Until the beginning of October last year, equity markets had generally been faring well, while bond and commodity markets reflected firm underlying economic growth. Then, Q4 arrived and markets fell sharply in both October and December. The big question at the time and since was whether the falls represented the start of something pronounced and prolonged. In other words, had a bear market started?
"Fiscal stimulus is needed when economies are weak not strong"
Equity bear markets are almost invariably linked to economic recessions; they tend to precede them by an average of around eight months. Given the interconnectedness of the global economy nowadays this will tend to mean an economic recession that propagates globally, preceded by an equity bear market that in one way or another affects markets everywhere.
Although we started to prepare our funds for the next downturn a while ago, I do not think a global recession is imminent. There was, in my opinion, one key factor responsible for the Q4 market declines: the completely unnecessary tax cuts in the US signed into law at the end of 2017.
I say 'unnecessary' because the US economy was doing just fine, and so any fiscal stimulus such as the tax cuts was just going to add fuel to the fire - fiscal stimulus is needed when economies are weak not strong. Indeed, famed economist Nouriel Roubini described the cuts as the first expansion stage fiscal boost outside of wartime.
The economic boost provided by the cuts was positive, both for the US equity market and the dollar. In particular, investor exuberance focused on a small number of growth stocks, the FAANGs (Facebook, Apple, Amazon, Netfiix and Google). At the beginning of October, investors may have woken up to the fact that the rise in the FAANGs was unsustainable, and also that the tax cuts, rather than being a good thing, may simply have led to overheating and a greater likelihood of interest rate hikes.
Now things have settled down, we can see yield curves, the king of recession indicators, are far from making a firm move into negative territory. We therefore appear safe, for now.
Published in Investment Week
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.