Does history repeat or rhyme?
Rising interest rates. War in Ukraine. A collapsing New Zealand Dollar. Recession. Low business confidence. Low consumer confidence. Poor Government rating by business. The headlines can be all consuming. It may be surprising to many watching their investments and Kiwisaver funds wallow, but the global economy, bond and share markets have been here before and as the famous saying by Mark Twain goes “history never repeats itself, but it often does rhyme”.
One period that comes to mind as a comparison to todays investment markets is the 2001-2003 period – those of us with long enough memories will see similarities to todays economic conditions and state of markets.
Back in 2001 share markets were still in the shadow of the 2000 tech-wreck and the Y2K phenomenon. Over in the US, the Federal Reserve had taken a sledgehammer to the rampant market speculation – remember Fed Chairman Alan Greenspan’s “irrational exuberance” speech a few years earlier – having aggressively raised the Fed Funds rate to a high of 6% by early 2001. Finally, the US economy slowed and, in fact, saw a recession beginning in March 2001, exacerbated of course by the terrorist attacks on the World Trade Centre in New York in September that year. By the end of 2001, in response to the slowdown and recession, the Fed Funds rate had been substantially and quickly cut to 1.75%. Still, the US’s broad share market index, the S&P500, lost 13% for the calendar year.
In to 2002 and it turned out that the Federal Reserve’s monetary policy loosening was not enough, and share markets were further roiled by accounting scandals at Enron and World.com and the build-up in tensions between the US and the Middle East. The S&P500 fell a further 23% over 2002, seeing its low of 776 later in the year. From the tech bubble heights of 1520 in September 2000 to the low of 776 in October 2002, the S&P500 had fallen 49% over a two-year period. With the US catching a significant cold, the rest of the world must have been really bad as well, right? Well, no. In 2001 the NZ share market as measured by the NZSE40 index (the prevailing index at the time) actually performed quite well, returning a respectable 11%. The Australian share market as measured by the ASX200 returned 7% for the same period. Both economies and share markets had been severely affected by the Asia Crisis in the 1998/99 period and were by then on the road to recovery.
What can we glean from history when looking at the current global situation? Well, we have been here before – war, terrorist events, inflation – none of these are new to asset markets. It does not necessarily mean it is an easy journey, but Central Banks have learnt from past events and have the tools to address, ameliorate and even solve these problems, eventually!
As we saw above when recalling events and markets back in 2001, Central Banks can and oftentimes do reverse course very quickly. We are currently seeing inflation rearing its ugly head in many if not most segments of the economy, particularly in most commodity prices. Supply chains and economies are slowing quickly: big tech in the US is shedding jobs with the likes of Amazon, Facebook and Twitter all recently announcing facility closures and chunky job cuts. Against this slowing backdrop, bond yields at around 5% start to look interesting particularly when we contemplate the possibility of the current increasing interest rate cycle coming to an end – if the slowdown bites.
Periods of monetary policy tightening and difficult investment markets can eventually see skeletons emerge as we saw with the accounting scandals of World.com and Enron. I would expect that is a possibility again, particularly after such a long period of loose monetary policy and “easy money”. When markets feel like a one-way track of pessimism though, it is often where the greatest opportunities lie and that is where the great investors like Warren Buffett have prospered over the years. From the low of 776 in October 2002, the S&P500 went on to double over the next five years.
One analyst that noticed these cyclical trends is Citi Group’s Tobias Levkovich. Tobias, who was tragically killed in a car accident last year, established what has become a highly-followed panic/euphoria index, now known as the Levkovich index. The index has an impressive track record of predicting the share markets based on a variety of market sentiment inputs. Simply, when his index reaches peak euphoria, it suggests that everyone who is going to buy has already bought. In contrast, when the index reaches peak panic everyone who is going to sell has already sold. Right now, the Levkovich index is flashing panic which, if we are to believe the reading, tells us that share market returns from here are likely to be much better than those we have experienced over the past year or so.
For investors, seeing the wood for the trees can be extremely difficult, but as we sit here today the S&P500 is 3650, more than double what it was before the Global Financial Crisis (GFC) in 2008. After what has been a very difficult year, taking a long-term view is important. The 40-year annual average gain for the S&P500 is 12% pa including the effects of the 49% fall from the tech wreck, the 57% fall following the GFC and the 34% covid crash a couple of years ago, among other drawdowns.
Central Banks can reverse course from tightening to loosening monetary policy very quickly and there are always opportunities in the associated panic. With bond yields much higher than their levels of 12 months ago, the bond market might not be a bad shelter from the storm right now, while selectively looking for attractive share market opportunities.