The recent market turmoil
The collapse and current volatility in most western equity markets is consistent with what we know about how our brain works in times of stress.
During our evolution our brains developed three distinct parts. The first to evolve is a central core which is structured to ensure our survival. It responds rapidly to perceived danger and controls reflexive behaviour by shutting down bodily functions which are in shock: this is the basic instinct designed to allow us to survive.
The second part came later; this controls social desires and emotions such as intuition, sexual urges, anger, unhappiness and so on.
The third part which is the last to evolve is the rational, sophisticated thought section. Under normal circumstances this part dominates, but in a crisis we revert to the central core and go into survival mode. This is why the model of rational market behaviour is so flawed. Markets are driven by individuals who can quickly switch from the rational assessment of the environment to the irrational, instinctive and herd like response. This is what we have witnessed and will continue to witness as individuals begin to realise that their very little the Government (i.e. other people) can do about the macro-economy.
When this happens our time horizon moves from the longer term considered view of things to an immediate knee-jerk response. And we cry out for leadership ie for another human who can show us the longer time horizon and create in us a greater sense of security. When we are in this state of mind we tend to believe anything if we think it improves our chance of survival.
Alas all the economic forecasting models do not embody this thinking in any way. Expect a lot more turbulence, but remember keep your head when all around you are losing theirs.
The UK Economy and its prospects
The immediate outlook is poor, unless fuel and food prices fall significantly in the next three months. Household real incomes are falling by nearly 3% year on year. This is reflected in retail sales data: sales volumes are flat. We will experience a mild double-dip at the end of this year; the economy will shrink about 0.7% in real terms. Many will not even notice it, but the political impact could be considerable with the opposition claiming it could have been avoided. This isn’t true, but the point will be made ad nauseam. Base rate will remain at 0.5% for another 12 months at least.
As I have said before, the problem is corporates hoarding cash. Good for them, bad for the system. Western Governments cannot do anything about this apart from taxing cash holdings which I wouldn’t advise!
Please note that Government sector deficits are the mirror image of Private sector surpluses. There is yet again a feedback loop in operation: USA companies are holding on to cash because they see Congress divided and not in control of things, they see a weak President, they see an increasing number of opportunities to purchase weaker competitors at fire sale prices and finally they note that the prospects for domestic demand expansion are poor. The Obama incentives to hire more workers will fail; instead it will increase Private sector surpluses and the Government sector deficit. Most companies employ more people when the order book is growing fast and it exceeds existing capacity. Reducing payroll taxes just allows companies to increase their cash balances.
Conclusion
The global economy will slow down to about 3% year on year growth as Brazil, India, China reduce their inflationary growth rates. Europe will stagnate with zero growth. The UK will have a mild double dip, and probably the USA too. If the oil price drops to $90 or below, Russia will slow down significantly, but the USA will avoid double dip. Over the next five years we can expect a saw-tooth pattern for GDP in the West with sustained growth not returning until circa 2015.
How to survive and expand your business under these conditions? Keep it simple, communicate with and motivate your employees, pay them what you can afford, find out what two or three things make the biggest difference for your customers, and deliver them consistently. Have fun!
Roger Martin-Fagg Sept 20 2011
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