published in South China Morning Post ,4th November 2015
We have managed to get through the shark tank of the month of October this year with nary a scratch – a month that often sees Black days, as the markets sell off to excise the excesses of the past.
November is altogether a relaxed month, one in which markets traditionally settle; even recover, as leads into the calmness of December and the closing of the books. November can provide news and entertainment but it does not normally provide market leadership.
This November it is different, in that the market has none of the typical excesses of September and October to correct. Remarkably, the MSCI World equity index is trading at almost exactly the same, as it was when it began the year. We have had some fun in the meantime. The index rose 6% by May, only to fall 9% by the end of September, and then to recover in just five weeks. Nevertheless, the record books show virtually no gain for equity investors this year.
It continues to be hair-pullingly frustrating for equity investors, unless you are a trader and that can work out badly or well. Hedge funds who fancy themselves at the volatility game are actually down 2.5% this year, below their stock market cousins. And for most investors, leaving cash in the bank is an admission of failure.
One mantra of investment is that there is always someone doing better than you are. Property for instance has had a fine year with Centaline’s Hong Kong house price index up the best part of 10%. Greater London house prices are up 10% this year and prices were up nearly 9% in Sydney in the second quarter alone.
Soaring property markets may be one inflating bubble but it is not the biggest or most worrying one. It is the bond market, generally regarded as one of the safest of the risk asset classes, which is well and truly at the top – even though predictions of its demise have confounded experts for half a decade.
It is at the top because interest rates can only really go to zero so the gains are constantly diminishing. Yes, semantics may say that interest rates can go negative, and indeed may be so in some parts of Europe, but gravity will eventually prevail. At the moment, ten year Japanese bonds are yielding 0.3%, German bonds 0.5% – and unusually the U.K. is at 1.92%, less than the U.S., which is at 2.14% per annum.
The chart shows the fall in the U.S. 10 year Treasury interest rate over the last 18 years, reflecting the massive fall in interest rates. Nowhere can there have been such an extended bull market rally in any asset in modern times.
Every time there was a little wobble in the economy, interest rates were cut by the Greens pan/Bernanke/Yellen clique, as can be seen in the chart – but never really raised. And each time, rates are cut, the debt levels rise because low interest rates means cheap debt and therefore more people use more of it.
Official figures on debt levels from the IMF make grim reading with total global debt in the region of U.S.$100 trillion, compared to assets of U.S. 140 trillion. That is some 150% of the world’s annual economic output.
McKinsey, the strategy consulting company, calculate that the world’s total debt is now 286% of GDP by including hidden debt that officialdom chooses to ignore. For instance, China’s debt has quadrupled since 2007 to 217% GDP, with much of it lent by the unregulated shadow-banking sector on real estate, grandiose infrastructure projects and “wealth management” products.
Small rises in rates are mathematically insignificant but they may well hard hit the psychology. If interest rates encourage investors to deleverage, what’s to say that the bond markets won’t crash as investors all go for the door at the same time, driving market interest rates much higher than official ones. History tells us that rising interest rates are bad for assets, and crashes are worse.
The impending interest rate rise delivers much greater stakes than the market believes. We will probably survive the first few rounds of tightening – with markets pricing equities higher for a while; but the dirty secret is that the debt problem is like a great white shark lurking just under the water seeking the arms and legs of the unwary – and maybe even the shirt off your back.
Richard Harris of Port Shelter (www.portshelter.com) has been in the investment industry in Asia for 37 years.