As the UK faces electoral choices filled with Dickensian levels of misery one could be forgiven for approaching Christmas with some trepidation. However, there is better news in the financial world where mendacity and spin is consistently thwarted by an ever-present reality, price. With mere days to go, 2019 is turning into rather a good year for financial markets across asset classes. Here’s a quick menu of performances to cheer the wallet:

  • World equities are up 25% in euro terms year-to-date (YTD).
  • It’s not just the US markets; Germany’s Dax is up 23% and Emerging Markets are up 11%.
  • Bonds have also enjoyed central bank rate cuts with benchmark bond indices up 6-7%.
  • Property markets as bond proxies have generated positive returns in aggregate.
  • QE has been good to commodities with oil, iron and even gold generating returns for investors.
  • And, if that’s not racy enough, Bitcoin as the lead cryptocurrency has almost doubled in value.

So, all good then? Yes, 2019 has been very good and history suggests subsequent returns can be pretty healthy after a strong year. However, Dickens’ Ghost of Christmas Past visited Scrooge not just to shine a light on kinder days. Scrooge was also forced to visit some less welcome memories and the dangers of CHANGE in intent.

Let’s jog readers’ memories here and think a little further back to Christmas 2018 when equity markets were nursing their third circa 20% negative correction since 2009. Fear was the prevailing emotion and not just in equities. Deutsche Bank’s investment research team a year ago were highlighting that 90% of the 70 asset classes they tracked globally were on track to post negative annual returns. The last time that breadth of carnage was endured was in 1920!

We referenced the dangers of change in intent earlier. Specifically, the critical change of intent in global financial markets has been the approach of the world’s central banks led by the Fed. As a quick refresher 2018 was the year when the Fed rapidly raised interest rates back to a more normal historical level. By January this year that tightening path was abandoned and we are now looking at the frothy results of a more accommodative approach from central banks, namely quantitative easing (QE). Think of the central banks as Scrooge. Markets and investors love “kind” central banks. So, here we are enjoying a benevolent central banking utopia of forever rising asset prices, right? Sadly no. There are two other human conditions we should watch for change.

First, the vast majority of the world’s population is not participating in this asset price inflation. Income inequality now approaches the 1930s extremes. The dangers of a populist backlash are already revealing themselves in trade protectionist campaigns waged by the likes of Boris Johnson and Donald Trump. Global trade is under pressure and could still derail the QE train and the global economy it is fueling.

Second, interest rates may be very low right now but there is another human behaviour which could cause real problems for a benign monetary environment. Expectation. Specifically, a change in consumers’ expectations of future prices for goods and services. That’s called inflation and that can raise interest rates and erode the value of financial assets very quickly.

It’s difficult to identify an inflationary catalyst in the current technology revolution. However, it is worth considering a current image in the news which is very far from a Dickens picture of Christmas. Check out the gigantic bush fires suffocating Sydney and the absence of any technology solution so far. One wonders whether climate change and natural catastrophes could ultimately cause dramatic scarcity of certain goods and trigger inflationary panic? At the very least, Sydney is a reminder of our own greed and refusal to change our polluting habits. These words may seem harsh and apocryphal but recall the Ghost’s final words to Scrooge as he begged for no further reminders of the unhappy consequences of his actions…

“These are the shadows of things that have been. That they are what they are, do not blame me!”

 

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