your savings goals. You can find out more about it here.)

And if there’s an emerging market you’ve had your eye on, then now could be a good opportunity to start putting some of your money to work. I wrote about some of our favourites recently – if you’re not already a subscriber, you can get access to the piece and get your first three issues free here.

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  • Highgate

    Is deflation such an awful problem? After decades of deliberate corrosion of savings in favour of profligate government borrowings it is time for some balance tobe restored.

  • mikeT

    Why the correction? With central bank manipulation tapering, investors looked at real value and concluded that the p/e ratios, especially in the US but also in the UK, are too high – historically (I read), but also fundamentally because consumer spending is patchy and will remain so until there is a sign of wages rising. The unemployment numbers suggest this will happen eventually but even these are treated sceptically because the improvement appears based on people dropping out of the market or taking up poorly paid (part-time) jobs (and they certainly will not be part of a consumer boom).

  • Chester

    Fascinating how up to a few months ago, mainstream media could not even recognise “deflation”. But reality is slowly hitting home, as will the realisation that central bankers are ineffective meddlers behind the curve. They do not create trends, they react to them, with daft measures that usually create unintended consequences

    Price action resulting from changes in social mood drives markets. The reflation in asset prices from 2008 was inevitable – history shows it happens after every major price correction. The unknown variables were extent and duration, which central banks successfully exaggerated

    What we are probably seeing now in the inevitable turn in a market top, which will drive prices well below the 2008 bottom in the next wave down. Again, inevitable if history is any guide. Leverage and negative social mood will drive it, with central bankers powerless to stop the eventual outcome

    Time to be very worried indeed, if you are invested in anything other than short funds and cash whilst this plays out

  • Man Friday

    John, an interesting article but in stark contrast with the regular doom and gloom epistle from weekly Tim Price and the FSL emails. Could we possibly have a more consistent view on behalf of the Money Week team? Failing that, why not publish a face to face debate between the several conflicting parties and arguments at MW and it’s related newsletters? This should, as far as possible, be evidence based with any vested interests declared at the outset. Hopefully this would help us all to rationalise future investment decisions. Whilst recognising this is far from being a perfect science with many known and unknown variables, (or we would all be millionaires) you should be able to rank the likely scenarios by probability scores and risk.

    It would be helpful to have some recognition of the differences of opinion and also the agreed positions across the team at Money Week publications.
    Man Friday

  • canuk

    The increased frequency of these corrections along with increased costs of sustaining a public safety net is contributing to wage stagnation. This can only get worst without a control mechanism. Nothing new really. Flat incomes have been with us for at least 30 years but the promise of cheaper goods through technology has now if you’ll pardon the pun materialized. To much speculation has created volatility that is not a problem in the developed nations yet but soon to be a reality globally if controls present in the past are not re-instated. Short term pain for long term gain. As for the debt that I am afraid is a right off. No longer an issue.

  • mikeT

    Wholeheartedly support Man Friday’s request for a reasoned debate between the MW opposites! In the meantime, does anyone have good info on index p/es?

  • Ellen12

    @ Chester. I think we are looking at whether people are expecting deflation or hyper inflation. The whole QE party is has been a massive re distribution of wealth upwards. I can’t see it ending unless central banks and governments are forced to do so. Thats where the deflationists are. But they have performed every conceivable manipulation right in front of us and we just let them do it. We are all zombies now and why would they stop now? The emerging markets are the high risk, high return area and the recent sell off probably just demonstrates some risk aversion. But everyone is after income and expect the fed to protect them from losses so I expect them to go piling back in there at the first opportunity. I expect a three bedroom semi in London to be worth a million before long. This will go on and on until central banks wake up and raise interest rates. Then houses can go back to being homes, companies can focus on their core business model and they can reserve the seats in the casino for gamblers instead of income seekers.

  • Charles Stemp

    Umm, so why didn’t John give us all those details the day before the plunge?

  • Anonymous

    @Ellen12 Depressingly, I agree with you; houses are the majority’s most visible asset so the Gov will keep on stoking the market, and consumer confidence, until the election. The BoE might posture and fiddle with the price threshold but so what? And as housing gains are largely unrealised, the emboldened consumer will simply borrow more….And so it goes.
    More about central bank manipulation. In answer to the earlier (QE) “$5 trillion gamble”, @Tott777 pointed out that the Fed currently encourages banks to lend the wall of new money back to itself by paying 0,25%. If it stops paying interest, this money will likely flood/inflate the real economy UNLESS the Fed “manages” the process by selectively selling the bonds it has acquired (or, I guess, increasing the taper?). That, however, will push up mortgage rates and unsettle the housing market. So….a rather delicate balancing act without finely-tuned instruments. My bet is that the CBs will prefer somewhat uncontained inflation to weak growth.

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