Growing debt levels fuelled by extraordinary monetary policies from the world’s central banks mean the economy is heading towards a financial crisis that will make 2008 look like “picnic”, according to Peter Toogood, investment director at City Financial. 
With central banks continuing to pump money into economies to stimulate growth, Toogood says a pattern of increasing debt and little evidence of financial stability could lead to the next financial crisis.
Earlier this month, the Bank of England cut interest rates to an unprecedented 0.25 per cent to stave of the potential threat of Brexit, while expanding its quantitative easing programme by £60bn to £435bn with the ability to buy up to £10bn of corporate bonds over 18 months.
While many warned there was little need to loosen policy, financial markets have reacted positively to the news with the FTSE 100 rallying 3 per cent and 10-year UK gilt yields dropping to their lowest ever level – continuing a rally that has lasted since the EU referendum.
Performance of index and gilt yields since EU referendum
Source: FE Analytics
Toogood said: “There are six savers to one borrower [in the UK] and you’ve just impoverished all the savers again. Real interest rates are now negative in this country.”
Meanwhile, European Central Bank president Mario Draghi announced last month that its stimulus package would remain unchanged until the repercussion of the UK voting to leave the EU has been realised.
Over in the US, the Federal Reserve, which was widely expected at the start of the year to look to raise rates multiple times over the course of 2016, has stuck with just the one interest rate rise to 0.5 per cent, which took place at the end of last year.
“It’s just a grand case where all these central banks have come to this agreement that they will just keep pumping,” Toogood said.
“Why do you keep giving all the people who have all the debt all the fun – it doesn’t make any sense and they’re doing this with no understanding of why.”
Low interest rates typically impact savers, as the amount they are earning in a current account is less than inflation, meaning they must look to move their money into riskier investments. This monetary policy has worked in the world of financial markets, but many question how much of an impact it has had on the real economy.
Indeed, though growth remains anaemic, the FTSE All Share has returned a hefty 171.41 per cent since the Bank of England first cut interest rates to 0.5 per cent in March 2009. Over that time, the 10-year gilt yield has dropped by 80 per cent.
Performance of index and gilt yields since the implementation of 0.5% rates
Source: FE Analytics
However, with bonds in some cases producing negative yields, more and more investors are being encouraged into equities, which he says are in a confused state.
“In April and May everyone’s going yeah wheel the wheelbarrows – get involved,” he said, pointing to the ECB’s decision to expand its QE programme.
He says this type of monetary policy would be absolutely fine if bond yields were around the 3 per cent mark, if credit was 5 per cent and if equities were providing a decent cash flow yield, but “they’re not doing any of that”.
However, with interest rates so low investors are buying into perceived lower-risk equities, something that they weren’t even doing at the time of the last financial crisis.
“The problem is you weren’t doing that [buying equities] in 2008 or 2009 when things were arguably fundamentally cheap, you’re doing it when the US stock market is trading at nearly three times price to book.”
He points to Unilever, which has traditionally been on an earnings multiple of 14 times and has been as low as seven times but is now trading at around 23 times earnings, as an example of this valuation discrepancy.
“The only cheap stocks are the ones that rely on the fact that the real economy absolutely flies and we have no change in interest rates, and in the very short term that’s what we’re going through right now – people believe that central banks are totally supportive,” he said.
“You don’t have to bearish on the economy here – we’re bearish on asset prices – they’re pricing in universal perfection and Armageddon at the same time.”
By this, he means that while defensive stocks have risen, they are now priced so highly that the outlook for future returns is turning increasingly poor.
“If you’re an active fund manager, how do you know what you own is worth – and that is the fundamental problem with continuously doing [lowering interest rates and printing money].”
He adds that while some stocks have risen to new highs, it does not mean that the economy is any better off. In fact, there is no reason to believe that the market can recover in the near-term.
“The reason we know we’re right is because the banks refuse to participate in it – and there is no bull market in history that works without the financial intermediaries working as well. That’s the fundamental problems with it, it’s solving a neo-liberal old style problem: keep on pumping money and demand will come back - just keep giving people more.”
He compares the current climate in the UK to Japan, where there is an emphasis on keeping people employed, but warns that people are not generating enough disposable income to drive economic growth. He also argues that a similar pattern to 2008 is emerging, with many using their earnings to buy new cars and taking out other examples of sub-prime debt.
Performance of indices during the global financial crisis
Source: FE Analytics
In the run-up to 2008, banks were lending to people with low credit, providing mortgages that were unable to be paid back. This is happening again, Toogood says, with the higher-risk debtors.
“Car loans are already $1.2trn - that’s past the peak of 2008. And by the way two-thirds of borrowers last year were sub-prime borrowers, so you’re doing exactly what you did with houses but with cars.”
“You’ve solved the debt problem from 2008 with another debt problem. We make 2008 in terms of debt to GDP look like a picnic” he said.
Overall, he says, the patterns remain the same as in the run-up to previous financial crisis.
“What is happening is the same as 98/99 and 07/08: sensible people are trying to take a step back and saying [to central banks] ‘have a think’.”
