; font-family: "Verdana","sans-serif";">“What are the
facts ? Again and again and again – what are the facts ? Shun wishful thinking,
ignore divine revelation, forget what “the stars foretell”, avoid opinion, care
not what the neighbours think, never mind the unguessable “verdict of history”
– what are the facts, and to how many decimal places ? You pilot always into an
unknown future; facts are your single clue. Get the facts !”
- Excerpt from the notebooks of
Lazarus Long, from Robert Heinlein’s “Time Enough for Love”.
Or instead of
“facts”, he could have said “prices”. Clobbered by months of write-offs and
profits warnings from distressed banks; nervously peering at the prospect of
softer property prices for the foreseeable future; and overshadowed by crude oil
trading north of $120 a barrel, stock markets have done the only thing one
could reasonably have expected them to do – they have rallied strongly off the
lows. No small thanks are due to the interventionist zeal of the US Federal
Reserve. Note how US equity markets bottomed this year just before the
emergency support lent to ailing (and “too interconnected to fail”) brokerage
Bear Stearns.
Are we now being
borne up by nothing more substantial than a relief rally ? Quite possibly.
Banks and investors now seem exhausted by news of the credit crisis, and
understandably want to focus on something new. Be careful what you wish for..
Pretty soon we can all get to worry about the impact of widespread deleveraging
on the consumer, on consumer spending, on the services sector that defines most
western equity market valuations, and whether rising food and fuel prices will
start to dismantle the growth story for Asia. On which note, UBS estimates that
China’s foreign currency reserves, which are currently the world’s largest,
could be cut in half over coming years if grain prices were to double again
from existing levels. Having until recently been a significant grain exporter, the
China of 2010 is forecast to be importing the equivalent of 40% of US corn
exports. Niels Jensen of Absolute Return Partners mischievously suggests that
as the largest wheat exporters today comprise the US, Canada, Russia, the
European Union, Kazakhstan and Australia, they might wish to set up between
them an OGEC (an Organisation of Grain Exporting Countries) to match the
economic clout (and vested self-interest) of OPEC in oil. As Niels indicates,
“..investors
will increasingly differentiate between the ‘haves’ and ‘have nots’ [in food
production]. And the ‘haves’ are those countries which control the world’s resources..
few countries are net exporters of both oil and foods on a large scale. Come to
think about it, it is less than a handful. And no Asian country is on the list.
(Italics mine.) So who is on it ? In the old world only one – Canada. In the
grey zone (emerging economies but not necessarily young and dynamic
populations) perhaps two – Russia and Kazakhstan. And amongst full blooded
emerging economies ? No-one today, although Brazil has the potential to turn
itself into a winner and so does Africa, it if can sort itself out.”
There are other
reasons to see pockets of opportunity within equity markets. US multi-nationals
will have benefited from the weaker dollar even though that trend now seems to
be going into reverse; and in the realm of energy services and infrastructure,
oil price strength – assuming it continues – may well outweigh the impact of a
newly enlivened dollar. The Financial Times reported on Thursday that “senior
officials” now have a “united” desire to see a stronger dollar versus the euro.
A degree of distress at an uncomfortably high euro is inevitable in the euro
zone, given the somewhat baffling monetary policy intransigence (if not
liquidity provision) of the ECB. But any supposed feelings from US officials
about a stronger dollar should be taken with a pinch of salt. Rhonda Schaffler
and John Brinsley for Bloomberg News reported on April 16th that
former Treasury Secretary Paul O’Neill (admittedly perhaps one of the worst in
the role in recorded time) had said that the
“’strong dollar’
policy that he and every other Treasury chief since 1995 endorsed is a vacuous
notion.. It implies in it that somehow we have the ability to manage the
relationship between the value of the US dollar and other currencies around the
world.. When I was Secretary of the Treasury I was not supposed to say anything
but ‘strong dollar, strong dollar’.. The markets actually have control over
those relationships. When people say strong dollar, if they don’t mean that ‘we
believe intervention can work and we’re prepared to intervene’, then ‘strong
dollar’ is ridiculous.”
It would be
similarly ridiculous to believe anything expressed by unnamed “senior
officials”. But even if the sentiments expressed were genuinely felt, as Paul
O’Neill points out, it is the markets, and not the central banks, that have the
capital to act upon them. And according to the BIS, average daily turnover in
the traditional foreign exchange markets runs at roughly $3.2 trillion. No
central bank can do anything in that market other than seize onto a change in
trend and hang on for grim life. The latest analysis of IMM data points to a
reversal in fortunes for both the euro (weaker) and Sterling (weaker) against
the dollar. Sterling’s specific exposure to a domestic banking, government
finance and property crisis makes it look like a basket case currency against
just about anything. Look out below.
The hopeful nature
of equity market investors faced with the effects of the credit crisis (largely
priced in and behind us) but also with the looming impact of economic slowdown
points to the way in which markets have become juvenilized. Few investors have
the patience to sit out a slowdown, so the presumption becomes that markets are
now looking out to the anticipated recovery perhaps 12 to 18 months down the
line. Wishful thinking is no way to manage a portfolio. In some respects, the
hedge fund lobby is responsible for this infantilized approach to volatility,
peddling the myth that investors can almost without effort secure constant
positive monthly returns without incurring risk. But markets aren’t like that.
Will the equity rally be sustainable ? The most dangerous presumption would be
to presume that you really know. In the absence of such perfect foreknowledge, the
argument for asset class diversification – and the avoidance of obvious equity
market blackspots – remains as sound as ever.
Download the_infantilization_of_markets.pdf
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