By Vern Gowdie – The Daily Reckoning (Australia)-
When is the All Ordinaries going to breach the 6000-point level?
It’s been nearly a decade since the All Ords went through the psychological 6000-point mark.
It came tantalisingly close in March 2015, but then the market lost its footing and fell back to 4800 points.
Since then, the market has advanced and declined its way back to 5500 points…the same level it was in April 2014.
For two and a half years the share market has gone nowhere. In standing still, investors have had to endure two substantial corrections — 10% in late 2014, and 20% in 2015. Not my idea of risk and reward.
Investors are buying shares for yield — a fully franked dividend of 5% looks attractive compare to a 2.5% term deposit. However, is an extra few percent in income worth the risk of exposing your capital to an asset class that is in a highly fragile state? There is any number of issues out there threatening to bring the economic house of cards down, taking financial markets with them.
Where is the ‘oomph’ going to come from to push the All Ords higher?
The trends at play in the global economy indicate there is a bigger chance of ‘oops’ taking place than there is of ‘oomph’…
- Global debt — as a percentage of GDP — is at record levels. How much more can be added to the global debt tally? Don’t forget, it was this existing debt pile that created the ‘growth’ of the past four decades; if we don’t replicate the same level of debt accumulation in the coming decades, then, logically, lower growth ensues. Perhaps we can grow debt to the sky indefinitely. But that’s an awfully big assumption to make with your capital. Because, if it turns out the gorging on debt leads to regurgitation (debt defaults, write-offs, losses), it will be very messy for markets.
- Global interest rates are at historically low levels. When interest rates started at 18%, it was easy to keep the cost of money down. Now that we are zero to negative — and experiencing significant pushback on negative rates from unprofitable banks — how much lower can rates go? Not a lot. If you cannot make debt cheaper, how can you add more to the debt pile to fund the ‘oomph’ needed to push markets higher?
- Baby boomers are progressively moving beyond their economically productive years. The credit card wielding consumers of yesterday are moving into retirement. Their focus is on saving (for those approaching retirement) and trying to live on their meagre returns (for those in retirement). Will Gen X, Y and the millennials pick up the debt-funded spending baton, or will they opt for a less consumption-based lifestyle?
- The need for banks to recapitalise after the GFC means banking deregulation has probably gone as far as it can go. Banks being put on a tighter regulatory leash means the free-wheeling days are over. Acting with a little more restraint means less debt being injected into the system…the very fuel needed to replicate the growth of the past.
- Asset markets are at record levels (the US share market, and major capital city property markets). Central bankers wanted economic inflation and instead created asset price inflation. Zero interest rates have forced investors to bid up the prices of any asset paying an income…even junk bonds. Any movement higher in interest rates will trigger a rush to the exits. Asset prices are a bubble in search of an interest rate pin.
- Global competition within the labour market, together with the increasing use of automation, is suppressing wages. This is evident in the inflation adjusted median income of US households (the world’s biggest consumer economy) going nowhere since 2000…yet, living expenses have increased significantly over that period. Bill Gates saw the automation trend back in January 2007 when he wrote in the Scientific American: ‘As I look at the trends that are now starting to converge, I can envision a future in which robotic devices will become a nearly ubiquitous part of our daily lives …’ With incomes under pressure from robotics, how can households feel confident in taking on more debt?
Summary of possible outcomes
Debt levels may expand, mainly from the public sector funding a variety of stimulus projects. Although, the ability to issue bonds would be challenged if the next credit crisis results in sovereign debt default/s. Investors and ratings agencies may take a far more cautious view. We are already seeing Standard & Poor’s warning the Australian government to get its house in order or risk a downgrade to our AAA rating.
It’s hard to see global interest rates doing an encore performance in the coming years. They may go a touch lower — albeit Australia’s cash rate is likely to go below 1% — but the capacity to keep making money cheaper is becoming harder and harder with each rate cut.
There is already discussion among respected economists over the merits of negative rates…they are not doing what the academic models suggested would happen. People are saving instead of spending.
A society with an ageing population, combined with a birth rate that’s not replacing itself, is a recipe for economic disaster…just look at Japan. Do governments increase immigration intakes, and/or cut back on benefits to the elderly, and/or increase the rate of broad based taxation (GST)…or all of the above?
Immigration intake is a political hot potato after the Brexit vote. Even if you do increase the intake, there have to be more productive (rather than unproductive) immigrants allowed into a country…otherwise you are compounding your welfare payment problem.
In all likelihood, we’ll see a combination of all three factors, but with different weightings applied. Tougher cuts to future welfare payments. Incremental increases to GST. A continuation of current immigration programs balanced between humanitarian and financial considerations. That is, provided Western countries remain a preferred destination after the next credit crisis hits.
It’s hard to see banks being permitted to expand beyond their current extensive range of products. My bet is on a form of re-regulation being introduced…possibly forcing the banks to spin off various parts of their business…enabling the riskier division to be more readily identified and valued accordingly.
Asset prices have been floated higher by a flood of QE. Valuations are high by historic standards. It’s highly likely there may be more upside left before the inevitable correction occurs. But participating in that period of temporary gain is akin to ‘picking up pennies in front of a fast moving steamroller’.
It would appear that global wage pressures are going to continue squeezing households in the developed world. Without rising incomes to finance greater levels of debt, economies (dependent on debt funded consumption) are going to struggle for growth.
The next 5–10 years are shaping up to be particularly difficult — tax increases, welfare cutbacks, wage stagnation, higher un- or under-employment, asset prices undergoing a severe correction, rising social tensions and an increase in political uncertainty.
These factors make it look more likely we’ll see more ‘oops’ rather than ‘oomph’ in the years ahead.
There will be opportunities, but only for those who are thinking about, and preparing for, a future that is shaping up to be different to what we have experienced in the past.
The investment industry will tell you that, in spite of these major disruptors, the share market will still deliver superior returns.
That might be true in 50 years’ time — after the disruptors have worked their way through the system. However, those with a shorter investment horizon — 10, 20, or even 30 years — may not live long enough to see the share market deliver on the industry’s promise.
If you think this is an exaggeration, here’s something to consider: The Dow Jones index reached a high of 350 points in 1929. It took until 1954 (25 years later) for the index to move permanently above this level.
The Japanese share market is still 50% lower than the record high it reached in late 1989…27 years ago.
Study the past to divine the future.