All that glitters
If you were to look at equity markets today with no knowledge of recent history, you might well assume the economic and financial world is unequivocally positive. The FTSE 100 has just been through its longest winning streak in history to hit all-time high price levels, and valuations in markets such as the UK and US look stretched.
On the back of this, you could think interest rates have normalised, employment conditions are strong and productivity is booming, in turn helping corporate profits and consumption in an economic ‘Goldilocks’ scenario, with a strong, sustainable outlook.
This is clearly a long way from reality, with productivity falling, persistently weak real wage growth and many markets seemingly dependent on extremely loose monetary policy. At the same time, markets have mostly shrugged off a number of political shocks that would have historically triggered a re-evaluation of risk as investors come to terms with the increased uncertainty. For the moment, the usual rules seem to have been suspended.
To add to the surrealism, just as UK equity markets were hitting fresh high valuations, gilt yields were collapsing to all-time lows (see chart).
Conversely, if you looked at the recent gilt market in total isolation, you would probably have thought it wise to stock up on tinned beans and bottled water, and await the collapse of civilisation.
There have been conflicting signals coming from these two markets.
The apparent paradox of both equities and gilts – your classic risk-on and risk-off asset classes – rallying together over a sustained period has been made possible by the extreme intervention of central banks in the wake of the global financial crisis, which is clearly not sustainable.
A look at recent financial history is informative, as it shows how we got to the current state and what the implications for the future may be as a result.
