The only way is up?

Take technology as an example

Take technology as an example. The largest companies in the world are now the technology giants that play an ever increasing role in our daily lives. The impact that technology has upon economic performance should not be underestimated yet, during the autumn, technology shares fell out of favour, with much speculation that a bubble akin to the dot com frenzy that ushered in the new millennium had developed and was about to burst, replicating the events of nearly 19 years ago.

Personally I believe the situation to be very different today to the conditions that saw investors rush into companies that were all too often more hope than substance some two decades back. The FAANGs, as they are often known (Facebook, Apple, Amazon, Netflix and Google) are generating substantial revenue and significant profits. They are changing the face of business and society in ways it would have been difficult to envisage even when the Silicon Valley entrepreneurs were first selling their wares to an eager investing public as the dot com bubble inflated.

The largest companies in the world are now the technology giants that play an ever increasing role in our daily lives. 

Perhaps share valuations did get somewhat ahead of the game. This, combined with the fact that a series of issues will have drawn to the investing public’s attention the likelihood that governments and regulators will adopt a more interventionist approach to these companies, could well have prompted a rethink over what these businesses might be worth in the future. This is not to say the correction we have seen necessarily has much further to go, or that all technology companies will be subject to the same pressures as time goes on. Still, it is worth remembering that bank shares suffered a significant downgrade in the aftermath of the financial crisis of 2008.

Technology is not the only issue that investors need to keep in their sights while the rest of the nation concentrates on Brexit. Interest rates have always been an important component in determining both economic performance and the direction of markets. The trouble is that we have had nearly ten full years of near zero interest rates – at least, so far as those rates set by governments and central banks are concerned. This country, Europe, the United States and Japan have all experienced both low interest rates and monetary stimulation as efforts were made to stave off sustained recession in the wake of the financial crisis. But it is all coming to an end.

Or is it? True, we have seen a modest increase in interest rates from the Bank of England and are experiencing true wage growth for the first time in ten years. The Federal Reserve Bank has also embarked on a series of rate hikes, while the European Central Bank is reining back its bond purchase programme. But all this is contingent upon global economic growth being maintained at a respectable rate. The outlook, though, is not as encouraging as we might hope. Indeed, the International Monetary Fund is forecasting that growth rates have peaked, while the Organisation for Economic Cooperation and Development (OECD) is also predicting a slowdown in economic activity around the world.

Third quarter GDP figures from Japan and Germany – the third and fourth largest economies respectively – actually disclosed a contraction in both cases. While this may be explained by one-off circumstances, it serves to underline the fragility of the global economic system. While the US and ourselves appear to be chugging along quite nicely, there remains the spectre of a trade war between America and China, while the nature of our leaving the European Union could have profound implications for our own economic progress.

All of this makes the extent of interest rate rises around the world far from certain. In America there is still an expectation of further tightening, with one leading investment bank forecasting four rises next year, adding a full 100 basis points to the Fed Funds Rate. But if the slowdown in growth around the world accelerates or domestic economic expansion falters, the Open Markets Committee which sets rates could well pause their action, fearful of a policy mistake.

Ten year government bond yields in the US stood at a whisker over 3% in mid-November. The long term average for the Fed Funds Rate stands at around 3.4%, leaving plenty of scope for further increases. But much will depend on what is happening elsewhere and the loss of control by the Republicans of Congress could well rein in some of President Trump’s likely excesses. Interest rates should probably rise to reflect a more normal background, but when and how far is anybody’s guess.

Illustration by Emily Nault

Understanding Finance

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