The global financial crisis was, at its core, a debt crisis. It was a critical juncture in a multi-decade period defined by growth and fuelled with debt. Policymakers, seeking to avoid a 1930s-style depression, loosened monetary and fiscal policy in the aftermath of the crisis, but this was not without consequences.
Large scale quantitative easing depressed interest rates and encouraged debt issuance to run rampant. We’re now grappling with a wall of leverage and anaemic inflation, leaving little room for interest rate normalisation. In fact, the direction of travel for central banks across the US, Europe and Asia is towards rate cutting. Negative yielding bonds have topped $12.5 trillion which offer a miniscule but insidious erosion of capital.
Source: Bloomberg, July 2019
Negative real interest rates have two primary externalities:
- They contaminate the cost of capital by driving it down and compromising its efficacy as a signal for worthwhile investment projects.
- They lead to speculation in the search for yield and asset price inflation. This has associated costs of exacerbating wealth inequality leading to political and social unrest such as populism.
Source: Refinitiv Datastream, Haver Analytics, Goldman Sachs, July 2019
Source: Minack, 2019
I’d argue that the political tensions we’re seeing today are rooted more in the financial policies of recent decades than in the current debate around globalisation. The irony is that some politicians are searching for solutions within protectionism instead of addressing monetary and fiscal policy dogmas.
The result is that we see clear examples of the misallocation of capital across different regions and markets. We once accused economies like China of misallocating capital with its ‘State Capitalism’ system. But the same is evident across free markets; whether that’s venture capital funds investing in ‘disruptive’ projects that don’t add economic value, runaway real estate prices in China, Canada and Australia, or a preponderance of expensive but unprofitable disruptors with no clear timeline to profitability such as Tesla, Uber and Revolut. In its IPO document, Uber even warned that it ‘may not achieve profitability’, ever!
The consequence of this delinking between prices and value is a sort of ‘Japanification’ of developed markets, so-called because of the high debt, low growth and low inflation that’s characterised Japan for the past 30 years following the post-war boom. Today, Japan still suffers from ‘zombie’ companies, which only survive because of the availability of cheap refinancing.
The challenge to traditional public companies is not so much from the rise of China - it’s already captured the lion’s share of industrial output - but rather from venture capital funds that have the financial firepower to confront and defeat incumbents. This Schumpeterian revolution of ‘creative destruction’, where economic progress means turmoil, is unfolding before us. One example is the gutting of high street retail grandees by online upstarts.
What is certain is that globalisation is slowing. When Donald Trump became US president in November 2016, global trade started to reaccelerate, but that’s now slowing down, most likely due to a simple case of economic gravity rather than intended policy. We are in a late cycle environment, which, combined with a declining working age population, will restrict growth potential.
For investors, this is uncharted territory. Any direct comparison with the past is problematic because there are few historical reference periods with similar dynamics - for example, an economic review finds no meaningful instances of negative interest rates back to at least 2000 BC.
The rising market could continue, and it’s tempting to sit back and enjoy the ride, but that shouldn’t be done naïvely. The markets are bathing in blissful complacency, which usually foreshadows a rude awakening. So far, we have muddled through these unprecedented conditions, but as asset managers we must factor in the risks. We must look forward, favour a quality bias and be ready to act swiftly for whatever the result will be.
What question should we tackle next?
Email your suggestion firstname.lastname@example.org
This document is for Investment Professionals only and should not be relied on by private investors.
This document is provided for information purposes only and is intended only for the person or entity to which it is sent. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This document does not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities in any jurisdiction or country where such distribution or offer is not authorised or would be contrary to local laws or regulations. Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. The research and analysis used in this documentation is gathered by Fidelity for its use as an investment manager and may have already been acted upon for its own purposes. This material was created by Fidelity International.
Past performance is not a reliable indicator of future results.
This document may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organization that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG, authorised and supervised by the Swiss Financial Market Supervisory Authority FINMA. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German Institutional clients issued by FIL (Luxembourg) S.A., 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg.
In Hong Kong, this document is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, Independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road., Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C Customer Service Number: 0800-00-9911#2 .
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.