Change has always been part of life. However, some changes are so dramatic and significant they alter the course of life and history for ever.
The global financial crisis (GFC) of 2008/09 put the global financial system at risk, triggering a great recession and raising the risk and fear of deflation.
We saw the advent of negative-yielding debt and interest rates in a number of markets. But thanks to unprecedented monetary policy interventions and measures such as quantitative easing and ultra-low interest rates by central banks, the worst was averted.
Post-GFC, despite a turnaround in economies and markets, most major economies have remained dependent on supportive policy measures, especially in the face of still large and growing debt levels.
A combination of these factors has led to sluggishness of major economies for at least the last decade.
On average, economies have registered lower growth than before such that concerns about secular stagnation – a condition when there is negligible or no economic growth in an economy over a long period– have been haunting many quarters.
The stock markets have benefitted most from stimulus measures; the average citizen less so.
Increasing income and wealth disparities – the so-called wealth gap – have become a growing issue, and have given rise to increasing populism.
Now, an unprecedented crisis with huge ramifications
Fast forward and the whole world has been plagued by the intractable coronavirus pandemic.
Shutdowns of economies and restrictions on socio-economic life have plunged the world into a crisis unprecedented in modern times. Many alive today never would have thought that they would experience a pandemic in their lifetimes.
The coronavirus has facilitated and accelerated changes across the globe, especially the utilisation of technology for remote working and socio-economic connection and interaction.
The lockdowns and restrictions affecting economies and societies make the current pandemic different from any that came before, necessitating major interventions to cope during this crisis.
Governments and central banks have dug even deeper to aid and support the economy and society during this very difficult and trying time.
The wealthier developed market governments are considering further economic support measures for their respective economies, even if it means upping their rising debt levels to do so.
Less fortunate countries, especially developing ones, are constrained on account of stretched and dire fiscal positions; many are struggling to even procure the necessary vaccines.
Through the fiscus and central banks, the pandemic crisis has further increased the role and influence of government in the economy – something that started with the GFC and has now been compounded by the Covid-19 pandemic.
The pandemic will doubtless scar the world longer term, be it economic, technological, social or psychological.
Rising interest rates pose a major risk to a world awash with and dependent on cheap debt, and any reductions in fiscal and monetary largesse are likely to unsettle markets. At some point the growth in debt generated by aiding economies and society and trying to restore growth will need to be addressed.
Alternatively, a ‘Minsky Moment’ may materialise and trigger events that compel changes.
A Minsky Moment, named after economist Hyman Minsky, defines the tipping point when speculative activity or any other market development reaches an extreme that is unsustainable, leading to rapid price deflation and unpreventable market collapse.
Then there is the environmental, social and governance (ESG) trend.
The last decade has also seen increasing importance and focus on the development of a sustainable green/environmental (decarbonisation), social and governance framework that has started to dominate the political and socio-economic agenda.
These developments have increasingly spurred changes in economic policy and the investment environment.
Despite it all, the markets have rallied massively.
The shuttering of economies due to the pandemic caused a major sell-off in markets. Massive government and central bank support, as well as the reopening of economies coupled with rapid vaccine developments, have been key factors in the subsequent massive rally in markets.
In fact, markets have staged such a dramatic turnaround that the current bullishness betrays the dire situation just a year ago.
This bullishness is noted in:
- The extent of margin debt (the amount of money an investor borrows from a broker via a margin account to buy securities or sell short a stock); for example, the rate of change in US margin debt in the last 12 months is greater than at the 2007 peak with margin debt outstanding reaching a new record high.
- US households’ equity allocation as a percentage of their total financial assets rose to a record high of 41% according to data from JPMorgan and the US Federal Reserve. A Gallup survey from June 2020 found 55% of Americans owning stock.
- Retail banking clients, notably in the US, have also been pouring into the market.
The times we are in are also displaying unusual bullishness and investment ideas.
Meme stocks going viral
Fear of missing out (FOMO) on market rallies and newbie retail traders blindly following the crowd have increased. For example, meme stocks – stocks that have gone ‘viral’ – have led in some cases to spectacular price increases, mostly fuelled by people on social media.
One speculative investment pursued up the risk curve that has been popular given bullish sentiment is the Special Purpose Acquisition Company (Spac).
A Spac, also known as a ‘blank cheque company’, is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.
The International Financial Law Review indicated that about $70 billion in Spacs was raised in 2020, with more than $160 billion of inflows to the end of April 2021. Several Spacs have seen spectacular declines since listing (notably in the electric vehicle space). Investor ignorance and consequent losses on these investments have sparked rising Spac litigation.
Another popular trend has been the rising interest in cryptocurrencies led by the bellwether Bitcoin. The promise of fast riches by investing in cryptocurrency markets has certainly cottoned on in a world of FOMO investing.
The popularity of cryptos has been enhanced through the legitimacy accorded them by Wall Street, and prominent personalities and entities embracing them. This space is sporting some of the most contagious forms of investor overconfidence or hubris; many cryptocurrencies crashed in May and the ‘ride’ is extremely volatile; so much for it being a store of value.
Cryptos are increasingly becoming a preferred currency by crime syndicates and ransomware hackers. Concerns have prompted regulators to move into the crypto sphere.
Adding to the mood of the times has been the launch of a new investment vehicle, the FOMO ETF. It trades on the Chicago Board Options Exchange and offers investors an avenue to invest in most active meme stocks and funds, including Spacs and crypto-adjacent companies.
Central bank digital currencies
Cryptocurrencies laid the groundwork for the consideration of central bank digital currencies (CBDCs), which are now being considered and researched by a number of countries.
China has set a first-mover advantage by developing a viable CBDC. This will be speeding up the digitisation of payments, thereby potentially increasing the efficiency and effectiveness of monetary policy.
These developments introduce a whole new way in which the payments system functions and how monetary policy will be conducted – and will certainly have implications for banks.
Change, change, change
Another development to note is that the average age of the world’s population is rising quickly. Moreover, the rapid slowing in the global population and thus labour force will become more apparent over time. Changing demographics will become more pronounced and will have ramifications for economies and society.
At this juncture, the combination of pro-growth developed market fiscal policies and the bias on the part of major central banks to let economies ‘run hot’ in order to restore full employment, remains in force.
Concerns have arisen about the rapid rise in inflation beyond expectations as economies reopen and demand is recovering faster than supply (even though base effects constitute a large part of this). There is the risk that this may bring about a potential further rise in bond yields and/or a policy mistake from the US Federal Reserve with ramifications for markets.
But for now, and despite the prevalence of the pandemic, continued positive market sentiment reigns with the backing of developed market central banks’ dovish stance (especially the Fed) and the promise of further fiscal stimulus.
Have the authorities discovered the holy grail of successfully steering economies and markets through all manner of difficult times (GFC and Covid-19 pandemic)?
So far, so good. But we should remind ourselves that while it may endure, markets are not a one-way street. Indeed, change is ever with us.
Fabian de Beer is director of investments at Mergence Investment Managers.