finweek

The return to normalcy is fraught with uncertainty

Maarten Mittner is a freelance financial journalist and a markets expert.
Maarten Mittner is a freelance financial journalist and a markets expert.

The return to normalcy in global markets may take much longer than anticipated.

The average surge of 20% in global markets at the end of April, following the March meltdown, may be an indication of a swift recovery going forward, similar to how markets reacted in 2009.

But should the Covid-19 pandemic not be a one-off event, which seems likely, any recovery may prove to be premature.

Greater volatility seems assured. And expect anomalies, such as oil prices falling into negative territory, some tech companies surging and markets climbing at times, despite a continued rise in coronavirus infections.

The response to the present economic malaise is under much more difficult circumstances than in 2008. Governments then discounted the fiscal option, which was the preferred response to the Great Depression of the 1930s.

On the contrary, fiscal spending was allowed to contract in developed countries, under the guise of “austerity”, and as bigger companies started to pay less tax. To stimulate economies, and to stave off a real depression, monetary tools were used.

Central banks increased money creation, mostly by expanding bond offerings in the capital markets, and kept interest rates at historic lows. This boosted equity markets, causing flipside problems of ballooning debt and rising inequality.

Global economies held on to steady growth over the past decade, but nothing was really done to address the root causes of the 2008 imbroglio. Nobody was held to account, least of all financial institutions and banks.

Apart from a few prosecutions of top managers at selected banks, mostly unsuccessful, and some discomfort from IFRS (international financial reporting standards) rules, these institutions were all designated “too big to fail”.

Assets have been massively mispriced over the past decade.The real value of companies was much lower, inflated and supported by taking up increased debt in a low-interest environment.

The top-income earners benefitted, but for most, life had become more of a struggle, particularly for middle- and lower-income workers as medical and educational costs rose.

The inherent fragility of this system is yet to be felt, as unemployment and financial distress climb in developed countries. But at least, this time around, there has been more of a concerted response from the authorities in that monetary rescue efforts are now accompanied by massive fiscal stimulus.

There is sure to be a reappraisal of risk management. Investors paid a heavy price for the lack of diversification into other asset classes. Placing life savings in equities has proven to be very risky for most.

It would be prudent to investigate other asset classes, such as houses, as an alternative, hopefully accompanied by a more favourable tax environment.

At present, only equity and capital market investments for retirement purposes qualify for a generous local taxation dispensation in that contributions are tax-deductible, to a limit.

Paying off a bond by Joe Average in SA has no similar benefits, not even interest may be deducted. Changes in this area could reduce risk by lessening the overreliance on share markets.

Despite everything possible being done to prevent a deflationary scenario, “Japanification” is still a distinct possibility for the US and the eurozone, brought on by lower oil prices and reduced spending.

That means living with a huge debt burden, subdued demand in the economy and the hoarding of money in whatever form, causing tepid economic growth, could become the new norm.

The big question is where future economic growth will predominantly come from? Digital or online companies could be the big winners, with Amazon CEO Jeff Bezos increasing his personal wealth by $24bn in a few weeks amid tumbling markets.

Bricks-and-mortar have been the main losers, with the retail sector and commercial property particularly hard hit. The future is fraught with uncertainty. Consumer spending had been the main driver of economic growth in developed countries for decades.

If consumers spend less within the parameters of mainstream businesses, and cheaper online systems are the winners, inequality could increase further, with digital companies extending gains, having very little incentive to pay employees higher wages.

Distrust in markets could spiral out further. Gold could be a short-term winner. The US 10-year bond could test 0%. Developing countries are expected to deal with hunger issues, in addition to fiscal deterioration and capital flight.

Populist movements movements are set to grow, which would probably entail stronger governments and less efficient markets, save for the owners of capital.

Geopolitically, things can also change dramatically. The effects of 70 years of globalisation since the end of World War II is likely to be questioned more, mainly in the US. This will have profound implications for countries such as China and Germany, which have been the main beneficiaries up to now.

The growing uncertainty and fundamental changes are unlikely to foster confidence in equity markets over the short term, which may further inhibit a speedy return to normalcy.

Maarten Mittner is a freelance financial journalist and a markets expert.

This article originally appeared in the 7 May edition of finweekBuy and download the magazine here or subscribe to our newsletter here.

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