There has been an increasing amount written in the press of late about a seemingly inevitable ‘massive crash’ in markets. During the course of any given week, I read a good number of articles explaining why “the end is nigh”, usually with a compelling sounding catalyst as to why this is going to happen any day now.
A few weeks ago it was all about Brexit. The last week or two it has been all about Deutsche Bank but in the recent past I have seen commentators point to a veritable cornucopia of reasons why the proverbial is finally about to hit the fan. In no particular order:
- Geopolitical tension in Syria and the wider middle east (lest we forget the dismal state the Yemen, Egypt, Somalia, South Sudan, Libya and a few others are in),
- the risk of a Trump election victory,
- the risk of a Clinton election victory,
- Italian banks going bust,
- French banks going bust,
- the threat of a water war between India and Pakistan – both nuclear states,
- the rise of Rodrigo Duterte the worryingly homicidal new President of the Philippines,
- unprecedented poverty and starvation in Venezuela – a leading oil producer.
There are even seismologists this month flagging the grim prospect of a magnitude seven or higher earthquake being on the cards some point soon in California given a recent swarm of small quakes in the region.
The list of doom goes on and on and on…
Of more relevance for financial markets and shares specifically: Many markets are at or near all-time highs as are corporate profit margins, implying they will struggle to go any higher. When corporate profits fall – as they very likely will - so do share prices. Global trade is stalling, which is generally bearish (for everyone, not just investors) and stock markets have also now been going up for many months longer than they usually do on average before there is a crash or pull-back. The metaphorical rubber band is stretched very tightly indeed and everyone is standing around wincing in anticipation of the disaster to come.
In addition, much of the buying volume which has driven stock markets to these heady levels, has come from companies themselves:
A trick many Chief Executives are very fond of when interest rates are as low as they are right now is to have their company borrow lots of money and use that money to buy back their own shares.
Without wanting to get too technical, this drives up earnings per share and, cynics might suggest (correctly as it happens), their justification for paying themselves large bonuses (as a result of the ‘growth in earnings per share’ ‘they’ have produced for the company).
You can see this in the chart below. Total buybacks (that is companies buying their own shares) are at record highs not seen since just before the financial crisis of 2008 / 2009. Oh dear! It gets worse: Interestingly, you can also see that corporates are essentially the only buyers in town given that the bottom half of the chart shows net quarterly fund flows are heavily negative – i.e. more conventional investors such as pension funds and hedge funds are big net sellers and have been for some time.
The same is happening in Europe.
Amazingly, European firms Deutsche Bahn, Henkel and Sanofi have all managed to raise debt at zero or even sub-zero interest rates in recent months. To be fair, I’d probably buy back my own shares if people would pay me to borrow their money and I’d then be able to pay myself a massive bonus too. The world is going truly insane.
This sort of craziness and companies all over the world borrowing money to buy their own shares would be bad enough but there is another buyer in town that is, arguably, even more of a red flag: Central banks.
The Swiss central bank (SNB) now owns more publicly traded shares in Facebook than Mark Zuckerberg. As we have seen, companies can borrow at very low or zero interest rates to buy their own shares. Central banks, in control of their own currency, can essentially invent money out of thin air to buy shares in whatever they want.
At the end of August 2016, the SNB held over CHF 127bn worth of shares, up 41% on the year before. It is not just the Swiss playing this game - the Bank of Japan already has enormous holdings in many leading Japanese shares and will be the top shareholder of 55 Japanese companies by the end of 2017 based on statements they have already made.
It looks as if the European Central Bank (ECB) and US Federal Reserve are hot on their heels!
To any student of capital markets, this looks truly as if the lunatics are taking over the asylum. When central banks are propping up stock markets, it seems likely that there is an unprecedented misallocation of capital going on. Authorities the world over are breaking capitalism in front of our very eyes. This isn’t going to end in tears. It is going to end in blood in the streets, revolution, war, pestilence, famine and quite possibly the opening of the seventh seal.
Or will it?
Next time I will seek to answer this question and talk about how you might consider investing given what is going on. In particular, I will look at two things that might help readers muddle through in some shape or form: First, how the difference between nominal and real numbers is going to be more important than ever (and how you can benefit from this reality) and, secondly, that it might actually be that technology saves us this time.
If you invested in the Railways in the 1840s you very likely lost your shirt. If you invested in the 1860s onwards (roughly), you had a good chance of becoming very wealthy. I think this is in some way analogous to the dot.com crash of 2000 / 2001 as compared to the value creation of the last few years: A significant proportion of the stock market's sensational rise (the S&P500 has gone from 666 to 2,150) in the last few years, has come from the biggest and most disruptive tech stocks: Google, Facebook, Amazon, Apple and so on. This time, these companies actually have literally billions of clients and profits as a result and are trying to solve human problems like no other entity in human history. The same can be said of a number of $100 or even $200 billion biotech and pharma companies who are getting ever closer to curing things like cancer, Parkinson's disease, dementia and a host of other things. All of this has created real economic value.
As I say, more to follow next time. Please watch this space. In the meantime, please don't hesitate to get in touch with any questions or thoughts and don't hesitate to forward or share these thoughts with anyone you think might find them interesting or benefit from sorting their finances out!