There was a time when investors could rely on a steady global economy to make solid returns on their investments. But in a world where markets can plunge and soar by 3 per cent in a single day on nothing more than a rumour, their appetite for risk has vanished, writes Harvey Jones
These are strange days to be an investor.
Stock markets seem to have lost their direction, plunging every time the Greeks riot, Spanish bond yields soar, US jobs figures disappoint or Chinese growth slips.
Next day, they rebound, as the euro zone cobbles together another doomed rescue package, or the US Federal Reserve hints at more quantitative easing.
Shares aren't the only investments behaving strangely. Bonds, cash, currency and property are also reacting in a weird and irrational manner.
Strange days, indeed. But what can you do about it?
Crazy currencies
The US has a mind-boggling US$15.8 trillion (Dh58tn) national debt. It has the largest deficit of all the major economies, at 12.5 per cent of GDP. The Federal Reserve has been rampantly printing money through quantitative easing and is widely expected to print even more in the next few months. At the end of the year, the country will hit a so-called fiscal cliff, when taxes rise and government spending is cut, equal to a 4 per cent drop of GDP.
Given all these problems, you would expect the US dollar to be plunging in value, says Steve Gregory, the Dubai-based managing partner at Holborn Assets, the financial services company. "Instead, it has grown stronger and is now seen as the world's safe-haven currency."
Expatriate workers in the UAE should actually celebrate every time stock markets fall. "When investors panic, UAE expats can send money to their home country at more attractive exchange rates."
The Japanese yen is behaving even more strangely, says Chris Towner, the director of FX advisory services at HIFX, the currency transfer specialists. "No country owes more money than Japan, which has the world's highest GDP-to-debt ratio at more than 225 per cent. Yet the yen is now treated as the ultimate safe haven."
The truth is that currencies are engaged in an ugly contest. The US dollar and Japanese yen only look pretty because rivals, such as the euro and sterling, are even uglier.
Bizarre bonds
If currencies are acting strangely, the bond markets are weirder still.
Western governments owe so much money that it is astonishing anybody is willing to lend them more, yet they have never paid lower interest rates, says Ian Lance, the fund manager at RWC Enhanced Income, the mutual fund. "The US has 3.3 times more debt than a decade ago, but the interest rate it pays on that debt has plunged from 6 per cent to around 2 per cent."
Germany can borrow at zero per cent, despite being in the teeth of the euro-zone crisis. This means investors are actually paying the Germans to look after their cash.
Borrowing money may be cheaper than it has ever been but governments want it cheaper still. "Central banks are spending billions to force rates down just that little bit more," Mr Lance says.
Euro-zone chiefs are behaving ever more strangely. The European Central Bank (ECB) has been lending money to European banks at 1 per cent so that those banks can either lend the money to sovereign states by purchasing government bonds or dump it back on deposit with the ECB. "Everyone seems to think this is great but when Bernie Madoff did it, he was arrested," Mr Lance says.
Investors have also lost contact with reality. "Before the credit crunch, the ratings agencies rated more than 50,000 subprime collateralised debt obligations as 'AAA'. Yet the markets still hang on these agencies' every word."
Erratic equities
Stock markets are acting even more strangely. It is no longer seen as remarkable for share prices to soar or crash 3 per cent in a single session day, and on the slightest rumour.
West and East now play to a different set of rules. When China cut its growth forecasts to a mere 7 per cent a year, markets tumbled. Yet the US and Europe would kill for that kind of growth.
While governments and individuals are drowning in debt, corporate balance sheets are fatter than they have ever been. Businesses are sitting on a mountain of cash: S&P 500 companies are sitting on roughly $2tn alone.
Instead of ploughing the money profitably back into their company, they prefer to play it safe by sticking the money into government bonds or cash, despite getting a negative return after inflation. That's how broken the global economy is.
Cracked consumers
In hard times, people traditionally stop splashing out on luxuries and stick to the basics, such as food and housing. In this strange recession, the reverse has happened, says Mr Lance. "While some high-street retailers and supermarkets are posting their worst sales for 20 years, Burberry has seen sales grow 20 per cent and orders for new Bentleys are up 50 per cent."
As the poor get poorer, global fashion brands such as Louis Vuitton, Hermes, Gucci, Chanel, Rolex, Cartier and Tiffany's are seeing out the recession in style.
Strange days
Many of these problems have the same underlying cause, says Clem Chambers, the founder of Advfn.com, the stocks and shares website.
"Western governments have distorted global markets by driving down the returns on bonds and cash through their policy of slashing interest rates and printing money," Mr Chambers says. "Stock markets aren't functioning properly. The global economy isn't functioning properly. Politicians aren't functioning properly."
No wonder so many investors have lost their appetite for risk. "Markets are no longer efficient because they are no longer free. That makes it impossible to calculate risk and reward. You can't trust the stock market. You can't trust the banks. And you can't trust governments."
It could all end with a bang tomorrow, or the crisis might drag on for years. So how should investors respond? First, try to keep your head, even as all around you lose theirs.
Tackle your debts and don't risk money you can't afford to lose. Buy shares on the dips, rather than getting sucked into a short-lived rally. Look for cash-rich global companies paying attractive dividends, which you can reinvest for growth.
Diversify by spreading your money between equities, cash, bonds and property. Finally, invest for the long term, at least five or 10 years, to give you enough time to overcome today's turbulence.
The current craziness can't last forever. Or can it?
