How should we handle this situation? The traditional answer would require careful analysis about macro-economic and corporate trends, investor psychology, monetary policy decisions, and market valuations. Hence, the list of triggers to buy into the bear market would include looking for a peak in the core rate of inflation, a steady rise in unemployment restraining wage pressures, evidence that investors are capitulating, signs that the terminal interest rate is in sight, demonstrated by flattening yield curves and a peak in the US dollar, all supported by stock market PE ratios closer to their historical norms than recent excesses.
This time, such evidence is necessary, but not sufficient. Each bear market is different, and this one warrants further analysis on politics across different capital cities.
Starting in the UK, there has been a tsunami of critical commentary following the chancellor’s fiscal statement last month. To quote the inestimable John Authers at Bloomberg: “This was one of the biggest and most damaging market reactions to a policy announcement in memory. The error was entirely avoidable and self-inflicted, and its perpetrators have no choice but to own it.”
Putting party politics to one side, there was much good in the chancellor’s statement, both his intent to raise the UK economy’s growth rate and some of the initiatives announced: the potential boost to investment, house building and infrastructure. Questions can be asked, of course, about the efficacy and the time scales. Growth depends on trust and a framework of policy stability, which need to be rebuilt.
However, the recent turmoil in UK markets is merely an example, admittedly a stark one, of a worrying situation facing many central banks, finance ministries and market investors. The key question is: what should be the new relationship between fiscal and monetary policy in the Western world? Against the backdrop of the 2008-09 financial crisis and the subsequent austerity to restore public sector finances, central banks kept interest rates at such low levels for so long that they became embedded into asset prices.
‘Tight fiscal and easy monetary’ is turning completely around as central banks attempt to tackle the inflationary after-shocks created firstly by the pandemic and then the energy and food price surges after Russia’s invasion of Ukraine. Governments are desperately trying to limit the pain for the electorate. Liz Truss may be castigated for £45bn of tax cuts and £60bn of energy subsidies, but the German government has just announced a €200bn ‘defensive shield’ including a gas price brake and sales tax cut. The US Administration recently announced a $400bn package to reduce student loans, and doubtless the Democrats will do more if they perform well enough in the approaching mid-term elections.
In coming weeks, several governments face important decisions which will determine whether this bear market stabilises or deepens. Will Russia try to punish Europe for its support of Ukraine by taking more action to limit gas and oil exports? Central banks would need to respond to further increases in headline inflation. Will China decide to ease fiscal and monetary policy considerably or modestly after the 20th Party Congress? The renminbi, yen and sterling are just three examples of currencies under serious pressure from the US dollar’s inexorable rise, sufficient pressure to require verbal or actual intervention from the authorities.
Following the German example, how far will other EU governments go in easing fiscal policy? By trying to limit the extent of the recession facing Europe, such decisions put the ECB even more onto a collision path.
Even when a trough to the bear market has been seen, then investors also need to focus on some structural problems. The world economy is suffering from the adverse effects of the pandemic affecting labour markets – exemplified by those suffering from long Covid and the wave of early retirees – as well as the evidence of deteriorating climate change aggravated by Russia’s energy price shock. Hence investor confidence would be boosted by clear signs that labour supply and demand is at last rebalancing in the G7, and sufficient resilience in energy supplies across Europe for winter 2023, not just 2022.
Interest rates and bond yields are back at levels not seen for a decade. The world of easy money is over, meaning difficult questions need to be asked about the weightings in growth and value stocks, emerging market and alternative assets. Conversely, cash and investment grade debt can start to be included in portfolios again, fulfilling their original roles as sources of income. Yet this is not a return to the norms of the early 2000s.
State intervention is back in a way not seen for decades. This matters far more than stock and sector picking, important though that is, but reflects the anger of populations affected by years of inequality. The outcome of the battle between easy fiscal and tight monetary policy will determine the nature of this bear market and the shape of the recovery.
Andrew Milligan is an independent economist and investment consultant and board adviser to Devlin Mambo
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