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Alert! This week has seen a spasm in global financial markets. The major U.S. stock index, Standard & Poor’s 500, is now down more than 20 percent from its peak, the technical definition of a bear market. The stock price of American high -tech companies is down even more. The cyber currency is still down, with the largest, Bitcoin, falling more than half this year, and a few more are now worthless.
And now we get a response from the world’s central banks. Today the Federal Reserve is expected to announce an interest rate hike. Tomorrow the Bank of England is expected to do the same, the only problem in both cases is that the amount increases.
In Europe, the situation is slightly different, as the European Central Bank has not yet moved, but only signals that it will raise rates next month. But this is enough to cause the debt of the eurozone economy to weaken, especially in Italy. The ECB held an emergency meeting this morning and made a claim designed to calm the market.
What can we learn from the past few days
So there’s a lot going on. When the market is in turmoil, the problem is to sort out what’s new and important, and what’s just a nuisance – and then figure out what investors need to do about the situation.
We have learned some new things in the last few days. One is that central banks, especially the Fed, have died serious about controlling inflation. He acknowledged that the previous attitude, that inflation would be temporary, was wrong. So they will stop quantitative easing – in effect printing money – and they will increase interest rates. This will affect the amount of credit and the price. It will be more difficult to borrow, and it will cost more. We don’t know how high interest rates will be, but they will be higher than the market expected even a week ago.
A boring investment is better
Next, we have seen that the more risky the investment, the more likely it is to fall. Not only the shares of go-go companies, even successful ones such as Apple, have fallen more than stodgy and boring companies. The search for solid profits has led to an increase in the value of solid but unfashionable companies. So Apple shares are down 27 percent so far, while Shell shares are up 34 percent.
One of the side effects of this change to stodgy is that the UK market relatively has not done badly. The FTSE100 index of the largest companies quoted in London is just down 3 percent in the year to date, compared to 21 percent for the S & P500, 15 percent for Germany’s DAX index, and 16 percent for France’s CAC. index. However, the price of UK medium companies has been hit hard, with the FTSE250 index down 19 per cent since last December. So nothing can be celebrated there.
We’ve also learned that investors are scared, they want dollars. They may not want American stocks but they want the currency. The dollar is currently at a 20 -year high against a basket of currencies. The pound has been hit by fears about the UK economy, but the push down to $ 1.20 is partly a function that the dollar has got stronger against it all. US Bank Wells Fargo thinks that euro will be parity with the dollar, which has not happened since 2002.
Cryptocurrencies are unreliable
Lastly, the easiest and most difficult lesson. Crypto-currencies are not a hedge against inflation. This is an interesting idea that private sector money will be safer than fiat money made by the government. Crypto is restricted in supply, decentralized, and immune from political pressure, all attributes not owned by the government. Now we know that is wrong. The traditional fence against inflation, gold, is not a perfect fence but it has done a looks better rather than crypto-currency. It was around £ 1,350 per ounce on January 1, and is now more than £ 1,500.
How have you implemented the lessons of the past few weeks? The big question and everyone’s situation is different. The best answer is that investors should spread the risk. Bear markets typically last between nine months to 18 months. We may not be at the bottom yet, but no one knows where it will be and now it’s worth it. There are good solid companies around the world that make profits, and pay dividends. The dividend yield on the FTSE100 is currently 4%. Historically stocks have provided protection against inflation. There may be a global recession and there will be profits, but if there is, there will be a recovery. There is a business cycle, even if Gordon Brown thinks he has eliminated the boom and bust.
So, we should not be afraid of bear markets any more than we should be afraid of higher interest rates. I think we can squeak by without a recession this year. But if there is a recession there will be a recovery, and in the meantime, there is an opportunity to invest. Warren Buffett, the legendary American investor said in 1986: “We only try to be afraid when other people are greedy and become greedy when other people are afraid.” That of course applies now as it does now.
Need to know
What surprised me the most last week was the crash in the European bond market. In financial terms, this is more important than a crash in crypto, because the market is larger. The total value of the euro zone’s national debt is about $ 13 trillion, roughly the same as GDP. The total value of all crypto-currencies is less than $ 1 trillion.
But the bond market has always attracted less than equities or crypto-currencies because they are less fashionable. As mentioned above, the ECB held an emergency meeting as Italy’s 10 -year debt result rose by more than four percent.
Because Italy has more debt than any other European country after France, the real danger is the unspoken fear of all European bankers.
Earlier this year, Italy’s 10 -year state debt yield was 1.2 percent. On Tuesday evening it was almost 4.2 percent. While Italy has been able to repay its debt when interest rates are very low, as it has been for the past decade, having to service 4 percent becomes even harder.
The markets were scared
Actually, not all debt that needs to be rolled out will come this year or next. So for some time Italy, like other borrowers, has been isolated from increases in rates. In that sense, they are the same as having a mortgage with a fixed rate for several more years. But the market is scared.
At any rate, the assurance that the ECB is in the case (even if the language is bland) reduces the outcome of the debt. This dropped again to 3.8 percent yesterday. But if long -term global interest rates continue to rise, pressure will remain on weaker borrowers. In the case of the euro, Italy is the weakest link.
Italy must go
But Mario Draghi is now the Prime Minister of Italy and I noticed that one of his advisers, he said this week if the ECB makes a mistake when raising rates. The Prime Minister’s office said he spoke in a personal capacity, but it would be surprising if he said something that Mr Draghi did not think of. At any rate, Italian pressure on the ECB to keep rates down and thus reduce pressure on Italy has been seen.
Where is this done? I don’t know, but I see another crisis looming for the euro. Eventually I thought that Italy should go, but how and when is unpredictable.
My new book on the future of the world economy, The World in 2050, is available here. I would very welcome your thoughts on that.
This is the Economy Chair with Hamish McRae, subscriber-only newsletter from i. If you want to get this straight to your inbox, every week, you can sign up here.
