What ends a bull market? Everyone has a firm idea of one sort or another on this – some crazy, some seemingly rational: it’s valuations; policy mistakes; the alignment of the stars. It’s interest rates. It’s October. It’s a run of corporate scandals and bankruptcies. It’s inflation reaching 4%. It’s just time.
But to focus on any one thing is, I think, slightly to miss the point. A better way to look at the end of a bull market is to think of it as if it were trapped in an amusement arcade’s penny falls machine – the ones into which you roll a coin to the back of a pile of coins in the hope that it will tip the rest over a ledge and into a collection drawer. The piles of coins always look about to fall, but they don’t until long after it feels like they should (this drives kids crazy, of course. If you want an afternoon to end in tears, end it on a penny falls). The current market is frustratingly jammed with coins.
Valuations are high across the board, in some cases back to 1929 levels. Stocks are being sold on stories rather than on financial fundamentals – “Look, there’s a car in orbit”! Prices have been rising for much longer than usual: if this bull market makes it to August it will be the longest in history. There is evidence of rising inflation all over the world.
Governments are in agreement with workers (correctly) that wages are too low and must rise. In the UK, pension deficits are a constant drag on capital investment. Dividend cover is too low. Investment trust premiums are too high. Everyone has more or less had it with quantitative easing. Bond yields are rising.
Global politics aren’t helpful. China has pulled back from its strategy of GDP growth at any cost. There is trouble ahead in the EU: the German and the Italian elections should make it clear that populism is still with us.
Possibly most important of all, Jay Powell, the new chair of the US Federal Reserve, appears to be less interested in looking after stockmarkets at the expense of everything else than his predecessors. “We do not manage the stockmarket… I think the general thing is that the stockmarket is not the economy,” he said.
He might prioritise controlling inflation over continuing to pin all hopes on the wealth effect – the idea that if you make people feel rich by shoving up asset prices they will spend and in doing so save the real economy. Any one of these falling coins could by now have ended our long bull market – rising yields in particular are rarely good for investors – but none have. That’s something for which most of us are, of course, heartily grateful. After all, the bit of penny falls analogy that doesn’t work is this: crashing coins make you richer. In most cases, for most people, crashing markets don’t.
This leads us, as so many things do, to Donald Trump. Might his tariffs be the coin that tips the balance? Could be.
Trump’s tariffs may be ridiculous, but everyone can “do stupid”
Trump reckons that the US is global trade’s “big loser” and that slapping 25% tariffs on steel and 10% on aluminium on top of the ones he has already put on solar panels and washing machines will show the rest of the world that he is a big winner.
The problem is that even if we know the high costs of retaliation (the risk of escalating something relatively minor into a trade war) this is no guarantee that other trading blocs with supposedly less volatile leaders will not retaliate. As Jean-Claude Juncker, president of the European Commission, said this week, in the wake of the EU’s discussions about putting punishment tariffs on US agricultural products, steel and Harley-Davidsons, “We can also do stupid.”
This won’t be news to anyone watching the Brexit negotiations – the EU is as open to economic self-harm for short-term political gain as everyone else – but future historians will, I am sure, roll their eyes when they see yet again how fast macho posturing turns into real trouble.
How much trouble remains to be seen. There is no obvious economic justification for the new tariffs and the immediate domestic gains from them in the US will be limited. The US imports very little steel from China (where there is no longer much overcapacity anyway). The US steel industry is doing fine already, with production up 3.4% last year) and in any case the US economy is driven much more by services and technology than heavy industry.
Should aluminium and steel turn out to be more than a one-off whim of Trump’s – and the beginning of a full-on trade war aimed at China – the second-order effects could be nasty. The resignation of Gary Cohn from the White House is worrying, as is Trump’s attack on the World Trade Organisation (mostly a force for good) and the very high risks of retaliation. The global economy shrank by 20% during the trade war of the 1930s. Everyone can do stupid.
All that said, one thing to bear in mind is that anyone who sees any of this as a bolt from the blue has not been concentrating. It has been clear for some time that the economic pendulum has been swinging; that globalisation – something that has been brilliant for many but miserable for others – was likely to go into reverse, at least in part.
You have seen it in the physical walls that have gone up around Europe, and those that are on the way between Mexico and the US; in the backlash against the tax affairs of big corporations; the backlash against the social responsibility of the big tech companies; and of course in the rise in protectionism across the world.
According to a report from law firm Gowling WLG, the world’s largest economies have put in place more than 7,000 protectionist measures since the financial crisis, with the EU and the US being the worst offenders. If markets crash now, steel and aluminium might look like the proximate cause, but the real one will just be the weight of coins.
How to prepare yourself
You should be ready. But how? If you haven’t done so already this might be a good time to make sure you aren’t holding too many of the market’s most expensive shares and one to hold a little more cash than usual.
That done, hang on and try and remember the positives: there are huge productivity gains to come from automation and digitalisation (one new US fund that focuses on this is Arbrook/G10 American Equities Fund). The healthcare and biotech sectors throw up amazing possibilities every day. And, against a good many odds, global GDP growth is reasonable.
The companies you are invested in, as long as they have a good mixture of organic growth and financial stability – that is, low debt – should weather the next penny falls storm.
• This article was first published in the Financial Times