November 21, 2017

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Goldilocks continues to rule

credit - goldilocks environment

Goldilocks continues to rule in investment markets

A Goldilocks environment is one where there are no extremes – economic growth is positive but moderate, inflation is low, exchange rates fluctuate within a comfortable range, central banks pursue market-friendly money-creation and interest-rate policies. Conditions are neither too “hot” nor too “cold.”

The year did begin with a shock for equity bulls. Markets took a sharp knock. However, by early February a rebound was under way, and in early March the most important and best-performing of the major markets, America’s, set a new high.

Such a pause for breath or “technical correction” was widely expected, even desired, by professional stock-watchers, as confirmation of markets being in a sound uptrend without developing into an unhealthy bubble.

The real surprises this year have been in unfashionable assets – gold and bonds.

Gold prices went into decline from September 2011 despite a money bubble that inflated the values of other investment assets. The explanation seems to have been that when widely-predicted inflation caused by all the easy money did not appear – in fact we have been experiencing disinflation – speculators and investors steadily abandoned the yellow metal for more promising asset classes, especially equities.

Gold set a bear-market low of just under $1,200 an ounce at the end of June before rallying. At the end of December it repeated that low. But it did not breach that level. Chartists would say there was a “double bottom” — a potentially important signal that the metal is stabilizing and building a base from which to launch a renewed bull market.

Since the beginning of this year, gold has been rising strongly, and greatly outperforming equities as an investment class.

The other surprise has come from bonds – about which so many otherwise-respected investment advisers have been consistently wrong for so long.

After plunging in value in May and June, the US’s ten-year Treasuries fluctuated for the rest of last year, but with a downward drift. However, with the arrival of 2014, the bonds rallied strongly in the same way as gold.

Germany’s long-term government securities, the Bunds, have proved to be far better investments than the Treasuries. They bottomed earlier, have been rising more strongly this year, and have recovered almost all they lost in last year’s bond-market “heart attack.”

Where are the markets likely to go from here?

The US economy continues to grow, but slowly. There is less fiscal restraint in an election year. The housing market is strong, but losing some momentum. Inflation continues to trend downwards, and by some measures is below 1 per cent. Unemployment continues to fall, but mainly because fewer people are looking for work, and the quality of employment is poor (too many low-paid and part-time jobs). For years all the fruits of economic growth have been going to the 1 per cent at the top of the pile.

The European economy is struggling to achieve any growth at all. The banks aren’t lending as their balance-sheets are remain too loaded with dodgy assets. Because of stifling over-regulation, austerity and high energy costs, businesses are unwilling to expand – except outside Europe – so few extra jobs are being created to soak up unemployment.

The Ukraine crisis is no help. And political divisions within Europe are worsening rather than improving, as electorates become increasingly alienated from the elites that rule them.

China continues to expand at a phenomenal pace, the government having set a target of another year of plus-7 per cent growth. But the risks are well-known – a huge and poorly-controlled secondary banking system, bubbles in toxic debt and real estate, and a seriously unbalanced economy. Although unlikely, a hard landing would have major global consequences.

Japan has embarked on an aggressive programme of reforms dubbed Abenomics, but the outcome is uncertain. The easy bits have been done — a much weaker currency, unprecedented money “printing” and fiscal stimulus. So far little progress has been made yet with the politically-difficult reforms such as liberalizing trade, labour and business markets.

Emerging economies are critically important for the world economy as they usually account for half its annual growth in purchasing-power terms. Recently they have had a hard time because “tapering” by the US central bank triggered diversion of capital from them, and focused international investor interest on lower-risk developed markets. However, conditions are improving in several of them and the outlook for economic growth is good, at least in Asia.

CopyRight – OnTarget 2014 by Martin Spring