When we sat down this week to review world markets and world economies the surprising thing was how few surprises there have been so far this year. We expected the euro to survive its brushes with mortality in the Dutch and French elections. It has done so. We like many have forecast reasonable growth of a little over 3% for the world as whole this year. That seems to be on track. In common with the crowd we looked forward to US rate rises, which are duly materialising. We assumed Japan and the euro area would press on with negative interest rates and more official bond buying. We expect more of the same. All the main economies of the world have governments wishing to promote more growth. Inflation has gone up a bit but is not a problem.
So we asked ourselves as you must when you think you can guess the future, what could go wrong? We considered the usual list of events and changes that could get in the way of a sustained recovery or could unhinge asset values in share and bond markets. Could China make a major policy mistake and end up with the hard landing some have been forecasting for several years? Could the Italian voters decide to seek revenge for high unemployment and slow growth by voting against the euro? Might one or more of the Central banks move too rapidly to put up rates, and cause a panic? Could inflation power higher, shifting the balance of opinion on how acceptable it is? Could there be another energy and commodity price collapse, undermining investment in capital hungry sectors? Could one of the world’s trouble spots escalate conflict beyond its immediate frontiers?
Our short answer to these and similar worries is we think they remain unlikely. The world continues to live under the shadow of the Great Recession and western banking crash of 2008-9. Memories are still fresh, so central banks do not want to tighten too much too soon for fear of creating another recession. China has weak banks, overborrowed state enterprises and local government with some stretched balance sheets. Much of the debt is not only domestic, but it is owed by one part of the state to another. This should make it manageable for the authorities. They can decide the pace at which they write off bad debt or prop up overborrowed institutions that have to pay the interest. The Chinese government takes pride in not having presided over a banking crash in 2008, so it would not wish to create one now.
A more sustained and synchronised recovery should lift demand for energy and commodities sufficiently to avoid a major plunge in prices. The world’s central banks are aware of the weakness of some customers of their commercial banking systems and not keen to put them under undue stress with rapid rises in interest rates. There is risk to the euro from Italy, but the euro so far has a knack of muddling through.
It’s true that economic growth and an absence of real economy shocks is not always sufficient to sustain rising share prices. Earnings and dividend growth has accelerated so far this year and looks set to help more in the months ahead. There are still plenty of cautious investors worrying over whether they should have made a bigger commitment to shares, and still plenty of cash sitting on the sidelines. This does not feel like the top of a bull market, when people are optimistic, fully invested and often borrowed to own more. There are still plenty of worriers, plenty of things to worry about, and a downbeat mood about everything from President Trump to Chinese banks. The sell off on the news of more troubles in the White House reminds us all shares can go down and moods can sour. Underlying it all, however, is a reasonable recovery and a lot of central banks wanting to promote more growth, not less.
The above article by John Redwood, Charles Stanley’s chief global strategist, was first published by Charles Stanley on 19th May 2017.