Even before Covid came along, the South African 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 very jagged reef.
Here we are in early 2022 with an economy that is smaller than it was 5 years ago with 14,3 million people unemployed (according to the latest data available from StatsSA at the time of writing).
Despite all this pain, the South African stock market is giddily riding a global wave and keeps reaching all-time highs. On a personal level, people see the value of their savings and investments going up and up.
We know that Coronavirus is not one of our home-made crises; the storm is global and it is very real. Yet, we also know that 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 at close to or below zero.
So what on earth is going on and what or who is responsible for this, you might ask?
We can thank the great minds that run monetary policy in the developed economies of the world, a crew of ‘experts’ and academics who have inflated an enormous bubble in the markets. They have effectively created free money, by lowering interest rates – even below zero percent in some cases – and further fuelled the markets by injecting trillions of dollars of liquidity through their various forms of quantitative easing programmes. Their 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 and it escalated after the last global financial storm in 2008. Central banks and governments in the developed world, in their determination to avoid economic reality being felt by the citizens and businesspeople on whose favour their jobs depend, have dug a massive hole, and continue to dig.
Adding to this massive 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 last 20 years to produce global growth of $50 trillion. Something is very wrong with that.
Can this carry on forever?
Not likely at all, although it has lasted longer than expected. Banks printing money, artificially inflating asset prices and dropping rates to zero has, 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 voters (and many others besides), and it will very probably be a lot worse than the pain that was avoided in the first place.
So, where to from here?
No one rings the bell at the top of the market, most certainly not the financial industry, given how heavily invested it is in markets going up and up. At times like these the age-old wisdom of Warren Buffett is so relevant: “Be fearful when others are greedy, and greedy when others are fearful.”
We can’t reliably predict when it 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 we 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 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.
What does it mean for us in South Africa?
Unfortunately, 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.
In part II of this series, my colleague Chris Eddy will dig deeper into the implications of the coming storm for South African investors.
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice. 10X Investments is an authorised FSP (number 28250).
