Markets often have setbacks. There is always plenty to worry about. Recent price falls have not related to any one event or new fact that has emerged. Some people want to take some profits. Some people have become more nervous about how sustainable the recovery might be. Some worry that the Central Banks led by the US might push interest rates up a bit more than expected, hitting bonds with knock on effects on share prices too. Like all good worriers, we have asked ourselves, could this correction turn into a share bear market? Is this the end of the current long cycle?
We do not think so. There is no agreed length to a cycle. There are long cycles and short cycles. This is a long one, but that does not mean it has to end soon. Cycles end when Central Banks and governments decide to end them, usually to curb excessive inflation. They end them by forcing up borrowing costs and restricting credit. They also can end if the authorities lose control of the banks and credit system. If a series of defaults on borrowings occurs, this can lead to banking stresses, falling asset prices and recession. People and companies are reluctant to invest if the value of the businesses and properties they invest is going down.
Much of it comes down to a question of confidence. If companies lose confidence they stop investing, and they stop hiring new people. This can then transmit the loss of confidence to the people who cannot get jobs or who lose their jobs in the sectors that do the work to build the properties and put in new plant and equipment. A crack in business confidence can lead to a loss of consumer confidence. If consumer spending then falls or its growth slows, that in turn hits company cashflow.
There are various theories doing the rounds about how a wider loss of confidence could occur in ways which could slow the growth the world is experiencing. Some think the Fed in the US will hike rates too far too fast, slowing the successful US economy. This seems unlikely, as the Fed has a double remit to control inflation and to ensure a positive economic background for activity. As inflation is not a worry, there is no good reason to suppose the Fed will raise rates to the point of triggering a downturn.
Some think China will tighten credit too much, as the Central Bank and government seek to limit the rate of credit expansion which has been fast in recent years. In what remains a very managed economy the government insists it will aim for growth at a little over 6%. It is true there are weak banks and bad loans in the system, but much of the trouble is owned by the state. The state has the power to subsidise the nationalised industries who owe the money, or to capitalise the banks who might need to write off some of the debts. The debt problem is internal to China and should be manageable. It is true there has been some modest tightening recently, and the anti-corruption drive is having some impact on conspicuous consumption.
Some think there could be another commodity downturn after the rallies in oil and metals prices over the last year. This could in turn hit investment in mines and oilfields and dent activity. It is difficult to see why we should plumb new lows on commodities given the upturn in world demand for energy and raw materials as the recovery advances. Some modest falls in commodity prices should not in themselves end the cycle.
This bull market has been fraught with worry and disbelief by many professional investors for much of its life. The banking crash left a longer term shadow over investment confidence. Normally a bull market ends when most investors are very optimistic and fully invested. Additional buying dries up when more people have extended their risks, borrowed money to buy assets and can afford no more. It takes a bit of time for the turn of the cycle and the bad news that brings to have an impact, gradually pushing a correction in markets into something more serious. It does not feel like that at the moment. The likely news flow on growth and economies remains largely positive, whilst many investment professionals and commentators spend their time talking about what can go wrong. Some keep a cash reserve to reflect their disbelief. There is no surge in borrowing to buy assets and no daily euphoria about the gains to be made from stock market investing.
The above article was first published by Charles Stanley on 17th November 2017