There isn’t a huge amount of evidence to suggest the recent volatility in markets is a prelude to the next financial crisis, according to Miton’s David Jane, who says the current backdrop is more similar to the one presented to investors during the Asian financial crisis of 1998.
Investor sentiment has waned considerably over recent months as the extended bull run in equity markets has shown signs of deterioration thanks to uncertainty about China’s future and worse than expected economic data out of the US.
While there has been a sharp revival in markets over recent weeks, the likes of the MSCI AC World index is still down more than 10 per cent since its peak in April this year.
Performance of index in 2015
Source: FE Analytics
Of course, many managers are now decidedly more bullish on equities than they were as valuations have fallen and macroeconomic concerns such as China’s slowdown have pushed out expectations surrounding the first rate hike from the US Federal Reserve. 
However, others warn that the huge price swings in markets, heightened volatility, widening credit spreads and signs of deteriorating economic data are very similar to the backdrop presented to investors in 2007 before the global financial crisis in 2008.
Jane, manager of Miton’s multi-asset funds, has had a long career in the industry and says there are certainly similarities to the prelude to the last economic meltdown.
That being said, given the woes have originated from emerging markets, he says the current environment is more similar to 1998 during the Asian financial crisis – suggesting developed market equities can still perform well from here.
“If this was at the beating heart of the world economy, being the US, Europe or Japan, I would be much more concerned. I think the base case that I would have is it’s more like Asian crisis than the global financial crisis,” Jane (pictured) said.
“Therefore, it is an interim growth slowdown (or a correction within a bull market) and once things calm down stock markets should grind higher. However, I need to see more evidence to prove either case because both of them are well-argued and can be made perfectly validly.”
The former head of equities at M&G – who now runs the likes of CF Miton Defensive Multi Asset, CF Miton Cautious Multi Asset and Miton Cautious Monthly Income and has comfortably beaten his peers over the longer term – certainly has sympathy with the view that the market is similar 2007, though, describing it as a “reasonable thesis”.
Performance of Jane versus peer group composite during career
Source: FE Analytics
He points out that widening credit spreads, deteriorating lead indicators, heightened volatility and financial stress are all characteristics that are seen today.
Coram’s James Sullivan has been an advocate of this view, telling FE Trustnet after the events of August’s ‘Black Monday: “In 2007 we witnessed a few bumps on the road but it didn't really spill over until 2008 – we can't be sure this isn't history repeating – but for different reasons of course.”
Mark Burgess, chief investment officer for EMEA at Columbia Threadneedle Investments, also identified this trend this week.
“We have all read and heard about the challenges facing China, and the implications for the global economy, but the issues are broader than just how China and the developed world copes with the former’s inevitable slowdown,” Burgess said.
“Depending on one’s starting point, we are now some seven or eight years on from the start of the global financial crisis. For what it’s worth, my reference point is the HSBC profit warning in February 2007 when it cut its profit forecasts. Even if the crisis didn’t really start with a vengeance until 2008, history would suggest we are closer to the start of the next downturn than we are to the end of the last one.”
Interestingly, FE data shows the FTSE All Share has near enough the same annualised volatility so far this year (14 per cent) as it did in 2007. On top of that, the index has performed in a very similar way this year as it did in 2007 with a sell-off during the summer and sharp rally in the autumn.
Performance of index between 2007 and 2008
Source: FE Analytics
However, Jane says there are some notable differences investors need to consider before they become overly bearish.
“Policymakers are aware, are being active and interventionist whereas in 2007 they were quietly unaware. Also, the financial stress is very much around the periphery rather than the core,” Jane said.
He continued: “Therefore, my preferred case is a scenario a bit more like 1998 where you had the Russian crisis and hot on its heels was the Asian crisis.”
“There was excessive dollar debt in south-east Asia which led to many countries getting into financial difficulty, there was massive currency collapse as their debt was in dollars and therefore they couldn’t repay it, so the stock market corrected aggressively presuming there would be knock-on effects for economic activity – which there was.”
“However, it was an interim growth slowdown rather than an economic collapse. Actually, that is more parallel to today.”
The manager points out that, like in the Asian crisis of the late 1990s, a lot of emerging market economies and companies are feeling uncomfortable. This time, however, it is because there is a lot of dollar-denominated debt in the Asian and Latin American markets which is largely backed by commodity revenue streams.
As commodity prices have fallen, that dollar-based liability has caused financial stress.
Jane added: “Our presumption would be that policymakers are alive to that because, of course, your major trading partner is suffering. You want to be selling them stuff and you don’t want them to go bust. They want to follow a policy that will resolve that issue.”
The graph below shows the performance of the UK equity market versus emerging market equities between 1998 and 1999 and it illustrates that while the FTSE All Share was hindered by the huge falls in the developing world (it fell 23 per cent between July and October 1998), it rallied back strongly afterwards.
Performance of index versus sector between 1998 and 1999
Source: FE Analytics
Nevertheless, as there have been a few ‘canary in the coal-mine’ warnings this year that the rally in equities may not be as strong as people first perceived, Jane will remain cautious and keep his equity exposure at the lows of its historical limit (40 per cent).
“We have seen a massive deterioration in the jobs data, clear signs of financial stress in certain commodity companies, credit spreads massively widening out, the levels of debt in emerging markets are very, very uncomfortable and there are deteriorating levels of global trade.”
“We want to be in the position to bet on either scenario so we are running a very conservative, defensive portfolio. If it turns out to be the end of the economic cycle we will do OK (clearly we’d like to take further action) and if it turns out to be pulling the string on the bow for a final leg of the bull market, that would be pretty easy to deal with.”
He added: “But it’s too uncertain to be too overconfident. Volatility is extremely high and the market is not being predictable so it doesn’t pay to be a hero.”
