Years ending in seven have been fatal for markets: 2017 may be no different

 
Anthony Barklam
Markets Plunge After House Rejects $700 Billion Financial Bailout Plan
Total debt levels, including household, government and corporate debt, increased by more than $70 trillion over the past decade. The record $215 trillion level reached is equivalent to 325 per cent of global GDP (Source: Getty)

Years ending in seven make me uncomfortable. As many others who have worked in the City over the past three decades will attest, years that ended in seven have proved fatal for global financial markets.

1987 saw the original “Black Monday” stock market crash. That day, the Dow Jones Industrial Average fell by 22.6 per cent, a one-day percentage decline that hasn’t been seen since. 1997 heralded the Asian financial crisis, a contagious period of devalued currencies, stock markets and asset prices. 2007, meanwhile, is etched in everyone’s mind as the beginning of the global financial crisis, the worst of its kind since the Great Depression.

Each episode came at the end of a strong period of recovery from a previous downturn, each easy to see in hindsight, but categorised at the time as a Black Swan moment.

As we get further into 2017, I cannot help but recognise some familiar, foreboding omens. Investors, continuing their hunt for yield, and corporates, facing tough decisions regarding growth, leverage and financing, must be attuned to seven market indicators.

Read more: The new indifference: Why markets just don’t care about political risk

Equity markets, spurred on by Donald Trump’s economic agenda and healthy global earnings, have reached historic highs. The MSCI All-Country-World Index, a gauge of global stocks, the Dow Jones Industrial Average, the Nasdaq and FTSE 100 have all breached their previous records in recent months.

We need to question whether this is cause for unbridled optimism about the global recovery and growth story, however.

Interest rates, and associated borrowing costs, while beginning to rise in the US, remain at historic rock bottom levels in the majority of the largest global economies. In Japan and Europe, they are below sea level. Meanwhile, the ability of these economies to immediately cope with the potential withdrawal of quantitative easing is questionable. Only when this flow of money is stopped will we see natural liquidity levels and associated yield curves.

While the post-2007-8 downturn is largely done, it is clear the bond market is not currently convinced of sustainable long-term growth.

Global debt is another indicator that is reaching heady, worrying highs. According to a report released in April by the International Institute of Finance, total debt levels, including household, government and corporate debt, increased by more than $70 trillion over the past decade. Put another way, the record $215 trillion level reached is equivalent to 325 per cent of global GDP.

Read more: Global debt has never been higher. Should investors be worried?

Credit is clearly cheap and affordable now, but if the past three examples of years ending in seven are anything to go by, it is that conditions can turn extremely quickly.

European growth is still struggling for lift-off in some countries: Italy’s economy is significantly smaller than it was before the global financial crisis while France has continued to suffer from sluggish growth. A consistent and more evenly spread pan-EU growth story would be warmly welcomed and justify higher confidence of global recovery.

Geopolitical risk continues to spread across the globe. Tensions in North Korea, Syria and Russia, the continuing terror threat in Europe, and the rise of extremism could all produce market shocks.

Short-term market dynamics mean that many investors cannot stay un-invested for long or they may underperform. We already see large swings in markets due to lower inventory levels held by traders and market-makers. When the market turns in either term debt or equity markets, will there be enough liquidity to support the sellers?

Read more: We're stuck in a 21st century liquidity trap

Finally, technicals – the weight of cash and available cash for investment – are helping prop up current optimistic valuations. In both the corporate and retail sector, they are distorting fundamentals and how these fundamentals are being valued by the market.

Irrespective of market view, negative interest rates have propelled both equity and debt markets to levels that sit uncomfortably against each other. Whether you believe in the bullish equity story or the bearish bond story, the lesson of 2007 is that one will be proven right pretty soon.

For under-levered, cash hoarding corporates, there may be a temptation to hold off spending or delay strategic M&A decisions in this environment. However, with markets at such unprecedented levels of liquidity and buoyancy relative to the underlying fundamentals, now is the perfect time to take advantage of the frothiness and lock in finance at levels never seen before.

As the decade since the last crash approaches, and the harbingers of doom continue to roll in thick and fast, investors and corporates alike should give greater thought to how they want to see out the possible threat of 2017.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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