Why Are Financial Markets Doing the Opposite of What Would Be Expected?

For well over a year now a major correction in financial markets has been called in many quarters. Last summer those investing online were being urged to adjust their portfolios in preparation of a downturn after 8 years of growth. A year later and another big wedge of growth has been delivered. Tech stocks dropped in March and it looked like air was being let out of a situation approaching what might be described as a bubble. Last week big tech hit new record highs as capital moved back into the sector as a safe haven.

Financial Times columnist Gillian Tett calls attention to a whole range of bizarre aberrations in financial markets currently apparent. Across asset classes, markets are doing the exact opposite of what they normally would under the circumstances. The question those of us investing online in ISA and SIPPs have to ask ourselves is, what does it mean?

Despite a rattling of sabres between the USA, China and Europe over a new protectionist trade policy being implemented by the Trump administration, as well as a host of other geopolitical concerns, equity markets just keep going up. Corporate borrowing levels have also hit worrying levels on the back on leveraged mergers, take-overs and internal investment. That’s been reflected in dropping credit ratings being attached to corporate bond issues. But it’s not deterring investors who keep gobbling them up. They barely seem to be differentiating between what is considered risky and relatively safe debt. As such, risky debt premiums are almost non-existent.

The US Federal Reserve is also not having to offer any premium to entice investors into longer term Treasuries instead of just rolling over short-term government bonds. JPMorgan recently calculated that the yield curve between short and long term debt has inverted for the first time since 2007. Currencies are also not strengthening as would be expected on interest rate hikes. US interest rates are increasing way ahead of those in Europe and Japan but this is not being reflected in a strengthening dollar.

Despite interest rates being increased in countries such as Canada, the Netherlands and Denmark runaway house price growth in those countries is also continuing unabated. Gold has also dropped 5% in two months as geopolitical tensions increase. Instead capital, as mentioned earlier, seems to be going into tech stocks, treating them as a safe haven. These companies are classified as ‘growth’ stocks, which normally suffer as markets consider risk to heighten. Gold prices normally rise.

There is no obvious parallel in history to so many anomalies in the behaviour of financial markets all being apparent at once. When Tett asks what conclusions can be drawn from the bizarre behaviour, she arrives at two possible outcomes. The first is that markets are so confident in the global growth outlook that nothing else matters and it will justify the current optimism in coming years by driving revenues and keeping us all growingly affluent. The second is that investors have been blinded by the years of loose monetary policy and are no longer capable of pricing risk. Markets are in ‘melt up’, which inevitably ends in a ‘melt down’. Both are possible. Tett thinks the latter is the more likely.