“No.” – Amy
Carter (President Jimmy Carter’s daughter), when asked by a reporter if she had
any message for the children of America.
At some point over the last quarter century, politicians,
administrators, regulators and bureaucrats appear to have uniformly succumbed
to the simple-minded doctrine that people have become allergic to any form of
loss. Politics, and investment markets for that matter, have become largely
infantilised. It is difficult otherwise to account for such widespread belief
in things like the ‘Greenspan put’ – a putative strategy in defence of the
stock market that, like so many other presumptions about this most over-rated
of central bankers, was a colossal failure in its inability to prevent the
Nasdaq index from falling by roughly 80% between 2000 and 2002.
As Lord Overstone famously said, no warning can save a people
determined to grow suddenly rich. In the 1990s it was technology stocks. Thanks
in no small part to the Greenspan era of ultra-low interest rates, the most
recent decade brought us a bubble in property. The deflation of that bubble is
now occupying the tiny minds at the Treasury – the same people (collective
term: a shamble ? Or perhaps a dither) who rushed to the defence of a
second-tier bank that happened to employ Labour voters in a North of England
constituency. The latest wheeze, “announced” and then hurriedly un-announced,
is to suspend stamp duty, the better to allow first time buyers to lose their shirts
in a rapidly collapsing residential property market.
About the only good thing you can
say about the US property market is that the UK property market looks uglier.
In his latest quarterly letter, GMO’s Jeremy Grantham reveals all. Median US house prices relative to median
family income peaked just before 2005 at above three standard deviations above
the norm. There is more good news to the extent that the overdue correction is
now well under way: Grantham suggests that US property prices need to fall by
17%, or stay flat for four years, to reach fair value. It is in the nature of
bubbles, however, that price trends can overshoot on the downside just as they
did on the way up, so a presumption of simply a fair value conclusion to the
property crisis may be somewhat optimistic. Nevertheless, the US property
outlook is an oasis of sun-kissed loveliness by comparison to that of the UK. For
us benighted Brits, Grantham suggests, UK residential property prices would
have to fall by 38% overnight, or stay flat for some seven years, to
approximate to fair value. Again, the belief that this phantasmagorical mess
ends neatly at fair value, rather than well below it (like the last three
property busts) could be delusional. A good job the men from the government are
here to help.
While reading Mohamed El-Erian’s
considered account of our age of turbulence, ‘When Markets Collide’
(McGraw-Hill, 2008) one paragraph in particular leapt out at me. In the
interests of not taking Mr. El-Erian’s words out of context, it is reprinted
here in full:
“In financial circles, the
most-often-heard concern is that repeated attempts by officials to “bail out”
markets eats away at the integrity and credibility of mechanisms of market
discipline. You will hear the concern that the attempts to rescue investors
from their foolish investments will simply encourage them to take even more
thoughtless risk in future; insuring deposits at banks will weaken the
incentive for depositors to carry out an adequate level of due diligence; and
providing official emergency lending to countries and companies will encourage
others to assume excessive indebtedness in the knowledge that they will be
rescued from their foolish decisions.”
Future generations will find
within that text the germ of a particularly quaint idea – that depositors at
banks can now undertake any remotely adequate level of due diligence upon those
banks whatsoever. A banking specialist Ph.D who has spent twenty years at Bank
College studying nothing but banks, who lives on a river bank and commutes
every day to Bank, and whose every waking second is committed to understanding and
analysing banks, would struggle, even if presented with the entire resources of
every credit ratings agency in the world, to conduct due diligence upon banks
consistent with making an informed assessment of the risks they hold and the
risk they represent. RBS, which on Friday reported the first loss in its
40-year history as a public company, and which wrote down its credit book by
£5.9 billion, and which in June raised £12 billion in the biggest ever rights
issue in European history, was telling investors as recently as February that
it had no need to raise new capital. In the middle of a historic credit bust
caused by the foolish decisions of bankers and their managers, there comes a
point where there is no essential difference between incompetence (we do not
know what really sits on our balance sheet) and outright lies (we won’t tell
you what really sits on our balance sheet) – certainly no essential difference
as far as their shareholders are concerned. So Mr. El-Erian was also right, in
Thursday’s Financial Times, to suggest that it was, in the words of the
headline, “Time to act boldly and sort strong banks from weak”. But that
presupposes that a) there are any strong banks, and that b) the political will
exists to allow the market’s invisible hand to show the greediest or most
incompetent bankers the red card. The jury is still out on a) and as regards
b), the omens from the most recent policy pronouncements on stamp duty – fire
soundbite, ready, aim – do not exactly inspire confidence. The housing market
should be allowed to find a floor without the intervention of politicians. One
could say the same thing about the banks, but that would be to ignore the
apparent outbreak of ‘loss allergy’ that so transfixes our current
administrations. This is undoubtedly a challenging environment. Cometh the
hour, cometh the man. But as things stand, the phrase “lions led by donkeys”
springs to mind.
Portfolio update: the performance, and asset allocation, of the
model portfolio that we use as a template for discretionary client portfolios
are shown in the accompanying PDF document. 2008 has proven more difficult and
the markets even more volatile than we feared. Nevertheless, the portfolio is
showing a modest positive return for the year to date and – unlike a 100% cash
position – offers the potential for more substantial gains in the event of
markets stabilising. We continue to believe that this is a market that will
show more respect for the pursuit of capital preservation rather than capital
growth strategies. We obviously believe that investors’ interests will be well
served by a combination of asset class diversity and a concentration on
defensive investment, a focus solely on high quality assets and managers, and
the pursuit of absolute rather than market-relative returns. Equities are
currently enjoying a bear market rally but the extent and depth of the
fundamentals (weaker house prices; ‘walking wounded’ banks; what looks like
synchronised global recession) warrants continued caution. We would like to be
more positive, but the facts don’t support that sort of stance. If it looks
like a duck, sounds like a duck, walks like a duck, and has ‘duck’ on its passport,
there’s a better than average chance that it might just be a duck. This looks,
sounds, and feels like a bear market of quite some duration to come.
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