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It’s been a curious year in the markets from MoneyWeek’s perspective. Anyone who was bullish on the plays that we were bullish on – commodities, emerging markets, the return of nuclear power – saw a decent return. But so did investors diametrically opposed to us.
Our least favourite major equity market – the US – roared ahead, with the Dow reaching new highs. The UK property bubble continues to inflate, and risky debt still trades as if the cycle has been abolished. Almost the only bulls to lose money this year were those punting on the Gulf stock markets, which are likely to take years to regain their highs.
In short, it was a perfect environment for everyone. Demand was strong, profits were high and inflation was officially subdued (we have our doubts but the bond market apparently doesn¹t). The big question now is whether these benign conditions will continue next year……
Everything hinges on the US, the consumer of last resort. A US slowdown will surely affect the rest of the world; the idea that Europe and Asia can “decouple” entirely remains a pipedream. Alternatively, renewed US strength should mean a resurgent global bull market.
It’s clear that we’re at a turning point. As usual at turning points, some signs suggest there could be a soft landing followed by a reacceleration later next year. Other indicators point to a recession. It’s hard to cut through the noise and hear the signal, but on balance we feel that the probabilities point towards recession.
Among the most important reasons for this are housing and consumer debt. Housing is always a crucial industry to watch, because it’s highly cyclical and housing busts are highly correlated to recessions.
At present, every time home loan applications rise or housing starts pick up we hear a lot of confident claims that housing has bottomed. That seems highly optimistic. While you can never ignore the prospect that things will turn out differently this time, such a short and mild slowdown from such a high point would be unprecedented.
Meanwhile, it looks as if the American consumer’s spending power will fade in the months ahead. Wages have lagged far behind profits during this boom, so consumers have dipped into their savings to compensate. Even more importantly, they have been borrowing against the value of their homes and blowing the proceeds.
Now that house prices are sliding, this seems less of a good idea. Recent figures show that mortgage equity withdrawal has fallen sharply. More broadly, the Federal Reserve’s latest flow of funds data shows that household borrowing is suddenly declining year-over-year at the rates normally associated with a recession or very bumpy landing. The loss of this additional liquidity is likely to show up in consumer spending next year.
Of course, if firms start spending the bumper profits they’ve made in this boom – ie wages rise faster and corporate investment strengthens – a recession can be averted. What we see so far doesn’t suggest that’s happening, but a sudden pick up remains a possibility. However, if that happens, it’s hard to see the Fed cutting rates, so it certainly won’t be good news for everyone – 2007 would likely be a painful year for those many US homeowners with adjustable rate mortgages due to reset.
Since the bearish signs point to a recession by mid-2007, the next six months are crucial. If we get through the first half of the year with the economy strengthening, the boom is probably back on again for a while.
There are still plenty of imbalances out there that will eventually implode: too much junk debt, too many reckless private equity deals and the not-fully-understood ramifications of the vast growth in derivatives we’ve seen. But the reckoning might be deferred for a while if the economy remains robust.
Either way, it’s going to be an interesting year. We hope that it’s a prosperous one for you.
This is the last Money Morning before the New Year – we’ll be back on Tuesday 2nd January. But you can find out what MoneyWeek’s experts expect for next year in the Christmas issue of the magazine – out today. Subscribers can download their copy here: Latest issue.
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In London, the FTSE 100 closed lower, despite an early boost from medical supplies maker Smith & Nephew. The blue-chip index ended the day 14 points lower, at 6,183. Miners Kazakhmys, Rio Tinto and Antofagasta were the day’s biggest fallers on lower commodities prices. For a full market report, see: London market close
Across the Channel, the CAC-40 closed 4 points lower, at 5,510. The Frankfurt DAX-30 also ended the day lower, down 12 points at 6,573.
Across the Atlantic, stocks ended the day lower following weak manufacturing data and downward revisions to economic growth. The Dow Jones closed 42 points lower, at 12,421. The S&P 500 was 5 points lower, at 1,418. And the tech-heavy Nasdaq was 11 points lower, at 2,415.
In Asia, the Nikkei closed 57 points higher, at 17,104.
Crude oil was slightly higher this morning, last trading at $62.83, whilst Brent spot was at $61.92 in London.
Spot gold was steady at $618.70 this morning and silver had edged up to $12.41.
And in London this morning, telecoms company Vodafone announced that it may make an offer for a controlling interest in Indian wireless operator Hutchison Essar. Vodafone shares were down by as much as 1.25% this morning.
And our two recommended articles for today…
A beginner’s guide to investing in gold
– Beautiful, indestructible, rare and conferred the unique status of universal currency – no other investment compares to the enduring appeal of gold. If you’re new to investing in gold, or would like to know more about new ways to hold gold, from gold stocks and options to SIPPs and ETFs, see: A beginner’s guide to investing in gold
How globalisation prompted a return to pro-labour politics
– There may be no stopping the march of globalisation, but as Western workers increasingly feel downward pressure on wages, an important political shift is occurring. Stephen Roach looks at why the ‘win-win’ model of globalisation has failed to translate into reality. Click here: How globalisation prompted a return to pro-labour politics