‘The investment business has taught me — increasingly as the years have passed — that people, especially investors (and, I believe, Americans) prefer good news and wishful thinking to bad news; and that there are always vested interests to offer facile, optimistic alternatives to the bad news. The good news is obviously an easier sell.’
Legendary investor Jeremy Grantham of Boston based fund manager GMO
After nearly three decades in the investment industry, Grantham’s observation resonates loud and clear with me.
We (well, the majority of people) are wired to look for optimism — phrases such as ‘when life gives you lemons, make lemonade’ and ‘every cloud has a silver lining’ bear testament to our resilient and generally positive nature.
Our inherent positivity provides the investment industry’s marketing efforts with the perfect platform to promote the upside in every situation — as Grantham puts it, ‘… vested interests to offer facile, optimistic alternatives to the bad news..’
When markets rise to record levels, the industry predicts they’ll go even higher. Buy!
Alternatively, when markets fall to record lows, the industry declares them cheap and destined to turn higher. Buy!
The industry’s view is that there’s never a bad time to invest and there’s never a good time to sell.
A cursory study of market charts shows this not to be true. The Australian share market is still 20% below its late 2007 high. Therefore, selling (or not buying) in late 2007 would have been an excellent call. But the industry is not wired that way.
Consider this extract from one of the industry’s high profile economists when asked for the likely performance of the Australian share market in 2008:
‘The ASX 200 share index is likely to rise to around 7300 by the end of 2008 thanks to combination of reasonable valuations, okay profit growth and solid fund inflows. The normal signs of a major market top are still not present…‘
As it turned out, the ASX 200 ended 2008 at 3700 points (nearly half the predicted level).
We all make bad calls. Yours truly is guilty. However, when the industry makes a call on the markets, it is always up. In all my time in the industry, not once did I hear an economist employed by a fund manager go out on a limb and say they thought the market might be lower next year. It simply wasn’t in their job description.
Yet we know from history that the market’s bullish years are offset by bearish ones. The industry seems to ignore the reality that at times in the cycle there is simply no good news out there. Sometimes you have to be patient and wait for the reward to outweigh the risk. This view is an anathema to both the investment industry and anxious investors searching for some magical pre-determined rate of return on their capital.
In my opinion, the world we find ourselves in today is vastly different to the one that shaped the investment community’s generally optimistic views on markets.
For the best part of three decades (1980 to 2007), the greatest credit bubble in history powered the global economy and, by extension, investment (share and property) markets. We developed an addiction to (and in some cases, a blind belief in) continuous growth.
From 1982 to 2007, the Australian share market grew by a staggering 1500% (460 points to 6850 points). In the 130-year history of the Australian share market, there has never been (and most likely never will be) a 25-year period of performance that comes remotely close to this one. Surely it’s no coincidence this stellar market performance just happened to occur at precisely the same time as The Greatest Credit Expansion in the history of money.
What is less well known is from 1968 to 1982, the Australian share market managed to eke out a paltry 10% gain over the entire 14-year period (420 points to 460 points) — less than 1% per annum growth. This rather pitiful period of performance is conveniently airbrushed out of the industry’s marketing efforts.
The Great Credit Expansion came to an abrupt end with the subprime implosion. Subprime lending was the bottom of the credit pyramid. Like all Ponzi schemes, the pyramid collapsed when the base could no longer be expanded.
The Great Credit Contraction began in 2008, and six years later the effects of this ‘cooling’ process are being felt in all corners of the globe. The dreaded deflation is being fought in Europe, Japan and to a lesser extent in the US.
Central bankers and politicians the world over are desperately trying to re-ignite the rampant consumerism that was so prevalent in those heady pre-GFC days.
Initially, policymakers responded with relatively modest and measured ‘strategies’. The fleeting success of these ‘strategies’ has gradually led to the situation we have today — trillions in freshly minted dollars combined with zero bound interest rates. Any pretense of caution from the central banking community was abandoned long ago.
The US share market has been the major beneficiary of the Fed’s determined stance to rebuff the effects of The Great Credit Contraction.
From its lows in 2009, the US share market has recovered to record highs. The investment industry trumpets this achievement as proof positive the worst is over. The message is resonating with the punters — with bullish sentiment amongst the investment community reaching record levels of optimism.
If the global economy is genuinely recovering, why are the US stimulus efforts still in place and Europe seriously considering its own version of QE? Why have bank deposit interest rates in Europe moved into negative territory? Why is the commodities index 20% below its 2011 peak? Why has the Baltic Dry (shipping) Index fallen 60% over the past five years? Why is there an unofficial currency war?
The latest Investors Intelligence Advisors Sentiment survey registered an overwhelming 80% of bulls on the S&P. The Volatility Index (VIX) — better known as the fear gauge — is closing in on a record level of complacency.
When pretty much everyone is on one side of the boat, the boat tips.
In the rush to participate in the Fed’s party, it appears Stein’s Law has been forgotten or ignored: ‘If something cannot go on forever, it will stop’.
Excessive money printing and artificially inflated markets will not cure the ills created by the Great Credit Contraction. Debt needs to be expunged from the system. Debt withdrawal is going to be a long and painful process — the exact opposite of the euphoria created by credit expansion.
Eventually economic reality and markets will collide — unfortunately, the higher the market, the harder the fall.
The good news in this dour outlook is that patient cashed up investors will be rewarded handsomely.
The bad news is that if you are waiting for the investment industry to forewarn you of imminent market danger, you are destined to be a lot older and poorer.
for Markets and Money