Markets are teetering on the edge – what will push them over?

Penny falls machine © Getty Images

What ends a bull market? Everyone has a firm idea of one sort or another on this – some crazy, some seemingly rational: it’s valuations; policy mistakes; the alignment of the stars. It’s interest rates. It’s October. It’s a run of corporate scandals and bankruptcies. It’s inflation reaching 4%. It’s just time.

But to focus on any one thing is, I think, slightly to miss the point. A better way to look at the end of a bull market is to think of it as if it were trapped in an amusement arcade’s penny falls machine – the ones into which you roll a coin to the back of a pile of coins in the hope that it will tip the rest over a ledge and into a collection drawer.  The piles of coins always look about to fall, but they don’t until long after it feels like they should (this drives kids crazy, of course. If you want an afternoon to end in tears, end it on a penny falls). The current market is frustratingly jammed with coins.

Valuations are high across the board, in some cases back to 1929 levels. Stocks are being sold on stories rather than on financial fundamentals – “Look, there’s a car in orbit”! Prices have been rising for much longer than usual: if this bull market makes it to August it will be the longest in history. There is evidence of rising inflation all over the world.

Governments are in agreement with workers (correctly) that wages are too low and must rise. In the UK, pension deficits are a constant drag on capital investment. Dividend cover is too low. Investment trust premiums are too high. Everyone has more or less had it with quantitative easing. Bond yields are rising.

Global politics aren’t helpful. China has pulled back from its strategy of GDP growth at any cost. There is trouble ahead in the EU: the German and the Italian elections should make it clear that populism is still with us.

Possibly most important of all, Jay Powell, the new chair of the US Federal Reserve, appears to be less interested in looking after stockmarkets at the expense of everything else than his predecessors. “We do not manage the stockmarket… I think the general thing is that the stockmarket is not the economy,” he said.

He might prioritise controlling inflation over continuing to pin all hopes on the wealth effect – the idea that if you make people feel rich by shoving up asset prices they will spend and in doing so save the real economy. Any one of these falling coins could by now have ended our long bull market – rising yields in particular are rarely good for investors – but none have. That’s something for which most of us are, of course, heartily grateful. After all, the bit of penny falls analogy that doesn’t work is this: crashing coins make you richer. In most cases, for most people, crashing markets don’t.

This leads us, as so many things do, to Donald Trump. Might his tariffs be the coin that tips the balance? Could be.

Trump’s tariffs may be ridiculous, but everyone can “do stupid”

Trump reckons that the US is global trade’s “big loser” and that slapping 25% tariffs on steel and 10% on aluminium on top of the ones he has already put on solar panels and washing machines will show the rest of the world that he is a big winner.

The problem is that even if we know the high costs of retaliation (the risk of escalating something relatively minor into a trade war) this is no guarantee that other trading blocs with supposedly less volatile leaders will not retaliate. As Jean-Claude Juncker, president of the European Commission, said this week, in the wake of the EU’s discussions about putting punishment tariffs on US agricultural products, steel and Harley-Davidsons, “We can also do stupid.”

This won’t be news to anyone watching the Brexit negotiations – the EU is as open to economic self-harm for short-term political gain as everyone else – but future historians will, I am sure, roll their eyes when they see yet again how fast macho posturing turns into real trouble.

How much trouble remains to be seen. There is no obvious economic justification for the new tariffs and the immediate domestic gains from them in the US will be limited. The US imports very little steel from China (where there is no longer much overcapacity anyway). The US steel industry is doing fine already, with production up 3.4% last year) and in any case the US economy is driven much more by services and technology than heavy industry.

Should aluminium and steel turn out to be more than a one-off whim of Trump’s – and the beginning of a full-on trade war aimed at China – the second-order effects could be nasty. The resignation of Gary Cohn from the White House is worrying, as is Trump’s attack on the World Trade Organisation (mostly a force for good) and the very high risks of retaliation. The global economy shrank by 20% during the trade war of the 1930s. Everyone can do stupid.

All that said, one thing to bear in mind is that anyone who sees any of this as a bolt from the blue has not been concentrating. It has been clear for some time that the economic pendulum has been swinging; that globalisation – something that has been brilliant for many but miserable for others – was likely to go into reverse, at least in part.

You have seen it in the physical walls that have gone up around Europe, and those that are on the way between Mexico and the US; in the backlash against the tax affairs of big corporations; the backlash against the social responsibility of the big tech companies; and of course in the rise in protectionism across the world.

According to a report from law firm Gowling WLG, the world’s largest economies have put in place more than 7,000 protectionist measures since the financial crisis, with the EU and the US being the worst offenders. If markets crash now, steel and aluminium might look like the proximate cause, but the real one will just be the weight of coins.

