Warning: turbulent market conditions ahead
Jeremy Warner checks his predictions for last year and looks ahead to what's in store
Saturday 03 January 1998
Fortunately, some of my other main forecasts were a little better. My prediction for the pound, which I said would remain strong because of rising interest rates, was closer the mark, and my reading of Japan was spot on. Tokyo, I said, would remain in the doldrums; Japanese stocks were still overvalued by international standards and there was no evidence of a revival in the Japanese economy.
I can also claim to have got the rest of the Far East partially correct, though for entirely the wrong reasons. I failed utterly to predict the economic crisis in the Pacific Rim economies - hardly alone in this - but I did forecast turmoil in the Far East. My belief was that this would be sparked not by the bursting of the region's investment bubble, but by the Hong Kong handover, which I thought would prompt an international crisis with knock on consequences for financial markets. In fact the handover could hardly have been smoother. All in all then, I probably shouldn't be awarding myself any more than about 4 out of 10 for crystal ball gazing - some of my micro-predictions on companies were wrong too.
This was a year that contained some salutary lessons now just for me, but for all forecasters. Perhaps the most revealing was the way in which the bear case for equities was reinvented during the latter stages of the year. To the extent that Western markets did wobble and lose their self-confidence, this was not prompted by the usual and most predicted set of circumstances.
In recent times, bear markets have generally been caused by the resurgence of inflationary pressures, sharp increases in interest rates and a consequent reduction in liquidity as economies slow and recession begins to grip. Moreover, the collapse tends to start on Wall Street and then spread to the rest of the world.
What happened in October, when Wall Street looked as if it was going to crash, was the very reverse. The crisis began not in the US but the Far East and then spread from these comparatively small economies to the world's largest stock markets. The fear that gripped markets was not that of inflation leading to higher interest rates, but of deflation.
It was said that recession in the Far East would force the region to chase the only growth market left - the US - which would become flooded with cheap imports made cheaper still by competitive devaluation. This in turn might cause an investment famine in the US, consumer confidence would collapse, and it would be like the 1930s all over again.
So here was another curious about-turn in perceptions. The world was suffering, it began to be said, not from the traditional bugbear so much cited by politicians of under-investment, but from over-investment. Rapid growth in the Far East had led to uneconomic investment and a surplus in worldwide industrial capacity. Markets might therefore begin to behave like the Nikkei since the collapse of the 1980s property and stock market bubble. Policymakers would find themselves trapped in a deflationary vortex.
For the time being, that fear seems to have receded, though there are still plenty of pundits around prepared to preach the theory. One such this week was George Soros, the international speculator and philanthropist who, as is his wont, proposed a number of largely unrealistic policy options to counter the supposed threat of worldwide deflation.
When markets are in such buoyant mood, however, every cloud has its silver lining. Such is the unrelenting optimism of Wall Street and the American psyche that many in the US have already come to see the Asian crisis as positively a good thing, at least in terms of its effects on the US. Trouble in the Far East will put a much-needed deflationary break on runaway US growth, dampen domestic wage pressure, and therefore reduce the need for any interest rate hike this year, it is being said.
With one leap we are thus back to the idea that bear markets are caused by inflationary pressures. If the effect of turmoil in the Far East is to keep these pressures in abeyance, then what's happened is not bad news for Wall Street at all. Rather, it might allow the longest running bull market in US history to continue for another few years yet.
Believers in the New Age, a new economic paradigm that will allow non- inflationary growth in the US to continue into the indefinite future, still outnumber those who find this view incredible. Indeed, the new religion seems to find more converts everyday. Even Alan Greenspan, chairman of the Federal Reserve, has watered down his view of a year ago that Wall Street stock prices were suffering from irrational exuberance. Furthermore, the sheer size of corporate activity said to be in the pipeline - takeovers, mergers, share buybacks and other capital repayments - both in the US and Europe, gives a powerful upward momentum to markets.
Wall Street thus becomes harder to read than ever. Is it deflation or inflation that will bring this bull run to an end? Or are the two set to cancel each other out, allowing stocks and bonds to carry on upwards. I said last year that Wall Street was horribly overvalued and riding for a fall and I've no reason to change that view. Neither the New Ageists nor the believers in Worldwide Deflation seem to me to have the answers. Markets depend crucially, however, not on what is happening but on what people think might happen. Wall Street over the next year will be ruled by whichever school of thought gets the upper hand.
One important pointer to the future is perhaps the fact that nearly all of this year's rise on Wall Street took place in the first half of the year. Despite its gyrations, the Dow has in effect been running on the spot since August, apparently unable to make up its mind which way to go. In a sense, then, the bull market has already ended, though it hasn't yet given way to a bear market. This seems to me a quite sound view of what we might expect from stocks this year. Be wary of Wall Street, don't expect miracles from London, and steer well clear of the Far East and Japan.
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