It is quite natural for elections to cause anxiety but financial markets are still in a calm dreamland state. However, the real reasons for election anxiety should be a cause for worry. The markets may be in a fairy-tale state but that doesn’t necessarily make them good investments.
Political surprises such as President Donald Trump‘s victory, Brexit, and the recently concluded UK elections portend a deep sense of uneasiness in current economic conditions. Despite the unease in market conditions, easy money, low inflation, and a comparatively steady growth worldwide have made Goldilocks the talk of the town among market analysts and financial service providers such as Nuvest Management Services.
In the words of J.P Morgan market strategists, “Goldilocks has not left us yet.” The opinion is shared by a few other analysts and economists at ING, Citigroup, and the Societe Generale of France who view the market from a fairy-tale angle. Growth is neither too cold nor too hot and the performance is still upbeat. Global stocks are on the rise given that the MSCI Index has gained close to 10% so far this year. With low inflation, bonds are enjoying good support as well. High-yield bonds in the US have so far returned 5% due to strong credit markets. It is indeed a fairy-tale state of gains in emerging-market stocks, currencies, and bonds.
At a closer inspection, however, the worldwide coordinated growth together with the increased liquidity from central banks as well as minimized inflation and wage demands, the fairy-tale may not last long. The political surprises in the last two years, especially in the UK and US, portray a completely different story outside the financial markets. The overall picture shows a global population unhappy with the status quo. The Goldilocks situation is best exemplified by the lack of a pickup in wage inflation, meaning that central banks have to maintain their policy loose. Low wage growth could also cause further political turmoil especially in elections, which may result in more electoral shocks that most investors are not comfortable with.
A good example is the case of the UK. In a speech delivered last year, Andy Haldane, Bank of England’s chief economist, wondered who actually benefitted from economic recovery given that, despite data showing growth, 50% of all UK households had not seen any growth in disposable incomes since way back in 2005. The recent increase in UK inflation sent real-wage growth below zero by the time the country went to the polls. All around the world, from US, UK, Japan, and Germany, central bankers are wondering why wage formation does not respond appropriately to declining unemployment while easy-money policies continue to deliver exceptional results in the markets.
Past returns could affect a part of Goldilocks that hardly ever gets mentioned, which can be equated to a serving of porridge. While porridge is known to be nutritious, it’s not really appetizing. From a financial market’s point of view, bond yields are particularly ultra-low, developed-market equities cheap, and credit spreads too tight. Prospects of high future returns are quite unlikely despite the bright outlook in emerging markets. This is why the current seemingly benign situation does not provide much investor confidence. Goldilocks may be with us for some time but happy endings don’t happen in all fairy tales.