The writer is a financial journalist and “More. Author of the book “The 10,000-Year Rise of the World Economy”.
For years, asset markets behaved rather like staff Star Trek:On a mission to “boldly go where no one has gone before” to reach new heights and find new machines for speculation.
But 2022 was a reminder that, like the cast of a sci-fi series, missions can have casualties. In this case, the red shirts, the hapless extras sent to confront the threat with Captain Kirk and Mr. Spock, only to be killed by the episode’s monster, were the cryptocurrencies that suffered in the collapse that ended with FTX collapsing.
But the more common assets also had their problems. The S&P 500 is down 16 percent at the time of writing, while the MSCI Emerging Markets index is down 23 percent.
The causes of these failures are known and interrelated. The first was Russia’s invasion of Ukraine, which disrupted energy markets and added a “supply shock” to existing inflationary pressures. This exacerbated the second factor, the struggle of central banks to set the right monetary policy in the face of a combination of rising prices and impact on consumer demand. Financial markets have spent the year debating whether central banks will do too little to curb inflation or do too much to destroy the economy.
Not far below the surface of this debate was a more pressing long-term question. Given the level of accumulated debt in an advanced economy, is there a limit to monetary tightening? 2007-09 since the financial crisis, attempts to return interest rates to levels considered “normal” in the late 20th century have been reduced by market fluctuations. As Scotty regularly said about the engine Star Trek:USS Enterprise, “She can take it, Captain.”
As a result, fears about the fragility of the financial system are the best source of hope for the bulls. That’s why markets have been desperate for any sign of a “pivot” from the Fed. That axis should not include a decision by the Fed to reduce interest rates. just a sign that the rate of growth has slowed. At the moment of greatest danger, the markets would be saved just as Messrs. Kirk, Spock and McCoy would “glow” on their ship in the face of a Klingon attack.
So there was plenty of optimism this week as the Federal Reserve held its latest rate-setting meeting. Finally, inflation eased to 7.1 percent in November, the lowest rate this year. And the Fed slowed the pace of interest rate hikes, revealing a half-point jump rather than its earlier moves of three-quarters of a point. But Fed Chairman Jay Powell wasn’t ready to bail out the markets just yet. The central bank would need to see “substantially more evidence” that inflation is falling before easing the monetary brakes. The Fed’s projections were for higher rates, higher inflation and slower growth than previous projections.
Perhaps investors’ desperate need for confidence from the Fed should be food for thought. In a normal cycle, interest rates should rise as the economy grows, but equity markets can still thrive as earnings forecasts are revised higher.
Since the financial crisis of 2007-09, there has been a less healthy combination. Economic growth has been disappointing in the developed world, but that hasn’t deterred risk assets. equities, high-yield debt and property have all boomed. Is this really healthy? Extremely low short-term interest rates may make it much easier to finance the corporate sector, but may lead to the survival of too many “zombie companies” and thus prevent the “creative destruction” needed to transform the economy. increase productivity.
A world in which economies stagnate while financial markets soar would strike Mr. Spock as highly illogical. But it’s entirely possible that the pattern will resume in 2023. All the markets want for Christmas is the hope of lower prices; a stronger economy is not really required.
For things to change, one of three things must happen. The first would be for inflation to take root in advanced economies, as it did in the 1970s. This is not excluded. The combination of an aging population and a crackdown on immigration can lead to a wage-price spiral. In turn, this will reduce corporate profits and therefore stock market valuations. A second possibility would be a combination of higher energy costs and monetary tightening that would dampen markets as well as the economy. Again, this can happen. it happened in the early 1980s.
A third possibility would be much healthier. Somehow, advanced economies can find productivity improvements that can deliver faster economic growth and higher living standards for all. such a combination should also be good for asset markets. Unfortunately, absent some fantastic technological breakthrough, this seems the least likely outcome of the three. In an ideal world, both markets and the global economy could, in Spock’s words, “live long and prosper.” But very often in the real world only financial markets thrive.