“Stress level quite close.”
So ended an email I received from Charlie Morris yesterday. I had asked him his thoughts on a recent spike in a metric that’s built in to more than £250 trillion of assets around the world. These are not just financial assets. Some are much closer to home. In fact, I expect some of you reading this will be heavily exposed to it.
But first… porridge.
How do you take your porridge? Do you add things like honey, syrup or milk?
Some folks from my hometown tell me any addition to porridge other than a pinch of salt is heresy…
But before you start messing around with accessories, you need to get the temperature right. Extras don’t matter if your porridge is scalding hot or a soggy cold mush.
The porridge Goldilocks enjoys in the fairy tale is sometimes used as a metaphor for the economy. Low inflation (not too hot) with high employment and moderate growth (not too cold) are deemed “just right” by economists, and the “Goldilocks economy” meme is ploughed out by pundits and the press alike.
But the metaphor ends there. Nobody seems to mention that in the story Goldilocks steals the porridge, and that the story doesn’t end very well for her. They don’t even include the more alarming half of the title, and the rest of the cast – the three bears!
Turns out, these glossed-over parts of the plot actually fit economic reality pretty well. But once you take them into consideration, the outlook is a lot less rosy.
The porridge Goldilocks eats is not hers. She takes it. The economic growth since the crisis that stockmarkets have enjoyed has been funded by debt – consumption taken from the future, to be enjoyed in the present, and hung around the necks of the next generation.
The deep sleep Goldilocks falls into after eating the porridge is reflected in the extreme lack of volatility in markets over the past couple of years.
And to wake her up from that sleep, are the three bears. Bear markets certainly haven’t arrived on stage yet. But the fact that we are talking about a “Goldilocks economy” in the first place may herald their arrival…
The growling of the grizzlies
The Goldilocks economy narrative is only pushed through the media during stockmarket booms. Comparisons aren’t drawn to the bowl of porridge that was “too cold” when employment falls. Nor do you see descriptions of the Venezuelan hyperinflation as the bowl of porridge that was “too hot”.
From my perspective, it’s a contrarian indicator. When commentators claim that the financial elites have mastered the economy, as though it were just a bowl of porridge to be cooked, it’s a signal that we’re late in the game.
The popularity for the phrase “Goldilocks economy” in Google searches reached a peak in February. The last time it was so popular was in December 2007, as the world waltzed into the financial crisis. The correlation may mean nothing, but I’d be on my guard.
It was only January when Ray Dalio, manager of the world’s largest hedge fund, was saying investors avoiding markets and holding cash would be left feeling stupid as the Goldilocks economy pulled asset prices to new highs. How fast sentiment can change.
Volatility has returned to markets – the bears have woken Goldilocks from her slumber. Tim Price warned of the three bears set to return to markets this year in the December issue of London Investment Alert – volatility, higher interest rates and inflation. So far he has been vindicated. You can take a look at his most recent warning here.
Just yesterday the Dow and S&P 500 were hamstrung from their highs. The narrative promoted by the press was trade war fears – but perhaps it’s a result of “the great unravelling”.
The gruel thickens
As markets stagger, Libor – the London interbank offered rate – has begun to rise rapidly. Libor reflects how much it costs for commercial banks to borrow from each other. This is higher than the interest rates set by the central bank as commercial banks can default.
There are over £250 trillion of Libor-referencing assets in the world. The rate many people pay on their mortgages is Libor + a percentage premium set by the bank. In a short space of time, Libor has risen to its highest level since the financial crisis – the trillions in debt out there that’s linked to Libor is getting more and more expensive.
The “stress level” Charlie was referring to was the level at which this increase in costs was reflected in other asset classes. Credit conditions are beginning to tighten throughout the financial system. Debt is becoming more expensive. The economic porridge is beginning to taste bitter. And all the companies out there that could only survive at zero interest rates (“zombies”) will begin to choke on it.
In comparing the financial markets to Goldilocks, we should pay attention to how the story ends. There have been different interpretations of the story over time, but when in doubt stick with the original.
Before explaining the performance of the stockmarket with Goldilocks, perhaps the economists should have considered how the story ends. Something tells me they won’t be using Goldilocks as a metaphor if stockmarkets jump out the window – no matter how fitting.
Until next time,
Boaz Shoshan
Editor, Southbank Investment Research
Category: Economics