World financial markets have run the gauntlet of some very tough challenges in recent years, but it is far from over. Having survived the worst effects of the global crash, financial meltdown in Europe and growing geopolitical uncertainties, investors are not out of the woods yet. The worry is that markets are just about to topple out of the frying pan into the fire.
Over the next few months, investors will have to pick their way through a minefield of deadly dangers posing more upheaval for risk assets, market volatility and financial stability. Unfortunately, global policymakers may be running out of options to deal with these new threats as they arise.
The last thing the world economy needs right now is a meltdown in stock market confidence
In recent weeks, the investment climate has deteriorated at an alarming rate. Escalating tensions between the major superpowers over the Middle East and the spectre of a US military stand-off with rogue state North Korea should have left the bull market for stocks dead and buried long ago.
It is no exaggeration to say the world could be on the brink of a nuclear skirmish, but the markets are still acting like they have their heads in the sand. Sure, there may be some nascent switching into safe haven bolt-holes like gold, German bunds and the Japanese yen, but to all intents and purposes there is no real sense of dread, with investors hitting the panic button and piling into landslide risk reversals.
In a way, it is hard to blame investors who have been encouraged to act with “irrational exuberance” for so long, pumped full of quantitative easing (QE) steroids, flush with cash and desperate not to miss out on an eight-year jamboree for risk assets. It is what the global authorities had always hoped for – a solid financial market rebound aiding speedier world economic recovery.
Markets stopped making sense long ago, looking increasingly detached from fundamental reality. In the last eight years, this has been a liquidity-driven rally, with self-sustaining global economic recovery still hanging in the balance once the policy stimulus goes into reverse, especially now the US Federal Reserve has the tightening bit between its teeth.
World trade growth is looking as flat as a pancake, China’s growth locomotive is losing momentum, emerging markets look overstretched and there is still a huge question mark hanging over the future of a united Europe and the euro. The last thing the world economy needs right now is a meltdown in stock market confidence triggered by a sudden shock to global political stability.
Markets could be staring into the jaws of a very vicious downward spiral as increased uncertainty and falling stock markets feed back into weaker consumer and business confidence, reduced spending and investment and slower growth around the world. This time around, there would be very little to stop the rot as the major powers have pretty much exhausted the best part of their fallback options.
A few months ago, markets were riding high on expectations that President Donald Trump would “save the world” with super-stimulus and redemption for the US economy. Now investors are confused by Trump’s mixed policy signals, his growing policy failures on the home front and fears that Trump is looking to reap better success in overseas military ventures.
This is a long way from Trump’s promised land of “America First” and offers nothing positive for investors to latch onto. Waging bombing raids on Syria and Afghanistan and sending a US battle group steaming toward North Korea may do wonders to boost Trump’s political virility ratings, but not at the increased risk of head-on confrontation with North Korea, Russia, Iran and China.
All of a sudden world politics seem to be spinning out of control and this is no good for investor well-being. Investors are losing their traditional compass bearings and customary safe haven sanctuaries are losing their appeal.
Investors will need to pull in their horns and reduce equity exposures, but the options are limited. German bunds are mainly steeped in negative territory and holding cash remains a zero-return play.
Foreign-exchange-wise, Trump is dead set on talking down the dollar, the euro is vulnerable to severe political setbacks in the next few months and the yen remains dogged by chronic deflation doubts. The Swiss franc remains an expensive alternative for investors. It is no surprise gold offers so much allure for those seeking protection.
The day of reckoning is approaching fast and investors have fewer places left to run and hide.
David Brown is chief executive of New View Economics