The world’s financial markets are in an uncomfortable place this morning. On average they seem to have lost around five per cent of their value yesterday. No doubt they will swing all over the place today, because that is what always happens when events like this occur. But what does it mean?
I suggest there are a number of phenomena to take into account, the realisation of all of which is growing.
First, there is euphoria. This is firstly implicit in the share price itself, with the Dow Jones up 34% in the last year.
Second there is euphoria that, as I noted yesterday, there is currently growth in the world economy at above the long term sustainable rate.
Third, there was some sense of relief, if not euphoric, that inflation was returning, because that was what markets want.
Fourth, this gave rise to another euphoria about interest rates, which was that they might return to ‘normal’.
Fifth, central bankers responded by suggesting that they might respond to all this by raising rates. So it was ‘triples all round’.
But underlying it all was a sense of fear. Fear, for example, that the rent seeking outsourcing that has driven so much market activity for so long may be at an end with the collapse of Carillion and difficulty of Capita and Virgin.
And a sense of fear that although house prices - that universal barometer of well being for those who have more than they need to live off - might have peaked as over supply of vanity accommodation becomes apparent in London and elsewhere.
Coupled to which there may just be concerns about Brexit.
And a sense that a Trump tax cut may not be all good news if it results in massive deficits.
Whilst the perception that governments simply can’t deliver in the two biggest financial markets of the UK and US might be very real indeed.
So what happened? Euphoria hit reality yesterday, I suggest. I make clear, I am only guessing, but there is evidence to support the hypothesis.
First, there had been a disconnect from reality for a month or so in bond markets. They were seeing prices fall as interest rate perceptions, potentially reasonably, rose. But stock markets were not falling to reflect the growing risk that this represented. For a month or so there was a disconnect.
And that disconnect even continued when interest rates on 10 year government bonds in the US moved beyond 2.6%, which is more than two standard deviations from their long term downward trend rate, and then went well beyond it.
As I have long said, that meant that at some point the market’s confidence would be tested. The idea that ‘this time its different’ was bound not to last forever. And yesterday it looks likely that the euphoria ended. Time will tell.
But if it does end, what then?
First, interest rates may not rise after all. They may not need to do so. Interest rates would only rise with inflation and inflation in the US at present represented some returning confidence. The end of euphoria will sap that confidence. Perversely, that may in turn bring to an end the speculation that rates will rise.
Second, if the euphoria ends then the above sustainable growth rate economic growth will also go with it. There is no direct relationship between markets and real economic activity. Indeed, it often appears that the two are wholly unrelated. But that is not entirely true: sentiment is the link. And sentiment matters, a lot. People only invest if they feel good about the future. They feel good when they’re euphoric. They never feel good on the frown side. So growth will slow, and rapidly, because investment will fall.
Third, other asset prices are going to fall. Property in the UK is an obvious one, where over-supply of apartments to the rich is going to give rise to a serious price adjustment, and soon.
Fourth, expect all this to have knock on effects. The supposed high employment rates of the present time may well be a memory very soon.
So is it going to be a crash? I am presently doubting it, although I would expect a lot of recent market gains to disappear. For the FTSE to fall well below 7,000 but maybe stop before 6,000 would seem entirely plausible.
But that’s not the big concern. What really matters is the real economy. And there I see Brexit fears, market fears, property valuation fears and more having real impact and really hitting the economy hard.
Once upon a time I created People’s Quatntiative Easing for a situation like this. It really will be time to roll it out soon. I think we are going to need it.