All signals point to even stormier markets ahead

The reality of the economic challenges facing ordinary South Africans is visible all around us, yet we read that the financial markets are booming and those of us with pension savings see their value growing by the month.

This disconnect brings to mind the idea of seasickness, where the inner ear detects motion and the eyes register stability since the cabin moves with the body.

Even before Covid struck, the SA economy felt like a poorly constructed boat in stormy seas, with the effect of rolling blackouts, credit rating downgrades and revelations of corruption on a grand scale being magnified by the constant headwind of political uncertainty. When Covid and the resulting lockdowns came along it felt like we had suddenly hit a jagged reef.

Here we are in early 2022 with an economy that is smaller than it was five years ago and with 14.3-million people unemployed (according to the latest data available from Stats SA at the time of writing).

Despite all this pain the SA stock market is giddily riding a global wave and keeps reaching record highs. On a personal level, people see the value of their savings and investments going up and up.

We know the coronavirus is not one of our home-made crises; the storm is global and it is very real. Yet we also know global financial markets are hitting new records month after month. In the US, for example, the stock market is now trading at a valuation multiple that makes it one of the most expensive in history, with global bond yields close to or below zero.

What on earth is going on, and what or who is responsible for this? We can thank the great minds who run monetary policy in the developed economies, a crew of “experts” and academics who have inflated an enormous bubble in the markets. They have, in effect, created free money by lowering interest rates — below 0% in some cases — and further fuelled the markets by injecting trillions of dollars of liquidity through their various forms of quantitative easing.

This wild printing and purchasing spree has included buying highly speculative corporate debt. This is not new or simply a response to the pandemic. They have been doing it for more than 30 years, but it escalated after the last global financial storm in 2008. Central banks and governments in the developed world, in their determination to protect from economic reality the citizens and business people on whose favour their jobs depend, have dug a huge hole and continue to dig.

Adding to the enormous liquidity bubble we have China, which alone has created $25-trillion of credit over the past six years, making it the greatest and fastest credit expansion in history. Globally it has taken more than $155-trillion in debt over the past 20 years to produce global growth of $50-trillion. Something is very wrong with that.

Can this carry on? Not likely, though it has lasted longer than expected. Banks printing money, artificially inflating asset prices and dropping rates to zero have in many ways destroyed the allocation of capital. It has made making sensible investment decisions impossible. Not allowing failing companies to go out of business artificially preserves underperforming businesses and undermines the system.

From a systemic perspective it is all extremely dangerous. When the bubble bursts, as they always do, widespread pain will be inflicted on the global population, and it will very likely be a lot worse than the pain that was avoided in the first place.

Where to from here? No-one rings a bell when the market hits the top, most certainly not the financial industry given how heavily invested it is in markets going up and up. At times such as these the age-old wisdom of Warren Buffett is all the more relevant: “Be fearful when others are greedy, and greedy when others are fearful.”

We can’t reliably predict when the markets will turn, but the signs of fragility are everywhere, from the big declines we have seen in bitcoin, that poster child of bubbles, to the increasing volatility we see in US equities.

One potential game-changer is inflation, which is back for the first time in decades. While it will probably not be anything like the world experienced in the 1970s, its real relevance now is that it constrains the erstwhile “masters of the universe”, who can no longer continue to inflate the bubble without constraint.

With interest rates at or close to zero in the developed world and $290-trillion of debt to fund, any increase in funding costs will short-circuit the markets and the economy. Will it be the pin that pricks the bubble? Time will tell.

From the SA perspective, any big global market correction will have an enormous impact on emerging markets and therefore our financial markets. Capital will be withdrawn as risk aversion picks up. It will be painful over the short term.

However, while our markets have been on the rise, we have not significantly benefited from the euphoria that has inflated technology stocks or sent bond yields below zero. We have a market that still sensibly prices risk, with attractive real yields on offer in the bond market and a stock market that is not excessively overvalued.

• Eser is chief investment officer at 10X Investments.