This comes at a time when there are striking similarities between the global economy of 1997-8 before the dot com bubble burst and the global economy today. Clearly the stock market bubble which inflated at the end of the century does not correspond to the market today based on valuations, but we are staring at a reflection of certain global economic issues seen in 1998 which might be a cause for concern:
• An appreciating US Dollar.
• Falling commodity prices, especially oil.
• A pending rise in US interest rates.
• Tumbling emerging market currencies.
Given the current global issues, the following events might ensue:
The strong US dollar will harm the competitiveness of exports and, as 40% of the S&P 500 revenues are abroad, companies’ earnings will be squeezed. 75% of emerging market debt is in US dollars which is increasing the relative value of borrowings.
Low oil prices are damaging revenues of emerging market economies which are net exporters, reducing their ability to service their debt which could lead to credit re-ratings and capital outflows, isolating them from capital markets.
In addition to a stronger dollar, a US interest rate rise would result in losses on unhedged dollar borrowings. Even a small rise in US bond yields would also lead to significant reductions in capital inflows in to developing nations.
The monetary injections into Japan, Europe and China might not sufficiently offset the reduced availability of dollars following the end of the US QE program, creating liquidity issues.
Investors will certainly be hoping that history does not repeat itself. Indeed, there are many differences between the global economy of 1998 and that of today which might eradicate any concerns of an impending financial crisis.
• Developing economies have moved away from a fixed exchange rate regime, so have the tools to allow currency fluctuations to restore competitiveness.
• These economies also have significantly greater capital reserves which make them far more prepared to fend off a financial crisis.
• While interest rates are rising in some developing nations, the height of short term rates in1998 were unparalleled.
In terms of the stock market comparisons, the price/earnings of the S&P 500 was 57% higher in 1999 than it is today and the FTSE100 was almost twice as expensive in 1999, so, although valuations are above the historic average, investors are not getting carried away.
Whilst the FSTE100 has only just reached its all-time high, it has been nearly two years since the FTSE All-share surpassed both pre-crisis and dot com levels. The FTSE100 has lagged behind the All-share index due to the significant weightings it gives to the oil and financial sectors, which have struggled. This suggests that, once commodity prices recover, the index still has a long way to go.