The ‘everything’ bubble
Central bankers would like investors to believe they can withdraw monetary stimulus and normalise interest rates in 2018 without negative consequences. That view is naive, says Newton’s Nick Clay.
The past decade has seen a substantial shift in the way consumers in developed nations own (or rather do not own) a whole range of goods and assets. From falling rates of home and car ownership to streaming the latest ‘box set’, the way we purchase the things we want and need has fundamentally changed.
Increasingly for millennials, defined as 18- to 35- year-olds, renting is the new norm. Passing one’s driving test was once an essential rite of passage. However, studies around the world suggest fewer young people are getting driver’s licenses, as sharing services such as Uber and Lyft crowd out the private car.1
Owning one’s own home is also falling out of fashion among a growing Generation Rent. In the UK, home ownership among 25 to 29 year old's decreased from 55% in 1996 to 29% by 2015.2
Asset price inflation
What does this trend to rent tell us about the world in which we live? One thing it doesn’t indicate, as some have suggested, is that we are moving towards the end of ownership. When it comes to big lifestyle purchases, younger consumers are not that different from their parents’ generation. Most millennials still want to buy a home and car but, for great swathes of the population, these goals have simply become unobtainable.
This is a consequence, not of changing attitudes but of the central bank response to the global financial crisis. The distortionary effect of quantitative easing (QE) has pushed up asset prices across the board; not just equities, but bonds, property, art, cars, wine, almost everything you can think of.
In 2000, we had the Dotcom bubble. In 2007 we had the housing bubble. Today we have the 'everything' bubble and it is distorting our economy, including the ability of consumers to buy and own assets.
Since the global financial crisis, asset prices have risen substantially but incomes have not recovered at all, even at a time when the United States and UK are apparently at ‘full employment’. During the 1980s, growth in wages was skewed to people in the lowest income bracket. Today, that segment of the population has continued to lose money while the people in the top 1%, holding most of the assets, have continued to benefit. This inequality contributed to the vote for Brexit, the election of Donald Trump as US president, the push for independence in Catalonia, and the populist rebellion against the established elite.
The prevailing narrative among central bankers is that QE and other stimulus measures were the only viable responses to the global financial crisis. With the recovery now firmly on track (even though we still have the most lacklustre economic recovery in history) interest rates can be normalised and asset purchase programmes unwound.
The thorn in this rosy picture is debt. As asset markets have risen, incomes stagnated and valuations have become more expensive, consumers, companies and governments have become ever more dependent on debt, with little regard for the long-term consequences.
It would only take a small increase in interest rates for people to begin to struggle to service their payments. This is already beginning to happen, as evidenced by recent delinquency rates in auto financing. In the US, around eight million Americans are 90 days or more behind on their car payments, according to data from the Federal Reserve.3
Regulators in the UK are also concerned, after low interest rates and loosened lending standards contributed to a boom in car loans in the form of personal contract plans (PCPs) – a form of hire purchase.4 Close to nine out of 10 UK private car buyers are now using PCPs to fund their purchases.5
The looming crisis in car finance is part of a wider malaise. As talk grows of interest rates normalising, credit card debt, which likewise rocketed in the aftermath of the global financial crisis, is also triggering concern.6
Looking further down the road we believe these elevated levels of debt could begin to be a real problem.Central bankers such as the Fed’s Janet Yellen and ECB’s Mario Draghi want us to believe that central banks can walk away from stimulus without any consequence. Yet we believe the idea that things are beginning to normalise, that central bank dependency can end without major fallout, is naive in the extreme.
Major economies today are hypersensitive to the cost of debt, to the level of interest rates and to asset values. The credit-dependent world the central bankers helped to create relies on asset prices remaining high. If markets were to experience a wobble, if economic growth started to slow, the same cast of characters would do exactly the same as before: go back to stimulus and print more money. Their attempt to control the system has made it more fragile not safer; we have a bigger debt mountain now than in 2007.
The situation we find ourselves in would not be so worrying if we were at the beginning of an economic recovery, employment was picking up and wage inflation growing. However, the recovery in the US has already been the third longest in history; we are at the end of this cycle not the beginning. That’s why we think the outlook for next year and beyond is not one of a return to normal levels of interest rates, steepening yield curves and an accelerating economic backdrop. Rather, it’s one of continuing low interest rates, yields under pressure and disappointing economic growth.
So far, markets have shown a remarkable ability to ignore these issues. This suggests investors have utter faith central bankers will always bail us out, the result being a pretty elevated market and pretty elevated risk - though all the risk measures in the market will tell you there isn’t any risk at all.
Against this backdrop, income investing - with dividends that can be reinvested to compound over time - can be attractive. Investing in stable dividend-payers, sitting on lots of net cash, can make any future volatility in the market an opportunity not a risk.
What to watch in 2018
- Lacklustre economic growth
- Rising debt and loan delinquency rates continue to rise
- Expectations are central banks will restart QE if economies stumble.
1. The Atlantic: ‘The Decline of the Driver's License’, 22 January 2016; Radio New Zealand News: ‘Fewer young people learning to drive’, 31 October 2016.
2. Office for National Statistics: ‘ ‘Five facts about… housing’, 17 August 2016.
3. Federal Reserve Bank of New York: ‘Quarterly Report on Household Debt and Credit’, August 2017. NB: 3.9% of auto loan balances were 90 or more days delinquent on June 30.
4. FCA: ‘Our work on motor finance’, 31 July 2017.
5. The Finance and Leasing Association:, 6 October 2017.
6. Financial Times: Why is consumer debt hitting the headlines?’, 31 May 2017.