On Friday night, we saw Wall Street plunge 4.1% in a move that rattled markets across the globe. And this was despite the fact that everyone thought America’s economy was out of the woods, so to speak. Then Australia’s stock market followed, tumbling 3%.
So why did that plunge happen then?
It’s worth noting that until last week, the US stock market was more than 300% higher than the lowest point of the darkest hours of the 2007-2008 financial crisis, and it was 88% higher than its pre-crash peak in 2007. This was the second longest stock market boom in history, transcending logic asÂ investors drove the market to new records even as the US economy barely limped out of the crisis. Many investors had been working under the assumption that unusually low volatility and inflation in asset prices would continue, even with above-average growth at a time of low unemployment in America.
And this all comes back to pumped up asset bubbles. “Bubble trouble”, if you will. You see, central banks decided to pump up asset bubbles to revive the global economy, post-GFC, and now they’re trying to deflate them, which is otherwise known as a reduction of monetary stimulus. This is because monetary policy post-GFC in the US, Europe and Japan, sent interest rates below zero for the first time in recorded history, and these countries also printed a lot of new money. All this did was inflate asset prices, from stocks to commodities to property. And when this monetary policy experiment is coming to an end – as it now has in the US, and how it will be shortly in Europe – the markets didn’t know what to do.
The Australian Bureau of Statistics recently released the Household Income & Wealth Report 2015 – 2016Â which includes concerning numbers :
The below graph from that report illustrates nicely the growth in debt over the past 13 years and the acceleration in more recent years:
Graph 2 (below), also from the report, shows the rapid increase in debt when compared to Income and Assets:
None of these figures, and in fact the trend for greater indebtedness, in themselves, mean we are facing an economic calamity. We could see huge asset growth and income growth over the next 5 years and all of the graphs and figures here would have become meaningless. What it does tell us, however, is that the Australian economy, and in particular Australian consumers, are in a poor position to handle any significant financial shock in the form of asset prices falling, increased interest rates or falling incomes. However, as Philip Lowe pointed out last night in his remarks to the A50 Australian Economic Forum, “…the quality of lending [has improved]…national measures of housing prices are up by only around 3Â perÂ cent over the past year, a marked change from the situation a couple of years ago. This change is most pronounced in Sydney, where prices are no longer rising and conditions have also cooled in Melbourne. These changes in the housing market have reduced the incentive to borrow at low-interest rates to invest in an asset whose price is increasing quickly.
On balance then, from a macro stability perspective, the situation looks less risky than it was a while ago. We do, however, continue to watch household balance sheets carefully as there are still risks here.”
The RBA’s latest economic forecasts, however, remain largely unchanged from those previously announced. The reason for this is that the RBA believes that the Australian economy will grow at an average rate of 3% (or slightly higher) over the next couple of years. GDP should pick up, as show wage growth, although the latter’s movement may remind some – for a while at least – of snails. The unemployment rate has declined to roughly 5.5% (which is good). CPI and underlying inflation are expected to remain at around 2-2.5% (and even lower for underlying inflation).
The RBA believes that this means is that overall Australia should remain safe from volatility in the markets. Other countries may be raising their inflation rates, but just as we did not remain lock-step with them on their way down, we do not have to their way up. Having said all of this, markets sometimes are very irrational, so what ‘should’ happen is not necessarily what does happen.