How to prepare yourself

You should be ready. But how? If you haven’t done so already this might be a good time to make sure you aren’t holding too many of the market’s most expensive shares and one to hold a little more cash than usual.

That done, hang on and try and remember the positives: there are huge productivity gains to come from automation and digitalisation (one new US fund that focuses on this is Arbrook/G10 American Equities Fund). The healthcare and biotech sectors throw up amazing possibilities every day.  And, against a good many odds, global GDP growth is reasonable.

The companies you are invested in, as long as they have a good mixture of organic growth and financial stability – that is, low debt – should weather the next penny falls storm.

• This article was first published in the Financial Times

  • APJ

    Merryn, everyone thinks that if stockmarkets falls the FED, BoE and all the other central banks will just revert to massive QE, and stockmarkets will consequently soar. So in a way, investors are looking for markets to fall so they can get their next fix of rocket fuel to take them to the moon.

  • Bab Boon

    How come no one yet is identifying Donald Trump as ‘Mr Crisis’?

    Whilst you can intermittently see some policy continuity between his avowed ‘when I get elected’ promises and what happens on the ground ……… (Its taken *how* long to get from moving into the Whitehouse to announcing teh protectionism he always half-promised)? ……. There’s a far stronger correlation between the poltical heat being turned on him in the US and his poking some wasp-nest agenda with a hard sharp stick to create an ‘external threat’ and deflect focus from himself.

    It seems no co-incidence that as Korea looks to be coming off the boil China gets more insults hurled at it for no especial reason (in the sense nothing obviously new has surfaced), promptly followed by his cunning wheez to create turmoil within and outwith the USA by starting a trade war.

    All of which I guess is coming a long way around to agreeing with, maybe even extending Merryn’s observation ‘Mr Crisis’ has a propensity to be far from being the steading hand of calm and mature leadership.
    His relationship with Jay Powel is entirely likely to be to ‘wind him up and let him go’ if ever he feels the smokescreen is becoming uncomfortably thin.

    The next Black Swan could well be wearing a ginger toupe.

    • ElRoberto

      He promised a lot that he has gone back on. Does not get much press. Believe it or not, although he promised to end Obamacare he also promised universal coverage potentially single payer, he also promised a lot of left wing social spending elswhere that either he lied about or his financiers have since convinced him to dump.

      Deregulations seem to be his main fulfilled promise.

  • ElRoberto

    The single dumbest idea in the corrupted world of modern political economy is one that Merryn seems to have been hit with. That rising asset prices makes people feel richer, so they spend more. Dumb as Sh*t.

    Those with assets usually feel richer – although with the main asset of housing a rising asset means trading up or helping the kids means you’re really poorer – while those without the asset feel poorer (they need far more debt to get on board or are trapped renting for longer).

    The main drivers of consumer spending are extra income for the middle incomers, the poor, as well as the young. So yes, higher wages is a must. Those who are enriched by rising asset prices are likely to be older and often richer and they tend to spend less of their extra money than others. Those who feel poorer and in need of either saving even more or taking on huge amounts of debt to get on a housing ladder are those who would otherwise have spent their excess cash. It is dumb, dumb, dumb economics. The bailouts and money printing got such loud cheers. Those who cheered were dunces. The backlash is understandable “populist” swings away from a failed centre ground.

    Asset bubbles, unsustainable debt levels plus the end of easy money. Is there really any other reason?

  • Kevin Hoque

    I think when this “everything” bubble bursts, then things are going to get a lot more interesting than 2007-2008. The central banks will be tempted to get back into their money printing ways. This will prop up the markets for a short time, until bond holders realises that yields will be negative in real terms for another decade or more and that governments have no hope of ever repaying their debts in real terms – they can only inflate them away (or default). This will likely result in the crashing of the debt markets and a loss of confidence in indebted economies and their currencies. I expect the precious metals to then skyrocket. But who knows what the future holds….! 🙂

  • AJAX

    Well-written as usual, but not sure about the complacent de rigueur airing of Free Tradism bit, the USA’s 1980’s created “Service Economy” failed in 2008 with the collapse of the banks (we’re just waiting for the Treasuries to blow now, which are being hollowed out in exactly the same way by the Stockmarket), & America is economically dying in consequence, & has been since the 1970’s. Free Tradism pursued dogmatically by 1st World economies is a recipe for their decline ultimately. Trump’s initial tentative foray into Mercantilism might be crude, but he’s on the right track. The 1st World needs to re-shore its manufacturing capacity from Asia to rebuild real wealth in its societies, the debt substitute that’s been pursued since the 1980’s is almost out of road, & the deleveraging of it will be societally traumatic I fear.