So I think, basically, we could see a similar period of economic weakness that we saw in 1973-74, which was essentially demand-driven.
It might not necessarily be a recession, in a global sense, but just very weak growth, which would have a commensurate impact on equity prices.
This kind of scenario is not readily amenable to monetary policy, because monetary policy controls interest rates, so if interest rates are the cause of a decline in the market, as in like ‘94 or ‘80, it can be reversed by loosening monetary policy very easily.
If a financial crisis is the cause, then a combination of monetary policy, reforms and so on are needed, like in 2008.
But a purely demand-driven decline – you need some fiscal stimulus to turn it around, and aside from the oil, there doesn’t seem to be any fiscal stimulus out there.
Indeed the US economy is struggling with this issue of controlling the government deficit.
In Europe, the same thing. Austerity is still driving most of the markets in Europe as they have a fiscal pact that actually has legal teeth to penalize countries for spending too much.
China could instruct major fiscal stimulus if they wanted to, however, it would mark a return to policies which are not sustainable in the long term.
Emerging markets arguably have priced in a lot of the deflationary impact. They’ve gone down a lot and the currencies have gone down a lot. And so it may be that the opportunities for turnaround in the market are more on the emerging side then on the developed side.
But it’s probably premature to go into emerging market equities until we get some kind of resolution on whether the developed markets are going to stabilize or go down further.
So, for that reason we’re seeing, basically this demand-weak recessionary impulse, or deflationary impulse, working its way through the system at the same time as the deflationary of oil is working its way through the system.
Looking into next year we’re likely to see volatility at the beginning of the year, I think, a fair amount of volatility from all of these deflationary impulses.
Further into the year I believe there’s reason for optimism for fiscal stimulus. In terms of getting back into the market it might well be the case that emerging markets will be the place to go because of valuation considerations.
Andrew Harmstone is portfolio manager of the Global Balanced Risk Control strategy at Morgan Stanley Investment Management
