This article is taken from our FREE daily investment email Money Morning.
Every day, MoneyWeek’s executive editor John Stepek and guest contributors explain how current economic and political developments are affecting the markets and your wealth, and give you pointers on how you can profit.
The world feels like a fragile place right now.
Politics is fragile. The financial system is fragile. Our egos are increasingly fragile (or maybe I just spend too much time on Twitter).
At the same time, on a day-to-day basis, the economy just doesn’t look that bad. You might struggle to accept that fact, but things have been significantly worse than they are today.
So what’s a nervous investor to do?
The potential bad news
On the one hand, the world feels very fragile. It feels as though a lot of things could go wrong.
One financial system example from earlier this week – you might have noticed that there was much comment on the repo market in the US. I’m not going to attempt to explain in detail what happened here without doing a great deal more reading.
But I think that all you really need to know is that this is where companies and institutions turn to for their very short-term funding needs (ie overnight).
This week, the cash in this overnight float (if you like) dried up, and the Federal Reserve – America’s central bank – needed to inject a load more. In essence, everyone tried to dip into the petty cash at the same time and there wasn’t enough in the tin.
That’s a gross oversimplification. And it’s not anything to worry about immediately – the Fed was able to fix it. But the main concern is that no one is entirely sure why it happened, and no one saw it coming.
All we kind of know is that it was a side effect of there not being enough liquidity in the system, and in turn, that’s probably a side effect of quantitative easing and generally creative central banking. That also suggests that there are all sorts of strange incentives and pockets of trouble brewing that no one is entirely aware of.
So that’s a bit of a worry.
There is of course, also all the political fun and games. There’s Brexit (which is of course, potentially destabilising, regardless of your own political persuasion). There’s the rise of the hard left, which – in the UK certainly – is keen to transform tax and ownership rules in a way that would inflict serious damage on free markets.
There’s Donald Trump and his trade wars and tweeting. There’s the unrest in Hong Kong. There’s the attack on the oil field in Saudi Arabia, which the market appears to be taking remarkably well.
And these are just a handful of examples of turbulence in the world. I reckon you could pick a country at random and likely land on one where something politically disruptive is either happening or threatening to happen.
And in markets themselves, there’s a strange mix where equity markets clamber ever higher, even as private equity-backed “unicorns” are disappointing in ever greater numbers, and bond yields are only just rallying from record lows. It doesn’t exactly feel as though something “has to” crack – but it certainly feels as though the wrong move could tip something over.
The potential good news
On the other hand, there are a lot of things to be bullish about. Those of you who are regular readers will know that I am not an aggressively optimistic person by any means. But there’s no point on cherry-picking data to prove a point, just because you feel that the people in charge are making a mess of things.
For all that Robert Shiller reckons that stories matter in economics (and they do), the reality is that we can’t “talk” ourselves into recessions. Recessions happen for reasons.
The idea that the news controls and shapes how we behave is a wonderfully compelling one, particularly for people who feel aggrieved that others disagree with them on various political points. However, it’s not true.
You might worry about a recession because a party you hate is in power and the papers are full of angst. But if you have a job, and your wages are going up, you will still spend money on things, in essentially the same way as you did when the party you love was in power.
The big picture headlines make very little difference. What matters is your job security and your income’s ability to match your outgoings. If on average, that is improving across the country (as it is in most parts of the world), then it’s hard to see where downturns will come from.
To be very clear, this isn’t to say that downturns can’t happen. But they are caused by something. What usually happens is that a trend becomes overextended, and a lot of leverage is involved, which means that when it hits a wall, the debt suddenly needs to be repaid and the whole thing collapses or retrenches with a lot of collateral damage. (Property bubbles tend to be the worst for this).
So while it looks as though there are a lot of accidents waiting to happen, it’s also worth recognising that none of them has happened yet. And if that continues to be the case, then there’s a possibility that markets generally could do a lot better than anyone currently believes.
What can you do as an investor? It’s what I always say: stick to your plan. Don’t get sucked into assets that look ridiculously expensive by historic standards. Have insurance in your diversified portfolio (in the form of cash and gold) but don’t huddle away in risk-free assets, because you don’t know when the next crash is coming and in the meantime you want your money to grow along with the market.
It’s all pretty straightforward, boring stuff. Which really isn’t a bad thing, because day to day life provides more than enough excitement for most of us.
Oh and stay informed without mainlining the news – may I suggest a subscription to MoneyWeek, which will give you everything you need to know in a manageable and informative weekly format? 12 issues for £12 – you can’t go wrong.