Ten years after Lehman Brothers: how close are we to 'normality'?

Interest rates are rising from their record lows and global growth is positive, but the financial crisis still casts long shadows


Caspar Rock

Caspar Rock

Chief Investment Officer

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In September we will reach the 10th anniversary of one of the most seismic moments of the financial crisis – the collapse of Lehman Brothers.

A full decade may have passed since that shock to the global financial system, but we are still very much in the process of returning to some form of “normality”. Exactly how far we are along that journey is unclear.

Interest rates, in some economies at least, are rising back from their emergency lows. And from our mid-year vantage point it seems likely that 2018 will be the first year in which quantitative easing – the extraordinary process by which central banks have bought tens of trillions of dollars worth of assets in the post-crisis years – finally ends and starts to go into reverse. That too is an important milestone along the route toward normalisation.

Much is positive. Last year, broad-based global growth underpinned a favourable economic outlook. In 2018, the Trump Tax cuts, a pick-up in capital investment and high business and consumer confidence have led to the US continuing to maintain very strong moment­um. Europe, the UK and Japan have not been as strong this year compared to last, with manufacturing losing momentum. We continue to see strong earnings growth, especially in the US, and with this company price earnings ratios – which for a long while have been a cause for concern – are becoming a little more reasonable.

Even so, we remain vigilant of warning signs in areas we have identified as posing risks to markets, whether they are a turn down in growth; higher-than-anticipated inflation; or indeed as a result of the “known unknown” – of an escalation in harmful trade and tariff wars.

We continue to believe that a diversified exposure to alternative investments should add to returns and reduce volatility in portfolios. We have retained reasonable holdings of cash, given the flexibility it offers to capitalise on volatility.  

Recovery in emerging markets (EM) and expansion in the
developed world

Expansion Growth rising and above trend, inflation rising, tightening in monetary policy

Slowdown Growth falling but above trend, inflation rising, tight monetary policy

Recession Growth is falling and below trend, inflation falling, easing in monetary policy

Recovery Growth rising but below trend, inflation falling, easy monetary policy

US - Expansion             Eurozone - Slowdown
Japan - Slowdown        EM/China - Recovery


A picture of ongoing growth and rising inflation

The beginning of the year saw sharp upgrades to global growth forecasts on the back of the Tax changes in the US. However, a softer start to 2018 especially outside the US, coupled with the clouds cast by the US administration’s sabre-rattling approach to trade discussions and recent implementation of tariffs, have caused us to adjust downwards our growth forecasts. We now anticipate global growth of 3.4% for this year, dropping to 3.2% for 2019 as growth cools and inflation rises.

We see Japan and Europe, both of which grew strongly in 2017, in a “slowdown” phase where growth remains above trend but is diminishing. The US continues in its expansionary phase and China – along with other developing markets – is in a recovery phase of rising growth and looser monetary policy.

But how much of a risk is inflation?

In the US, unemployment is now lower than at any point since the start of the century. In 2009, as firms slashed overheads in the wake of the crisis, there were six unemployed workers per vacancy. Today there is less than one. This suggests stronger wage growth should lie ahead and is a factor which argues for greater caution in 2019.

A lag exists between economic recovery and an uptick in inflation, and we expect the momentum which is evident in the economy today to lead to higher core inflation for some time.

In response, we expect to see further interest rate rises. The Federal Reserve (Fed) now anticipates two further increases for 2018 and three for 2019. A similar tightening of liquidity conditions is underway in relation to quantitative easing, with the Fed having started to reverse the process in October 2017.

There is certainly much scope for policy tightening. Rates remain at extraordinarily low levels. In that sense, at least, normalisation remains a long way off.

In the three decades running up to the financial crisis (1981-2008), real annual short-term US interest rates – that is, after inflation has been deducted – averaged 2.2%. In the crisis period (2009-2017) that figure plunged to -1.6%, and it currently stands at -0.9%. We believe rates are unlikely to return to pre-crisis levels but should continue to move back at least towards zero.

Elsewhere in the world there is similar scope to tighten policy – should there be a need. In surprisingly clear guidance, the European Central Bank indicated in June that while it would cease its quantitative easing programme in December, it did not anticipate raising rates until the ‘summer’ of 2019.

History suggests that moderate inflation coupled with positive growth has proved a favourable backdrop for equities. Analysis of US stockmarket returns from the year 1872 suggests that periods where inflation has varied between 1% and 3%, as now, coincide with the highest annualised returns of just over 10%.

Valuations become more attractive as earnings grow

Company earnings forecasts are being revised and increased. The widespread combination of positive growth and gentle inflation is one factor behind this trend, but President Trump’s programme of tax reforms provided an additional boost for US businesses.

Drifting share prices during the first half of this year coupled with this improved earnings outlook means valuations have corrected and become more attractive.

Other unknowns

Political developments – whether these be national or international – remain a key source of risk. We can make predictions about longer-term outcomes of the widening rift between China and the US (see our cover story, page eight), but there is no knowing how today’s trade disputes will develop in the nearer-term, or what the consequences may be.

What we do know, at least, is that the language on all sides is increasingly inflammatory: a­t the time of writing, the Chinese authorities had used state-controlled media to describe President Trump’s administration as “rude, unreasonable and selfish”.

And in Britain the apparently shambolic process of Brexit – pored over by an increasingly polarised and sensationalist press – is similarly generating its own brand of acrimonious rhetoric.

History tells us that in many cases fiery rhetoric does not translate into actual policy. But while that thought may be comforting, it does not make these issues any less of an unknown.

The UK stockmarket is now one of the least popular among all developed markets, according to routine surveys of global portfolio managers. As the March 2019 deadline to effect the UK’s exit from the European Union draws nearer, uncertainty over the process is mounting. At Cazenove Capital we have been cautious regarding UK assets and sterling during the first six months of the year. As ever, we will be closely monitoring events to ensure our clients’ portfolios are appropriately positioned.

What regions are driving global growth? 

Contributions to world GDP growth year or year


Caspar Rock

Caspar Rock

Chief Investment Officer

Caspar is Chief Investment Officer. He chairs the Wealth Management Investment Committee, sits on the Cazenove Capital board and is also a member of the Schroder Wealth Management Executive Committee. He joined in 2016 from Architas Multi-Manager Ltd, part of the AXA group, where he was Chief Investment Officer and was responsible for all aspects of the investment activities, including investment philosophy, process and team. He also oversaw portfolio management at two of AXA group’s private banks. He previously headed the multi-manager business at AXA Framlington from 2006 to 2008. Prior to that, he managed a range of directly invested equity and, was Head of European Equities at Framlington and a member of the Healthcare team.

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.

This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.

All data contained within this document is sourced from Cazenove Capital unless otherwise stated.