Any addiction takes time to develop, but once fully formed, it becomes routine and eventually ‘normal’ behaviour.
Since the start of 2016, we have seen the asset markets developing a strong addiction to central banks around the world, which have been feeding them with monetary policies of all sorts.
Equity markets have been rising quarter after quarter, irrespective of the economic, political or social backdrop. Today we are observing such a strong feeder/addict relationship between central banks and markets that equity markets have complete faith in the central banks to always deliver the ‘sugar’ to them. In 2016, for example, it was China’s turn, injecting $1.4trn in the system.
‘Sugar’ has been fed to assets everywhere in the form of central bank balance sheet expansion. The latest data from the BIS (see chart below) indicates a further $70trn of debt added to the global central bank’s balance sheets since the debt crisis. Markets have made central bankers the most important people in the world, who choose to keep inflating yet another bubble – this time everywhere.
The consequences are far reaching. We have returned or surpassed the levels of indebtedness seen in 2007 everywhere, from finance, consumer, government and corporate. We have inflated bubbles in asset markets, we have inflated demand to unsustainable levels, (for example in autos, where in the UK over 80 per cent of all new cars are bought on finance) and we have funded share buybacks to levels last seen in 2007. We have stopped the capital cycle from functioning and allowed an abundance of new capacity to exist. Tesla is one poster child for this.
But a diet of sugar alone, devoid of protein, will wither the muscles. And this is happening across economies, corporates and society. Corporate leverage in the US is not being invested in future cash flows but instead in short term ventures such as buybacks. With the key beneficiaries of asset inflation being the top 1 per cent society has been divided unequally, causing Brexit and increasing the popularity of Trump and Corbyn. With the structural headwinds of ageing population, debt drag, surplus capacity and increasing protectionism, the world remains stuck in a low-growth scenario.
And yet, the consensus would have us believe we can now simply end this sugary binge as easily as we began it, and that there will be no costs or consequences. This is naïve, as we believe the addiction will be much harder to break, both for the addict and the feeder. Much of today’s world is addicted to low rates and excessive debt, and any withdrawals will be met with ‘just one more mint’. Yet it is John Cleese presenting the bill at the end of this Monty Pythonesque scenario that is the most important factor. There is a bill to be paid, and as these sugar-high valuation levels gradually retreat, we will all be paying the bill via low future returns.
Nick Clay is a portfolio manager at Newton Investment Management