For a start I want to apologise to Robert Palmer for stealing the key line from his 1980 pop hit. Or maybe I want to apologise to Arthur Conan Doyle for stealing the idea that it was the clues that changed everything – at the time the radical idea behind his character Sherlock Holmes who appeared in 1887 in Study In Scarlet, but whatever the case – I’m sorry.
I’m sorry because for the past year I have been writing about the long slow grind, about the death of volatility and about the unlikelihood of exogenous shocks to the sharemarket. I have been writing about the fact that I think shares are overvalued and by and large have been keeping my powder dry – continuing to invest in my business rather than in the market and preserving cash, because the chance of volatility had kind of evaporated.
Well I was wrong.
I had written long and quasi-academic articles about how, maybe the past 50 years were an aberration and that maybe we were in a much slower growth – post Keynesian, post monetarist grind and that the new normal of – well pretty much nothing happening – was in fact the old normal and that we had better get used to it.
I was – as I have just previously pointed out – wrong.
Here’s the thing – volatility is back and it’s causing real chaos. Not for me, and not really for most Australians but for the people who had been taking big bets on long periods of great calm remaining the future of the share market.
Because like all economists I am brilliant at hindsight, I can tell you the exact moment that volatility came roaring back: 8:30 am Friday Feb 2, 2018, when US Government Labour Report showed a surprisingly strong rise in wages.
To be honest everyone was kind of expecting a rise in wages – in the region of 0.5% to 1%, but the data came in at rise of 2.6% and the market wet its pants. Wage inflation – which had effectively been running at zero for a decade had suddenly popped.
The logical reaction to this is that if wage inflation is back, then inflation is back. If inflation is back, then the price of money changes. This news prompted bond yields to shoot upwards, which means that the price of bonds drops fast.
Within hours the contagion in the $14tn US Bond Market had spread to the sharemarket and the long bets on not much happening in the market had been wiped out.
This triggered a “correction” in the markets – technically that’s what occurs when a market shifts by 10%.
Let me be really clear here and perhaps if I wasn’t so verbose I would have led with this – things have changed and it’s going to mean real pain for some people and here’s why:
America and Europe and to a lesser extent Australia is full of adventurous souls who have borrowed large sums of money at effectively 0% interest and invested in the market for a nominal – let’s say 2.5% return. In the long slow grind of things – that’s an excellent thing to do – in a highly volatile market – its heartbreakingly stupid, unless you are a seasoned trader.
Let me be specific in my next metaphor: for the past decade, investing in the sharemarket has been like playing chess. Even a dolt with a little bit of practice and a few basic rules could be passably good. In a high volatility market if you are playing, you are playing in a new language, with new rules, in an unfamiliar country against people who are armed and would happily see you dead.
Understanding the sheer scale of this problem in the only market which updates figures reliably and quickly – the USA – gives you a clue as to what is going on.
On Jan 26th this year the US market had registered a year on year increase in value of $5 trillion, the Global Market by $14 trillion. These gains had lured mum and dad investors in – with share funds in the USA growing by $1 billion a day in 2017 according to tracker EPFR Global.
Get your mind around that number; $360 odd billion of mum and dad’s money has now dropped in value by about 10%. How much of that is borrowed at this stage is unknown and how quickly the volatility will change is also unknown – but get used to it, what was benign – is now stressful.
The clues are now everywhere that something odd is going on. Reports from the USA claim that the websites and mobile apps of Vanguard, TD Waterhouse and Charles Schwab crashed as retail investors scrambled to place sell orders, two of the ETFs that allowed people to bet on a calm market were all but wiped out by last Monday.
The most obvious clue in the market was the Credit Suisse exchange traded note (XIV) which was designed to go in the exact opposite direction to the VIX index (a measure of global uncertainty) was closed – probably permanently.
No one really knows that this means for Australia – awash with cheap debt and potentially overvalued assets. No one knows how to handle what the next 12 months will hold. We all know that it will be very different and that we ought, like Robert Palmer, to be looking for clues.
In many ways maybe it’s time to take a clue from Mr Palmer. Make a lot of money while you are young, move to Switzerland to avoid tax, and then travel the world with a beautiful partner.