Despite the tendency to think that we live in uniquely bizarre times, markets always follow the same cycles. Investors just need to keep calm heads, says Merryn Somerset Webb.
There's not need to panic the market is following the same old cycle
My favourite article from the last week was something I read on ChinaDaily.com.cn. It reported that several local officials in the north-east of the country, in their attempts to explain the dramatic falls in economic growth in their areas, had admitted to faking the data.
As one carefully put it to a reporter: "If the past data had not been inflated, the current growth figures would not show such a precipitous fall". So growth in Liaoning province would not, for example, have fallen from 9.5% three years ago to a miserable 2.7% now.
The truth would have perhaps have shown a steadier 3%-4% growth over the period. Maybe less. That wouldn't have given any particular euphoria, but it wouldn't have set up so much scope for disappointment either.
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There are a good few lessons for us all to pull from this little story. The first is the most obvious: learning from history is rare. Remember that, under Mao, China's Great Famine was caused in part by lying about agricultural production to meet targets.
The second lesson is equally obvious: give someone a target and tell them it matters that they meet it (be that for reasons of national pride or a life-changing commission-linked bonus), and they will.
And the third is obvious to most, but still a mystery to others: when it comes to economics, reality always trumps fantasy in the end.
And so we come to the carnage in the markets over the past few weeks. Last week the S&P 500 fell 2.2%, and the FTSE 100 fell 1.8%. They were trumped by China (it can do everything bigger and better): the Shanghai Composite index dropped another 9%.
Why? It is all about those collapsing Chinese numbers, worries that a weak China will properly devalue its currency (to boost exports), and concern that devaluation along with the collapse in commodity prices will unleash a new wave of deflation around the world, one that the central banks haven't a hope of being able to contain. After all, how can rates go any lower than they already are? We are at the limits of what monetary policy can do. The central bankers, as the analysts like to say, are "out of ammo". That, in turn, means that all the asset classes that have been bumped up by the previous rounds of QE and low rates will spend 2016 falling. And falling fast.
Economist Albert Edwards took to the stage this week at the Socit Gnrale conference to push this theme (as he does every year). The coming storm says it all about the "failure of the Fed's QE". This hasn't done much for US growth any more than our QE did much for UK growth (per capita GDP is still only a few percentage points higher than it was in 2007). What it has done is inflated global asset prices and commodity prices in particular "into the stratosphere".
Edwards says the US market is now so overvalued on the only two valuation methods that matter for the long term (Shiller's Cape and Tobin's Q, for those who are interested) that a 75% fall wouldn't come as a surprise to him.
He isn't alone in that kind of bearishness. Last week, Twitter lit up with quotes from a report out from Royal Bank of Scotland in which analyst Andrew Roberts suggested that the correct way to deal with the fallout from our 2008 crisis is with total and immediate hysteria. This year, he said in an echo of Mr Edwards, will be characterised by a rush to exit from the asset classes that benefited from QE. But "in a crowded hall, exit doors are small". Given the risks, it makes sense to "sell (mostly) everything".
I have sympathy with a lot of all this. China is slowing. China is devaluing. Mercantilism is rife (everyone wants a weak currency to help them boost their exports). Many markets are far too expensive. And the world is clearly carrying far too much debt to allow for good GDP growth.
Our failure to take serious economic pain after the crisis has meant dragging that pain out into years of trying stagnation and a probable round of deflation regardless. But here's the thing: we are nowhere near the limits of what monetary policy can do.
This week I chaired a conversation with Adair Turner, former chairman of the UK's Financial Services Authority. His solution to the problem is to monetise the debt; make it go away by printing the money to pay it off. Job done. Lord Turner isn't considered to be a crank.
Then there are negative interest rates Mr Edwards reckons the next US recession (which may well be just around the corner) will see the Fed funds rates go to minus 5% last year's US rate rise might not be with us for long. Sounds nuts doesn't it? So did quantitative easing when it was first mentioned eight years ago.
Finally, there are endless other possibilities knocking around in the grey areas where monetary and fiscal policy meet. Strategist Russell Napier reckons that even if outright monetisation isn't on the cards today, other forms of debt forgiveness are. He expects the US government to attempt to stimulate its economy by cancelling the deadweight of student debt, for example. Shocking as it might be, you'd be silly to think that the governments of the West aren't considering all these options.
They'll all be under discussion around one table or another at Davos. Outright deflation is not a given. More monetary stimulus is. It is also worth remembering that not all markets are expensive and that they are much more driven by liquidity and valuation than by GDP. That makes India, Japan, Europe and China still of interest (particularly given the falls of the past few weeks). I am not much invested in US equities and I don't intend to be. You also want to avoid government bond markets in general (lots of potential downside, not much upside) and to steer well clear of much of the US high-yield bond market (falling oil prices are hitting a lot of the firms active in it expect defaults).
But beyond that a little calm is required. We all have tendencies to think that we live in uniquely bizarre times. And ours has its own particularly nasty nuttiness: extreme monetary policy is a threat to democracy, equality and freedom, for example. Nonetheless, markets and economies always follow the same old cycles. The latter sees booms followed by busts and the former bulls followed by bears.
The only thing that ordinary investors can do to protect themselves from this cycle is to hold markets that look reasonable value, to hold extra cash when markets look expensive and to have some gold. If you are a regular reader of ours you will know this already. If you aren't, all you need to know is what I am now going to call the Liaoning rule: if something goes up a lot for no clear fundamental reason, it will probably come down again. Avoid those things.
This article was first published in the Financial Times
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Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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