Global Investment Strategy
June 29, 2015 (Weekly Update)
Paul Christopher, CFA®, Head of International Strategy and Co-Head of Global Real Assets
Weekly market insights from the Global Investment Strategy team
- Fears persist that Federal Reserve (Fed) monetary policy stimulus is producing financial market excesses.
- Although monetary stimulus has been large, important precursor characteristics of the prior decade’s crises are missing.
What it may mean for investors
- The combination of an improving global economic recovery, low global inflation and interest rates, and various other issues are moderating market optimism. Therefore, we currently favor equity over fixed-income markets and U.S. over international markets.
Keep Fears of a "Bubble" in Check
This year marks seven years since the 2008 global financial crisis, which came roughly seven years after the end of the technology stock boom. A common concern among investors is that the recent economic and financial recoveries are due to extremely low interest rates and other Fed policies that encourage the same speculative behavior that preceded the 2001 and 2008 crises. We think that caution has a place in an investment plan, but that investment conditions today differ from those in 2001 and 2007.
What's in a "bubble"?
In a financial context, the term "bubble" refers to markets in which sustained price gains outpace the improvement of supply-demand, earnings potential, and other fundamental factors. Often, a long respite from economic stress lulls people into a false sense of security and encourages the reckless behavior that inflates bubbles. For example, by the middle of the last decade, investors had seen 20 years of steady economic growth and low inflation, and had watched the world economy shrug off the effects of the technology stock boom with the relatively shallow 2001 economic recession.
Another characteristic of a bubble is easy access to credit, whether the funds come from international investors or from monetary policymakers. Easy and ample financing helps household and business behavior morph from a cautious search for value into an unthinking assumption that future income and profit will keep pace with accelerating borrowing.
Are financial markets at risk of a bubble today?
Far from recklessness, today a sense of caution still seems to prevail across the financial markets. The early, unsteady years of the current U.S. economic recovery failed to brighten consumer confidence, and even the sentiment rebound since 2013 remains well below the peaks of 2000 and 2007. Another missing bubble precursor is easy access to credit. U.S. policymakers have adopted aggressive and unusual monetary stimulus policies since 2008. The monetary stimulus has placed large sums of money at banks, but lending growth has been slow and does not suggest speculative activity.
The charts below illustrate that U.S. households and businesses have not exploited the available liquidity. Nonfinancial corporate business borrowing per dollar of profit and household borrowing per dollar of income are flat and below the aggressive borrowing levels that characterized the boom periods before the 2008 crisis. From the inverse perspective, these charts suggest that the current economic recovery is not an illusion of borrowing. In fact, profit and income are rising faster than borrowing.
Household and Nonprofit Net New Borrowing
(As percentage of Income)
Nonfinancial Business Net New Borrowing
(As percentage of Profit)
Four-quarter moving averages. Income and profit are before taxes and profit includes inventory valuation adjustment. Business debt includes commercial paper, municipal securities and corporate bonds. Household debt includes home and commercial mortgages, consumer credit, loans and advances. Sources: Federal Reserve (Financial Accounts of the United States), and Wells Fargo Investment Institute.
There is also concern about margin debt, as the S&P 500 hovers near an all-time high. Margin debt rises with equity prices and falls when they fall but does not seem excessive. As of the end of May, margin debt is 16 percent higher than a year ago, but this pace is several times slower than the 78 percent annual pace in March 2000 and the 68 percent rate of July 2007, ahead of the past two crises.
Don’t let bubble fears obscure opportunities
Reckless borrowing seems absent today, and may remain a distant prospect if the Fed raises interest rates and makes borrowing more expensive. For now, the key conditions of recent bubbles appear to be missing—confidence remains modest, the U.S. and the broader global economy are still improving, and borrowing is not extreme.
Our recently published mid-year outlook report discussed the problem of recency bias, the tendency to misjudge the future by overemphasizing the past.1 Looking back to 2008 and waiting for the next shoe to drop can give an investor cold feet and hide opportunities. In the near term, we believe in improving global economic and earnings growth coupled with low inflation. Geopolitical issues in the Middle East and Eastern Europe matter but help moderate optimism, and seem only modest headwinds for global growth. In this environment, we broadly favor equity over fixed-income markets and U.S. over international markets.
1 For the full report, please see 2015 Midyear Outlook: Opportunities in an Improving Global Economy, June 2015, at https://www.wellsfargo.com/the-private-bank/insights/investing/wfii-2015-midyear-outlook.
Paul Christopher is the head of international strategy and the co-head of real asset strategy for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
Mr. Christopher focuses on the international economic outlook and offers investment advice on currencies and commodities. He is frequently quoted in the national media, including The Wall Street Journal, The New York Times, Forbes, Time, Investor's Business Daily, USA Today, Bloomberg News, ABC News, NBC News, and CNBC.
Prior to joining Wells Fargo, he developed economic strategies to trade in global financial and commodity futures markets for Eclipse Capital Management. In previous positions, Mr. Christopher supplied international economic perspectives for Wells Fargo predecessor A.G. Edwards, and advised institutional clients of Istanbul-based Global Securities on the oil-based economies of the Caucasus and Central Asia. He has consulted with the governments of Hong Kong, Egypt, Russia, Kazakhstan, and the Kyrgyz Republic on monetary policy issues.
*As of Sept. 30, 2014
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Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
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