Business cycles wouldn’t be cycles if there were not similarities in how firms confront changing market conditions over time. But as the current cycle nears its inevitable end, investors should not lose sight of the unprecedented technological, political, and liquidity risks that will make the next cycle uniquely perilous.
By Christopher Smart
Respectable investors aren’t supposed to say, “This time is different.” But, given the market gyrations in recent months, they would do well to keep an eye on what really is different from the last time the business cycle turned. The last time, of course, was the 2008 global financial crisis. Unlike then, today’s underlying economic data remain strong, suggesting that a looming recession could come and go before we have even had time to measure it. But that won’t help investors looking to assess the potential risks and rewards of the next cycle, which will likely be shaped by unpredictable shifts in liquidity, politics, and technology. While academics convene conferences to analyze the legacy of quantitative easing (QE) by central banks over the past decade, investors want to know what the policy’s reversal will mean for future financial conditions. The major central banks have essentially stopped providing massive liquidity injections through bond purchases and are now unwinding their balance sheets, albeit at varying rates. Regardless of whether the U.S. Federal Reserve ignores market jitters and defies President Donald Trump to resume interest- rate hikes, its balance sheet is, for now, still shrinking by $50 billion per month. The European Central Bank halted its bond purchases in December 2018. And the Bank of Japan may be approaching the beginning
of the end of its QE program – though it is an open question when the “end of the end” will be. All told, the tapering of QE programs has left an enormous amount of liquidity draining through pipes of different sizes and at different times. Insofar as the global financial system is like a giant swimming pool, turbulent waters are tossing around the swimmers. Moreover, undercurrents that have been keeping the U.S. dollar stronger for longer are likely to be disrupted as relative growth expectations may shift toward the euro and key emerging markets. Don’t be surprised if an unexpected vortex suddenly swallows up a midsize bank or hedge fund as the QE tapering continues. Complicating matters further, new sources of political uncertainty have called into question the assumption that globalization and economic integration will continue apace into the next cycle. True, Trump’s import tariffs on aluminum, steel, and an array of Chinese goods have so far resulted in relatively small direct costs for a few targeted industries. But the potential for further disruptions to global value chains has forced multinational firms to reconsider where and when they should invest. This is what business leaders mean when they say they’re worried about “political risk.” Even if the United States and China agree to extend their current trade-war truce beyond the first half of March, the potential for continued
American Consequences
79
Made with FlippingBook - Online Brochure Maker