WB Yeats expressed the challenge of our times well in The Second Coming: “Things fall apart; the centre cannot hold… The best lack all conviction, while the worst / Are full of passionate intensity.”
As far as the City is concerned, the most strident providers of unsolicited advice to the concerned investor are, as always, product or asset class specialists. Those least willing to give gutsy market calls today will, in all likelihood, be generalist investment managers. These days, conviction is very hard to come by.
Writing as an investment manager with more than a little sympathy for the so-called Austrian perspective (for the ideal of sound money; libertarian principles; a quixotic yearning for small government), the world has gone mad. Watching Europe waltzing towards the abyss, I am not entirely alone in my fears.
Nomura’s economist Bob Janjuah describes the current financial environment as ‘Monetary Anarchy’. “I am staggered,” he says, “at how easily the concepts of democracy and the rule of law – two of the pillars of the modern world – have been brushed aside in the interests of political expediency.”
He is talking about the removal of elected governments in peripheral Europe and the installation of unelected ‘insider’ technocrats. But he could just as easily be referring to some of the crony capitalism on display in North America these past years. He is also “stunned that our policymakers seem so one-dimensional, so short-termist, and so utterly bereft of courage or ideas.”
Investors have also never before been presented with so much information, so quickly, all so immediately actionable. We tend to assume that financial markets – especially those for stocks – reflect the actions of thoughtful, human counter-parties expressing a view about subjective valuation over the medium term. It’s now estimated that high-frequency computer trading (essentially robots trading with other robots) now accounts for 70% of all equity trades.
According to Wired magazine, one new computer chip built specifically for this purpose can prepare trades in 0.000000074 seconds, while somebody out there is spending $300m on transatlantic cabling just so they can shave 0.006 seconds off equity orders between London and New York. We expect our colleagues to behave irrationally from time to time; we were never primed to prepare for the impact of R2D2 and C3PO let loose on the stock exchanges of the world.
It may be that the single biggest mistake being made by investors and policymakers today is confusing a normal business cycle with the deleveraging cycle of what Richard Koo has called a “balance sheet recession”.
In a normal cycle, central banks nudge interest rates higher to try to suppress the wilder aspects of an inflationary boom. As animal spirits depart the stage, growth abates, and as boom turns to slowdown, central banks are in a position to start cutting interest rates and trigger the boom/bust cycle all over again.
That is not where we are today. Today, central banks have slashed interest rates towards zero. They can’t realistically go any lower. And still people aren’t interested in borrowing. This is because, as Koo argues in his seminal book The Holy Grail Of Macro-economics: Lessons From Japan’s Great Recession, when households are more concerned about paying down debts than incurring more, the prevailing interest rate for borrowing money simply doesn’t matter.
What’s doubly weird about the current environment is that, with free money on offer virtually everywhere, you might expect to see inflationary pressure everywhere too. We’ve seen evidence of inflation in the prices of certain foodstuffs, commodities and oil, but inflation in all things still seems to be broadly under control – for now.
So we have two colossal forces fighting it out in the financial markets. On the one hand, mass deleveraging throughout Western economies. Households servicing their debts will be reining back on discretionary spending. All things being equal, this should mean lower corporate profits.
Lower corporate profits also seem plausible given that governments are on the prowl for money to fund their own high debts, and they’ll get that money wherever they can (higher corporate taxes, for example). On the other hand, central banks are doing everything in their power to reflate.
Having driven interest rates down to the floor, they’re now pumping monetary stimulus into the banking sector. Whether you call it ‘money printing’ or not, it is certainly handing new capital to the banks. Whether banks lend it on is another matter.
So we get to a weird market oscillating on a seemingly daily basis between ‘risk-on’ and ‘risk-off’. Whenever the market anticipates yet more quantitative easing, markets go risk-on. Whenever the market fears the withdrawal of quantitative easing, markets go risk-off. And governments and their central banks are either pumping the accelerator or toying with the brakes.
If, like me, you fundamentally fear money-printing, hold gold. If you think the printing will stop, hold quality bonds. Depending on your views of China, it may make sense to hold (or completely avoid) commodities, and in most circumstances it makes sense to own quality blue-chip stocks. But if you can foresee what lies ahead, you’re a better man than I am.
for Markets and Money
This article originally appeared in MoneyWeek.
From the Archives…
Gold Money: A Once-in-a-Generation Buying Opportunity
2012-03-23 – Greg Canavan
A Question Australia Might Have to Answer
2012-03-22 – Joel Bowman
Australian Tax: Running Government at a Profit
2012-03-21 – Nick Hubble
China: Why All Feasts Must Come to An End
2012-03-20 – Satyajit Das
Greg Smith – A Former Goldman Sachs Insider Finally Speaks Out
2012-03-19 – Eric Fry