I don’t remember greater uncertainty; what will happen to the economy in 2019?
An impossible year to predict, what can investors do?
What will happen to stock markets? This year such forecasts are nigh on impossible, what should investors do?
What’s unusual about the economy right now is that it seems to be defying logic. In 2007 and 2008 things were bad, but at least we knew they were bad. And contrary to the view that no one forecast the 2008 crash, in fact, during that period, economic writers were largely full of doom and gloom.
Just as happened in the comments section here last year, in early 2008 I was criticised for being too gloomy.
And I own up to it, last year I was gloomy. This year, I really am struggling to work out what happens next.
It is not just Brexit; clearly that is indeed turning into a chaotic mess, with a growing list of possible outcomes.
But there is the US too, and inflation and house prices.
Interest rates are at the heart of this one. Worldwide there is too much debt. It is especially a problem in China, but there are pressure points all around the world.
House prices have reached absurd levels, at home and abroad.
The average house price in the UK is £226,00. But that number is not typical of all regions. Where I live, you would struggle to get a two bedroom terraced house for that. In some parts of the country you would struggle to get a one bedroom flat for that.
According to the ONS, the UK median disposable household income was £27,300 in 2017. In other words, the average house price is eight times household disposable income. I don’t see how that is sustainable.
But if we live in an age when interest rates are permanently close to zero, then what matters is not the cost of the property, but how long you have to pay off the mortgage.
To take an extreme, suppose you could borrow at one per cent indefinitely. Under those conditions you could take out a mortgage for a property worth 100 times your salary, and earn enough to cover the mortgage — although you wouldn’t have anything left over.
The above model may seem absurd, but it is not that different from government accounts. If governments can borrow at zero per cent indefinitely, then there is no limit on how much they can afford to borrow.
Interest rates don’t want to rise
A year ago, it seemed like the age of near zero interest rates was nearly over. The Fed was increasing rates with apparent gay abandon (is that the only phrase left in which you can use the word gay in its original meaning?). The Bank of England seemed set to follow.
Economic theory seemed to be screaming that inflation was going to rise. How could it not? Unemployment was at near 40/year lows, of course wages were set to rise. In the US, at a time when the economy was close to full employment, the Trump administration orchestrated a massive tax cut. How could that not lead to inflation? Common sense and any vague understanding of economic theory said it was inevitable.
But it hasn’t happened. In December, US core prices — without food and energy — rose 2.2 per cent, year on year. This is not exactly runaway inflation.
In the UK, in December UK inflation was at 2.1 per cent, down from 2.3 per cent the month before.
Now with retailers cutting jobs, it seems the labour market may well loosen, the imperative to increase rates is waning.
Likewise, the US tax cuts turned into a damp squib.
What with the German economy tottering on the edge of recession, the ECB looks less and less likely to increase rates.
It seems to me that almost 11-years after the financial crisis, ten years or so after rates were cut to near zero per cent, that the interest rate cycle is close to peak, even though rates have barely flickered in the UK and euro area.
And if that is right, the massive level of private sector debts may be affordable.
Looking at the way technology is developing, I see downward pressure on prices in the medium and longer term.
I think that the main reason why house prices are so high is because the public expect them to rise. Our buying behavior, built on our expectations, leads to ever higher house prices. To me, it feels like an unconscious Ponzi scheme — people raising the deposit to buy a bigger house from the proceeds of the profits they made from the past house. )Assume you can get a 75 per cent mortgage, and you bought a £100,000 house with a £25,000 deposit and that house doubled in value. You then have £125,000 equity, meaning you can get a £375,000 mortgage and buy a £500,000 house. That feels like a form of Ponzi scheme to me, but if rates are never going to ride much higher than zero, maybe not.)
I believe that the underlying driver of low inflation and low interest rates is what the former Fed chair, Ben Bernanke, calls the global savings glut — the rise of China with its excessively high savings rates, the retirement of the baby boomers worldwide, and growth in corporate profits relative to wages has created a gigantic pool of money slushing around the global economy. This is either funding debt, supporting the global economy, or, as happened in 2008, can’t find a home, in which case it drains out of the economy, creating economic crises.
These conditions may change when the baby boomers have mostly retired, if wages start to rise faster than profits or if something changes in China. None of these three things are impossible.
As for investors; I would say this is a time for quality. Hold some cash in the event of a crash creating a buying opportunity, but go for stocks that tend to do well in the long run.
It is time to sit tight and play the long game.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees