When all the bears are hibernating, that's usually the time to be wary.

Equity markets in Europe and the US started the week in the same positive vein they ended the previous week. US equities, despite dollar strength, once again reaching the record levels it hit earlier in the year as markets in Europe remain languishing from recent peaks. The recent strength in the US economy continuing to boost sentiment. Despite the strength of the US economy the US yield curve continues to flatten.

Jay Powell’s speech at Jackson Hole at the end of the week seems to be the focus of a large area of the financial press. Economists are starting to concern themselves with the impact the dollar strength is having on emerging economies. The Federal Reserve’s expectation to raise interest rates twice more this year which could add further strength to the US dollar and lead to capital flight from emerging economies. The Federal Reserve unwinding its balance sheet to the tune of 50bn dollars a month adding to the tightening of liquidity in the economic system.

Zero or near zero interest rates were used to prevent the global economy from falling into meltdown in 2008 and beyond. The question some analysts are now asking is, has this led to excessive risk-taking in a hunt for yield that will now come home to roost? As the Federal Reserve looks to raise interest rates to bring inflation back nearer to its target of 2%, at a time when the economy appears robust.

Hermes, the highly respected fund manager, is quoted in the Telegraph believing that cracks are appearing in the credit market “akin to events in 2007”. Once again equity investors are ignoring the signs, they believe. They go on to point out that debt levels are higher now than they were 12 years ago and that these ultra-low interest rates have allowed zombie companies to survive. Since 2007 more than 70pct of the debt issued has been without some form of covenant, so in the event of the debt being unable to be serviced the money “will be gone”.

This does not make comfortable reading, put on top of this concerns that the Chinese economy is slowing as well, along with the possible effects an escalation of trade wars could have. Jay Powell will have plenty to talk about and it will be interesting how much heed he plays towards emerging market concerns balanced with the Fed’s desire to continue to raise interest rates during this period of economic strength.

The ten-year bull market has been dominated by doom-mongers, so far, they have been proved to be incorrect. At some point, one of them will be right. The problem usually comes when the bears are all hibernating.

Posted on August 21, 2018 .