Market overview June 2005

Whatever the multifarious reasons for the French and Dutch voting “no”, the votes do highlight growing anxiety, fear, and anger.  The euro and the EU institutions were always going to be severely tested once a marked Continent-wide economic slowdown was underway.  The social mood that is now evident is the precursor to just such a slowdown.  The likelihood of a dynamic response by the EU institutions to head off this slowdown is remote, though at some point there will be an inflexion point (probably at a time of Continental-wide industrial action and protest) that forces a radical re-think of what the EU is and what it can reasonably be expected to achieve.

For those in the US and UK the immediate relevance is the role of social mood to markets and economies.  Looking back over the last couple of hundred years it is reasonably clear that sharp stockmarket falls are followed by recessions (within a couple of years).  This is assumed to be because sharp stockmarket falls reflect a negative social mood, and in this mood consumers (and business owners) become less profligate, and an economic contraction ensues.  So why has it been so different following the stockmarket peak of 2000? 

Interest rates were cut to historically low levels as the stockmarket slumped, and the social mood (certainly in the Anglo Saxon economies) was hijacked by the siren call of cheap credit and rising house prices.  But the grasp of the central banks could not be held indefinitely.  As interest rates have moved up in the UK we are seeing how the social mood is changing, as housing market activity (if not yet prices) has collapsed, consumer spending is slipping away, and credit card defaults are rising.

In contrast the US consumer and housing market is remarkably stubborn, and for the reason we need look no further than Treasury yields.  Most US mortgages are priced off Treasury yields (which have remained low) not base rates (which have been rising).  It will almost inevitably end in tears, and there are many examples of ridiculous behaviour of the type that exemplifies social mood at the end of a bubble.  One of the best is that the Playboy of the Month for May has announced that she will abandon making a fortune out of taking off her clothes (sorry, “modelling”), to take up “real estate investing”.  This lady has many credentials, but investment guru she is not.

More seriously, earlier this year research highlighted that other than two periods (after World War II and since 1998) US real estate prices have mostly been flat or declining since 1890.  One day soon social mood will adjust (painfully) to that fact.