There is a growing consensus that 2011 won’t be a bad one for stock markets. Oddly I don’t disagree. I wouldn’t buy emerging markets – they are too expensive. But thanks to the desperate efforts of developed market politicians to reflate their economies, I’m pretty happy to be holding developed market stocks for now.
However, that could change fast. On a cyclically-adjusted PE basis most markets remain overvalued. That means that they will at some point revert to their means. They always do. So what might be the nasty shock that makes that happen? In the end it will probably be something none of us have thought of, but here are the most obvious possibilities. Note that, for the moment at least, number eight bothers me most.
1. Slowdown in China. Inflation in China is 5%. Monthly numbers are high. It isn’t far to double digits. Targeted inflation is 3%. The authorities have to do something about this. And when authorities take action they very often take the wrong one. Add in too much debt, much of it hidden, and the consequences of the long-term misallocation of capital, and there is every reason to think something might go wrong.
2. Greece leaves the euro. It might be better than putting up with austerity.
3. Germany leaves the euro. It might be better than having to bail everyone out.
4. Everyone leaves the euro. The end of monetary unions is always bad – regardless of how totally rubbish an idea they might have been in the first place.
5. The coalition collapses in the UK. Bad news for deficit reduction. Bad news for interest rates. Bad news for markets.
6. Social unrest in the emerging world. Rising food prices irritate the West, they starve much of the rest of the world. Global food prices have just hit a new high. See no.1.
7. Social unrest in the developed world. Government overspending has left an awful lot of people with misplaced feelings of entitlement. Austerity will make them angry.
8. Hyperinflation. Inflation at 2-3% isn’t that big a deal for equity markets. In fact, historically it has worked out quite nicely for them. Double-digit inflation is another matter. And it isn’t impossible. Sovereign debt across the West is past danger level. It won’t take much for populations to lose confidence in their currencies and start trading them for anything of value – another round of QE (quantitative easing) in the US to finance a few bankrupt states could easily do it. It isn’t far from there to wheelbarrows. I saw Adam Fergusson, author of When Money Dies over Christmas and asked him again if he expected to see double digit inflation soon. “14-15%?” He said. “Easy.”
9. War in Korea. Or Iran. Or Pakistan.
10. Capital controls in emerging markets.
11. A 20% fall in UK house prices. The number of properties coming on to the market is rising. The number of mortgages the banks are prepared to give out is falling. And buyers are getting stubborn. That’s not much help to the 8% of mortgage borrowers Shelter says use their credit cards to pay their mortgages. A small pop up in interest rates and we’ll be overshooting on the downside in no time.
12. A 20% fall in US house prices. This is where it all began. So the banks won’t be able to consider it over until US house prices are at least stable.
13. Another oil shock. We are already near $100.
14. Greedy governments. Bank robbers rob banks because that is where the money is. Governments follow similar logic. So who’s got the money now? Much of it is sitting on corporate balance sheets. Something for investors to keep an eye on.
All other suggestions welcome…