The term ‘secular stagnation’ suggests a prolonged period of low growth, low inflation and high unemployment but it is quite tempting to opt for a less formal definition along the lines of an economic condition during which official monetary fails to stimulate growth.
In the US, the FOMC seems increasingly divided over when to start raising interest rates but somehow still unanimous in denying that ZIRP and QE2 and 3 have all been largely futile. This denial has put Committee members in a bind. On the one hand, they are concerned about asset price bubbles but on the other are also are worried that raising interest rates could cause a stock market crash and drive businesses and households into crisis. In this rarefied world they are joined by investors who know what FOMC members think and even know that they know they know and vice versa! There are similar worlds occupied by the ECB, BoJ and PBoC. On this basis, it is possible to assume that money will remain cheap indefinitely, asset prices will keep rising and that central bankers, while nominally at the helm are unwilling and unable to steer in a new direction. This is not attractive to your typical central banker!
So what’s do be done? Almost certainly, follow the Bank of England in doing nothing for an indefinite period while opening up new lines of research on macroeconomic and monetary policy. This could well lead to the conclusion that private debt is just as relevant to growth as public debt and that it is the commercial banks that separately and cumulatively determine aggregate credit. In fact, the Bank has issued research notes that suggest it is half way there already. This is a subject for much future discussion but in the short-term it suggests that rates should not be raised until both growth and inflation look to be firmly established. In the meantime, it is probably best to let equity markets correct (the UK market does not look outrageously expensive anyway) and speculation in gilts burn itself out. More controversially, it might be worthwhile to regulate more precisely lending for speculative investment.
Selling off now assets acquired under QE programmes would represent premature tightening but allowing some to run-off without replacement might reduce ongoing distortions to market rates. Again more controversially, such a run-off might create some space for the central bank to fund directly public investment. Such controversial policies would be more fiscal and, therefore, political than monetary and would throw into question the need for an independent central bank. Don’t hold your breath!
It is definitely time investors for investors to wake up to the unreality of the world they share with central bankers. Writing in the Financial Times George Magnus put it well:
Speculative euphoria, even when encouraged by central banks, is defined by the way it ends — not with a whimper but with a bang….. Investors are still chasing low or negative yields in bond markets, fairly or fully valued equity markets, and rising property markets. Yet, it seems increasingly that, long-term investors aside, they are playing a greater fool game.
Investors often get their timing wrong often disastrously and the following chart shows that we may be at or close to another turning point where there will not be a greater fool waiting to buy.
Sovereign bond markets have become the gaming tables of speculators as who else could justify buying assets with negative yields to sell on to an even greater fool?
Turning again to George Magnus:
……the persistence of low real interest rates implies an environment of low real investment returns. So any euphoric returns today will be counterbalanced as night follows day. Central banks may be going boldly to the outer limits of monetary policy to encourage investors to buy risk, but it is difficult to reconcile the appetite for risk with what those policy actions actually imply.
Should investors throw in the towel? It is a conundrum. Institutions are still buying European debt on negative yields. Investors who have missed the doubling of the Chinese stock market since mid-2014 wonder if they can afford to stay out.
At least the penny appears to be beginning to drop amongst some people as shown in a recent BofA/Merrill Lynch survey of fund managers. Increasing one’s cash holding seems a smart move even if one is too superior to go for all that ‘sell in May’ stuff.
Regular readers will be aware that I advocated in March last year selective selling of equities and avoiding sovereign bonds. This may have cost money but it has also saved many sleepless nights. It is still not too late to do so now. However, I remain as convinced as ever that some individual stocks will ride though any storm provided one is willing to see them drop by up to 20% before recovering again. I also believe that returns as low as 4-6% through fixed rate coupons dividends or even capital appreciation are worth considering during a period of low growth and low inflation.