Low growth may be the ‘new normal’ for world markets

Last year proved to be a difficult one for global investors. 

It was dominated by the Federal Reserve, China, commodity price deflation, and related emerging market pain.

Geopolitical events abounded — a massive migration of people out of troubled parts of the Middle East and Africa heading to Europe, a number of key elections (the most recent being Argentina, Spain, and Venezuela), a very profound political crisis in Syria which now involves Iran, Russia, Europe, Turkey, and the United States, an uptick in radical Islamic terrorist attacks (Paris), and an unravelling of the old political order in Brazil.

The combination of the above factors played out in world stock markets.

Investors were confronted with several rounds of volatility, a painful downward plunge in energy and commodity prices, as well as related bonds and equities, increasing worries over the health of the high-yield market, and a cooling in US corporate profits.

However, from an Irish market perspective it was a very positive year.

In a year that saw the Republic of Ireland and Northern Irish soccer teams qualify for Euro 2016, Irish stock market “fans” had their fair share of wins also, with the Iseq up around 30% in the year, boosted by the very strong performance of the Irish economy.

But if investors around the world thought 2015 was difficult, it looks set to pale into insignificance compared to 2016.

We are less than two months into the new year and already it is turning into an “annus horribilis” for financial markets, with share values falling sharply across the globe and no sign of stabilisation in sight.

Indeed, if things don’t improve soon then it won’t be too long before the Irish equity market gains of last year are completely wiped out even though the economy looks set to be the fastest growing in the EU again this year.

It is difficult to know what the exact catalyst has been for the market unrest but the dramatic announcement at the end of January by the Bank of Japan that it was pushing its deposit rate into negative territory hasn’t helped.

The move has now seen Japan join the eurozone, Switzerland, Sweden, and Denmark in the negative-rate club.

Banks are the new focus and source of concern for financial markets, though we never really put to rest worries over oil/commodities, China/emerging markets or premature Fed interest rate lift-off.

While it would be nice to have a single trigger to explain the current market ills, the real story is intensified investor demand for safe and secure assets.

Worryingly, investors are willing to pay for the privilege of owning such safe and secure assets — especially liquid government bonds.

There are currently $6tn of negatively yielding bonds globally, double that of two months ago and compared to none a year-and-a-half ago.

Investing used to be about making a positive return and beating your peers.

Now it’s morphed into a game of who can lose the least money and beating falling benchmarks.

When investors are willing to stomach negative yields, it’s hard to convince economic agents — households and firms — to take risks and boost consumption and investment.

Negative long-term yields are a headache for relatively conservative investors such as pension funds, whose returns from relatively safe investments are evaporating.

They are also potentially damaging for banks’ balance sheets and interest margins as yield curves flatten despite negative central bank deposit rates.

And they are a problem for policymakers trying to build confidence in economic recovery and hoping to avoid deflationary expectations becoming embedded amid increasingly brittle global markets.

In many ways, negative yields are a reflection of how impotent central bank policy has become.

Policymakers have slashed interest rates to zero, or lower in some cases, and pumped up markets with trillions of dollars of stimulus, yet inflation and bond yields have stubbornly refused to rise. In many cases, they’re lower than ever.

That tells us that policy is not working and that you’re storing up a whole load of grief for the future.

Negative rates have so far not been a panacea for the eurozone’s economic woes.

Rates have been negative since June 2014, but unemployment remains above 10%, with inflation below 1%.

The real question is whether more rate cuts/negative rates or central bank balance sheet expansion will achieve what has proved elusive for seven years.

We have been through this script with Japan far longer than other central banks and yet the country is still combating deflation.

While the consensus is that the current environment is temporary/cyclical, the risk is that the headwinds to growth and inflation might prove more structural.

Indeed, we might already be at a new normal whereby pre-global financial crisis growth was in fact abnormal and an aberration and low growth/low inflation is the new norm.

Alan McQuaid is chief economist at Merrion Capital


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