Photograph: Alexander Nemenov/AFP/Getty Images
Have financial markets been correcting because of underlying weakness in the real economy? Or could it be that market turmoil will be what bring this long-lasting economic upcycle to its knees? As we turn the last page of 2018, the eternal “chicken or egg” question is very much open.
October certainly lived up to its adverse reputation, with the S&P 500 index posting its worst monthly decline since 2008, equities losing ground across the globe and bond yields nearing multi-year highs. Still, rather than marking the start of a deeper and broader downturn – one that extends even beyond financial markets – we view the recent corrective episode as a drill for what awaits investors, once the tipping point is eventually reached.
What if the main victim of US-promoted trade barriers were its own domestic economy? The European Central Bank recently made such a suggestion, which is also starting to be buttressed by economic data – be it in terms of the US trade deficit or inflation.
The current outperformance of US equity indices goes beyond an investor craze for Facebook, Apple, Amazon, Netflix and Google (collectively known as the FAANG stocks). It reflects a new versus old economy battle, which is starting to have serious real-world implications. And this battle is being fought on uneven terms, with still cheap and plentiful money providing an undue advantage to new economy companies.
The market is wrong in thinking that the US have nothing to lose in a trade war with China – just as it is wrong in expecting the world’s largest economy to weaken already next year.
Trade disputes are monopolising investor and media attention, with tough talk unlikely to abate before the US mid-term elections. But what if the more serious issues for financial markets were actually mounting inflationary pressures in the US and failing political unity in Europe?
European political waters were supposed to be calmer this year, after the many electoral hurdles of 2017. But investors’ nerves were tested again in late May with the ousting of the Spanish Prime Minister (leaving his successor at the helm of a very fragmented parliament) and complicated negotiations with respect to the formation of a populist government in Italy.
An important milestone was reached on April 24, when the US Treasury 10-year yield topped 3%, threatening to undermine the form of “equilibrium” that equity markets had settled into during the past few months.
Ten years have gone by since the Great Financial Crisis. The sequence of events that unfolded during this decade has profoundly transformed the world – not only for investors but for society at large. Democracy and free trade are under attack, technocrats have become very powerful, international institutions are unable to fulfil their historical role, and « peace for our time » is no longer assured.
What if the early February episode of market stress was not just a “healthy correction” within equities’ relentless upward march, but rather the onset of a more troubled environment?
The February 2 US labour market report sounded a warning bell, jolting equity markets out of their long-time state of sweet euphoria and blindness to budding inflationary pressures.
As we step into 2018, there is little question as to the direction of the global economy – barring an unexpected external shock. For the first time since the Great Financial Crisis, the OECD in aggregate is operating above potential, thanks to years of easy monetary conditions and the ending of fiscal austerity. Momentum appears to be particularly strong in corporate investment spending, with the compromise on tax cuts signed last month by the US Senate and House of Representatives only to add fuel.
