SUMMARY Headline writers are getting into a tizzy. Markets have tumbled in recent days and it is all the fault of China, Turkey or some other emerging market. But the real problems are closer to home, within developed economies, and particularly derived from the US. We explore that here, and what history tells us about the potential falls.
NB The latest Topfunds Guide, 26th edition, is now available. Do email to order your copy.
Is China causing markets to tumble globally, as headlines suggested in recent days? Or is it Turkey? Or… The reality is that the problems are much closer to home.
Of course there are adjustments that need to be made in various emerging markets, this is hardly a secret. Everyone has known for some time that China is midst a multi-year transition which will result in less headline growth – this is not new news. Dealing with a debt overhang is part of that transition – does anyone remember that occasional painful adjustments is how capitalist economies used to work?
Emerging markets showed that they could make those adjustments in 1997/98, and will do so again.
At least these countries illustrate a willingness to make adjustments.
In contrast, the indebted developed economies (that’s us!) have made little or no adjustments since 2008/9, ranging from the need for deep cuts in State entitlements or the need for fundamental change in banking systems. Remarkably, total debt is higher now than it was 6 years ago when it brought the world to its knees.
No adjustments, just more debt, the class A drug of choice administered by central bankers of developed economies.
The single plank which drove markets up in recent years, QE, is being withdrawn; this is the “tapering” to which you often see reference. (Though we mustn’t underestimate the stupidity, sorry, ability of central bankers to change tack and blow more air into the market balloon)
That the US stock market is in a dangerously unstable state is reasonably clear on reasonable criteria. These criteria are valuation, confidence, and easy money – we cover this in detail in the latest TopFunds Guide.
While the UK market does not display the same extremes it will go where the US leads.
There is no certainty around what happens next. We remain midst an extraordinary financial experiment, and central banks are in a corner. But we must consider what history tells us. In similar periods, displaying an equivalent state of instability, the US stock market fell on average by 46% – again detail in the latest TopFunds Guide.
And the nature and scale of the falls since the New Year suggest a new phase for the stock market, which could last weeks and months, possibly longer.
Earlier in the month we highlighted that if the US stock market went up in the first five trading days of the year it went up for the whole year more than 85% of the time. But if it went down, the market had a 50% likelihood of being down for the year. It went down in those first 5 days. Now the end of the month looms, and stock markets seem certain to end lower for the month. For the US stock market, the January outcome (up or down) has predicted the outcome for the rest of the year with 76% accuracy (or 89% if you exclude years where the market moved less than 1%).
It is appropriate to stay cautious.