A well-known securities firm likens its sales force to "the thundering herd." I have often wondered about the wisdom of such a trademark for a business so vulnerable to swings in sentiment. In this current bull market, a better metaphor might be mad pigs racing towards a cliff, rather than beautiful bison stampeding across the Great Plains.
It's worth recalling the logical fallacy of the Gadarene Swine, based on the Gospel story in which Jesus cast demons into a herd of pigs, which then fled into the sea and died. If you are running within the herd, a single animal that peels off to run a different way will be "off course," from your point of view within the herd. However, seen objectively from the perspective of an ideal observer outside the herd, the wayward animal may be heading the right way while the herd may be galloping to disaster.
Unfortunately, where the markets are concerned, we don't have an observer, high up on a mountain, who can see the terrifying precipice over the brow of the hill. All we have is a lot of opinions.
From the sunny side of the street, the view is rather beguiling: buoyant stock markets gaining new ground after an end-of-year lull, relatively subdued inflation in the major Western economies, cheap money from very low interest rates and a strong recovery in oil – a nice Christmas bonus for Canada. Yet, it is possible to look at these same indicators and draw quite negative conclusions about the future drift of stock and bond prices.
The big risk factors, according to Citigroup and its economics guru, Willem Buiter, are rising interest rates and a sudden oversupply of financial assets as the U.S. Federal Reserve unwinds it quantitative-easing program. Most investment banks are betting that the Fed will raise rates again this year and Goldman Sachs is forecasting no less than four separate increases. A return to (relatively) dear money combined with the arrival of $1-trillion (U.S.) of surplus bonds onto the market as the Fed unwinds its position will be enough to trigger a significant correction. Blackstone Private Wealth is telling its clients to expect a 10-per-cent to 15-per-cent fall.
There is a big difference between a correction and the arrival of an extended bear market. Mr. Buiter worries that the Trump tax cuts could worsen matters: If the fiscal stimulus is too expansive, the Fed could be forced to make even more aggressive rate hikes to choke off an inflationary boom.
The markets are looking a bit toppy, the Dow is discounting 23 years of earnings. More interesting is what is happening to yields. U.S. inflation in December was unexpectedly strong in figures just released and the news pushed the two-year treasury yield above 2 per cent, the first time since the financial crash, as investors anticipated a knee-jerk response from the Fed with a rate hike in March.
Meanwhile, the yield on equity shares has been tumbling, thanks to the strong gains in the stock market. As a result, for the first time since the crash, you can get a better income from lending money short-term to the U.S. government than from buying shares in long-term U.S. businesses.
This conjuncture doesn't encourage me to put more money into risk assets today. U.K. gilts and German bunds are also expected to move sharply higher in 2018. The European Central Bank gave a strong hint this week that it would quickly move to wind up its bond-buying QE program, thanks to higher-than-expected rates of economic growth.
But I am not convinced that the growth is sustainable in Western economies. In Britain, as in Canada, households have little headroom for more spending. The credit card has been sustaining the consumer boom for too long and the household-savings ratio has been eroding steadily, now down to almost 2 per cent. In Britain, the savings ratio has been in decline for seven out of eight quarters as households dipped into savings to pay the bills. Even so, major stores reported that the traditional pre-Christmas binge was a soggy affair and more retail bankruptcies are expected.
If the Fed and the ECB and the Bank of Japan get this delicate balancing act right, slowly reducing the stimulus accelerator and gently applying the money-supply brake as the economy expands, we can certainly hope for another year of balmy markets. But central banks are economic plumbers, not keyhole surgeons. Politics will get in the way, not least in Europe where the political standoff between Britain's lunatic nationalists and the European Union's indignant federalists is threatening to turn Brexit into a trade war.
If you invest, you could double or even triple the meagre return on cash. But a market correction could leave a much more sizable hole in your pocket. It's worth remembering that pigs don't fly.