When times were re­ally bad

The decade since the GFC has been bad but it’s not with­out prece­dent

Money Magazine Australia - - CONTENTS - Stephen Miller is an ad­viser at Grant Sa­muel Funds Man­age­ment.

Some of us (al­most) su­per­an­nu­ated mar­ket scrib­blers have for some time been fear­ful of what looks like the cur­rent in­flec­tion point in mar­kets. This prob­a­bly re­flects our rec­ol­lec­tion of a time when things were dif­fer­ent and, in my view, a whole lot worse – the 1970s. As if to prove the rock ’n’ roll maxim that “any­one who re­mem­bers the 1970s didn’t prop­erly live them”, a lot has been writ­ten about how “un­prece­dent­edly” bad the decade since the GFC has been eco­nom­i­cally. But by my reck­on­ing it wasn’t as bad as the ’70s and, for that mat­ter, the first cou­ple of years of the ’80s.

Those times were a real doozy: dou­bledigit un­em­ploy­ment, dou­ble-digit in­fla­tion and dou­ble-digit in­ter­est rates, and if that weren’t enough to make the av­er­age punter mis­er­able he or she could have been in­vested in a stock­mar­ket that went nowhere – the S&P 500 fell by around 40% in real terms over the decade of the ’70s.

Warn­ing signs

There are those among us who are fear­ful that re­cent times may be a har­bin­ger of things to come. This is be­cause the pre-con­di­tions for higher bond yields re­main.

First, the US econ­omy is at full ca­pac­ity. The un­em­ploy­ment rate is as low as it has been since 1969. More­over, it has strong and on­go­ing growth mo­men­tum that may well poke the in­fla­tion beast.

Sec­ond, the Fed has more “shots in the locker”. Fed chair­man Jerome Pow­ell told us that we’re “a long way” from neu­tral. From its cur­rent level of circa 2.25%, the Fed “dots” an­tic­i­pate a Fed funds rate a lit­tle above 3% by the end of 2019.

Third, the Fed is forecast to re­duce its balance sheet (hold­ings of trea­suries and mort­gage-backed se­cu­ri­ties) from around $US4 tril­lion to $US2 tril­lion by Fe­bru­ary 2021. In other words, one of the big­gest buy­ers of bonds in re­cent years is ab­sent from the mar­ket.

Fourth, de­spite be­ing at full ca­pac­ity, the US is forecast to run a bud­get deficit of close to 5% of GDP in 2019. In my view, this goes stun­ningly un­re­marked upon in broader mar­ket com­men­tary. Not only does the US fis­cal po­si­tion add to in­fla­tion but to fund the deficit the US Trea­sury has to is­sue more bonds.

In­ci­den­tally, and a lit­tle iron­i­cally given the pro­tec­tion­ist cru­sade con­ducted by the US ad­min­is­tra­tion, the ex­cess de­mand cre­ated by that fis­cal stim­u­lus will in­evitably spill over into more im­ports. Per­haps the pres­i­dent should look in his own back­yard be­fore ac­cus­ing the Fed of hav­ing gone “crazy”.

Do­mes­tic head­winds

That is all bad enough but I haven’t even touched on the do­mes­tic im­pli­ca­tions. There are emer­gent head­winds to meet­ing the Re­serve Bank’s rel­a­tively op­ti­mistic growth forecast of a lit­tle over 3%. In large mea­sure this re­flects an un­com­fort­able con­flu­ence of the im­bal­ances wrought by ex­ces­sive house­hold debt (mostly mort­gage debt) and a de­te­ri­o­rat­ing Chi­nese growth out­look, which it­self is a com­bi­na­tion of do­mes­tic im­bal­ances and fall­out from the trade dis­pute with the US.

I think that this means the RBA won’t be lift­ing rates un­til at least 2020 be­cause in­fla­tion won’t get suf­fi­ciently in­side its tar­get range.

In terms of the con­se­quences for mar­kets, the most ob­vi­ous one is fur­ther and po­ten­tially sharper falls in the $A as the in­ter­est dif­fer­en­tial with the US rises, with the RBA on hold and the Fed push­ing on with rate rises.

This may be an im­por­tant safety valve that ul­ti­mately cush­ions any diminu­tion in growth – but it is only a cush­ion and only oc­curs af­ter a lag.

The other con­se­quence is that house prices may con­tinue to de­cline. Con­tin­u­ing curbs on pri­vate lend­ing (reg­u­la­to­rily in­duced or self-im­posed by the banks in the wake of the royal com­mis­sion) may in­ten­sify de­fla­tion in house prices, re­duc­ing house­hold wealth and thus house­hold con­sump­tion and send­ing GDP growth lower.

So the re­cent tur­moil on global mar­kets does have real con­se­quences for us here. As bad as the ’70s? Prob­a­bly not, but de­press­ing none­the­less. And if that is not enough, I can dust off my ’70s Joy Divi­sion vinyl!

Newspapers in English

Newspapers from Australia

© PressReader. All rights reserved.