It's been a bad year for investors – and things aren't looking any better for 2019 either

The US is at full capacity, or pretty close to it, with the lowest unemployment for 74 years. So growth has to slow, and the question is whether this will be a hard landing or a soft one

Hamish McRae
Wednesday 26 December 2018 14:04
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The market wobbles may well turn out to be very useful
The market wobbles may well turn out to be very useful

It has been a dreadful year for investors. Unless there is some dramatic recovery in the few days left of 2018, it will be the worst since the financial crash of 2008.

It does not matter which asset class you take: US, European or Chinese equities, oil, gold, bitcoin (!), many hedge funds, even US treasury bonds or UK ten-year gilts – in just about every investment you will at best be square and at worst down a lot of money. Maybe classic cars and fine wines have done all right, but there are not many mainstream assets that are worth more now than they were in January. I suppose if you got your timing right and sold shares in May (UK) or October (US) you would have been fine – and it is this flip since the autumn from something near euphoria to something close to fear that is really disturbing.

Some calculations by the bank UBS just ahead of Christmas showed that the S&P 500, the broadest index for US Inc, was down 12.6 per cent on the year. Aside from the years of the depression in the 1930s, this made it the fourth worst sell-off in the October/December quarter since the 1930s depression. The worst was in 1987, next was in 2008, third worst 1941 (after Pearl Harbour), and then this one.

When you get a sudden market lurch like this you have sit up and pay attention. This is a real loss of wealth. The total value of all the companies in the S&P 500 is some $25 trillion. By contrast, the value of all bitcoin in existence is about $60bn. Were bitcoin to become worthless and that $60bn to disappear, it would make only a tiny dent on the stock of global assets. But a 10 per cent fall in the S&P is a big hit, and we have had more than that. Add in the fall in European and Chinese equities and the world is down about $5 trillion, equivalent to the GDP of the UK and France put together.

There are two ways of assessing the importance of this loss.

One is to note that share markets are creatures of fashion, and that the world economy is well-insulated from their gyrations. On a very long view, equities return about 6 to 7 per cent annually in real terms, i.e. after inflation. That is more than fixed-interest securities or cash, and in most markets more than property. But they are volatile. Because everyone knows they are volatile and has experience of that, the real economy can, so-to-speak, roll with the punches. A sharp fall in bond prices or house prices can be destabilising for the whole financial system in a way that a fall in share prices is not.

The other way is to observe that recessions often follow sharp declines in equity markets, after about an 18-month interval. But it does not always happen and the dip in share prices tells us little about the scale of the next downturn even if one does come. Thus that 1987 crash was quickly reversed and the next cyclical downturn did not come until the early 1990s. The 2008 decline was associated with recession the following year (a smaller gap than 18 months) but those were extreme circumstances. As for the downturn after the pricking of the dotcom bubble in 2000, that was associated with a recession in 2001, but it was a shallow one in the US and actually there was no recession in the UK at all.

So what will happen in 2019? Does this sudden lurch of the last three months tell us anything at all?

Here are my top five takeaways.

The first thing to be clear about is that we are due some sort of slowdown. The US is at full capacity, or pretty close to it, with the lowest unemployment for 74 years. So growth has to slow, and the question is whether this will be a hard landing or a soft one. Intuitively I vote for soft, largely because there has not been an explosion of inflation. And while costs remain under control, and employment remains high, families will want to go on buying goods and services – particularly services, which make up three quarters of the economy.

Next, there is a lot of debt around. One of the consequences of the ultra-easy money policies of the past decade has been the boom in asset prices; the other the surge in debt. That debt hangs over companies, governments and individuals the world over. The taps have now been turned off, and as a result bond yields – particularly corporate yields – are nosing upwards. Can borrowers stand higher rates? I suppose what worries me is that a lot of people have very little experience of rising interest rates and sort of assume that the central banks will protect them. If inflation rises they will not be able to do so.

Third, I am worried about China. The economy is slowing (this has been the first year since the early 1990s when car sales are going to be down) and it too has a mountain of debt, some of which is not being serviced. A slowing economy and bad debts is a bad combination, even if (as I do) you think the Chinese authorities will be able buffer the economy from financial stresses.

Four, I am worried about Europe. To say that is nothing about Brexit (though the tension with the UK comes at a bad time for the European economy). It is much more to do with the adjustment to the end of QE. The eurozone economy has been kept going by monthly injections of cash by the ECB. Take that away and, despite bargain-basement interest rates, the economy has suddenly slowed. It may even be in technical recession – two quarters of negative growth – though we don’t have figures yet. Next year could be very difficult for the European economy if indeed there is another global downturn.

Finally, the market wobbles may turn out to be very useful. Things were getting out of hand. There was Apple Inc, the first trillion-dollar company. Then there was Amazon. Now both are well down on their highs. There was an emerging bubble that has now been popped. Better to pop bubbles early. So a slowdown next year would actually be quite healthy if it prevented something worse in 2020.

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