JOHANNESBURG – The 10th anniversary of the 2008 Great Financial Crisis (GFC) this year may have elicited many memories, retrospectives, lessons learnt and opinions and views on how and why it is different this time and that another crisis is not in the offing.
The beginning of 2018 started with many market participants and pundits very confident and optimistic about the prospects for 2018. It is clear that the year has not gone the way the consensus was hoping. In January most investment outlook reports were all about synchronized global growth – now rather divergent – setting extremely benign expectations for the market environment.
Those who held bearish views or believed that markets could experience heightened volatility and thus more of a challenging year, were regarded as mistaken. The confident market outlook that prevailed, coupled with the fact that the bull market has persisted for so long, even caused the number of perennial market bears to dwindle; it hurts to be on the wrong side for so long.
There are now two schools of thought. The one would argue that just as some bears were capitulating, their views may in fact be coming to fruition now. The other would have you believe that the present cycle is not yet peaking. They argue that some classic late-cycle indicators remain somewhat allusive, such as strongly rising inflation, falling profits, over-investment or aggressive policy tightening.
So which school is correct? To my mind, it would appear that a number of developments have been pointing to increasing potential for a more difficult market environment coupled with some late-cycle markers. To list just some of the factors:
- The bear market in bonds.
- Softer property prices in major centres around the world.
- The sell-off in emerging markets after being flavour of the day.
- Reports of plans to build even taller skyscrapers in certain parts of the world, such as the Kingdom Tower, a Jeddah, Saudi Arabia project originally intended to be a mile high! – a classic reflection of upbeat sentiment and a late-cycle phenomenon.
- Speculative and contagious activity in cryptocurrency markets such as Bitcoin.
- Geo-political developments such as North Korea, Brexit and potentially “Italexit”.
- Ascendency and proliferation of separatist and far-right movements and authoritarianism.
- Trade wars (protectionist policies) that easily could spin into currency wars, with declining global trade as a result.
- Tighter monetary policies (“quantitative tightening”) by the US Fed in particular and the European Central Bank prospectively.
- Shrinking US dollar liquidity on the back of these developments.
- A passive investing trend triggered by late-stage market rallies.
- Narrowing market breadth with a declining number of stocks leading the market upwards.
- Extreme bullish sentiment and related gauges.
Against the above backdrop, of concern have been rising US interest and bond rates, government borrowing and the repatriation of US corporate profits, sucking USD liquidity out of global financial markets. Short-term interest rates are rising and quantitative tightening could raise the term premium and cost of capital while central bank injections of liquidity decrease, adding to the pressure on markets.
A rising dollar is increasing the cost of servicing dollar-denominated debt – a big problem for offshore borrowers. In a recent note, Nedbank CIB strategists concluded that “as the global economy and financial system have become more systemically leveraged, their sensitivity to changes in the cost of global capital has increased; hence, we believe the next downturn may be more serious than previous ones.”
I think there has been a tendency to forget the lessons of the previous crises as bullish market conditions continued. Furthermore, with pundits assuming that major central banks will continue to forestall or backstop any negative developments, the appetite for risk tends to escalate.
A known market adage has it that “bull markets climb a wall of worry”. Could it be that the positive economic backdrop and sanguine market outlook at the beginning of the year have made way for what another pundit proffered as “bull markets tend to end not on bad news but on great news” - and usually coupled with heightened bullish sentiment?
That may sound counter-intuitive but we did indeed have positive economic momentum; the EU was expected to maintain its improving growth trajectory into 2018 with emerging markets looking attractive and the strong economic data (notably GDP) posted by the US during the year. Profits have been rising, US fiscal stimulus was in the pipeline and generally low interest rates remained supportive of continued optimism.
Market drawdowns are still viewed as great buying opportunities by the bullish camp. Positive, good-news developments like these all contributed to sanguine expectations for and during the year.
In conclusion, the latest sell-off in global markets is precariously poised. Either the optimists will win the day if the market recovers and resumes its now shaken bullish momentum or market participants will increasingly give vent to an underlying uneasiness and a growing negative mood by taking risk off the table.
The risks are high and further strong market sell-offs could well damage the bull market that has been in force since the GFC of 2008.
Fabian de Beer is director of investments at Mergence Investment Managers.
The views expressed here are not necessarily those of Independent Media.