The credit crunch, 10 years on

Fidelity fixed income portfolio manager Ian Spreadbury believes today’s environment is eerily similar to that of 2007, but with three significant differences.

We are now, incredibly, almost 10 years on from the early stages of the credit crunch, yet much of the background all seems eerily similar to where we are today. 2006 was a year of global monetary tightening, with the US tightening cycle having started in 2004 on the back of reasonably solid GDP growth and a modest pick-up in inflation. Global GDP growth had averaged around 5 per cent a year over the three years to the end of 2006.

Both bond and equity market volatility were at, or close to, all-time lows, as were corporate bond spreads. Stocks were strong and, not surprisingly, high yield was the best-performing bond asset class in 2006 with a return of around 10 per cent - despite clear signs of deterioration in credit quality with concerns about share buy backs and event risk.

So what’s different this time round?

Growth is much lower

First, global GDP is much lower - around 3 per cent - and perhaps more importantly nominal growth has continued to trend down to the lowest level since the 1930s – all despite trillions of QE and a continuation of super low interest rates.

Chart: world real GDP growth.

Source: IMF Fiscal Monitor, gross global debt expressed as weighted average, October 2016.

Structural headwinds have intensified

Secondly, the structural factors which led to the credit crunch have intensified; in particular, high global debt to GDP, population ageing and wealth inequality. In fact, debt to GDP globally is back beyond the highs of 2006 - the debt bubble is back, it’s only the composition that has changed.

Chart: gross global debt (%of GDP)

 

Source: IMF Fiscal Monitor, gross global debt expressed as weighted average, October 2016.

Policy uncertainty is being ignored by risk assets

“Thirdly, although both realised and implied volatility are very low, unlike 2006/07, global economic policy uncertainty is very high, implying an elevated risk of policy error. The risk is that the optimism around Trump reflation is misplaced – we have already seen some tighter financial conditions with rising rates, higher mortgage rates in the US, dollar strengthening and QE tapering.

Clearly, underlying systemic risks are growing and at least the government bond markets seem to recognise the risks to growth, with yields flat or falling year to date and still running at extraordinarily low levels. I have been focusing more on safety within my portfolios - reducing high yield exposure and focusing on high conviction investment grade bonds, with selective exposure to government debt, inflation linked bonds and emerging markets.

With all this in mind, now is the time for investors to recognise the risks, to diversify and not to chase yield too aggressively.


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