Getting the big picture right is one of the most important things an investment manager/strategist can do. Anticipating and timing an inflection point, a move from one regime to another, is where reputations are made and the greatest value addition can be achieved.
Post global financial crisis (GFC), the world has been mired in a debt enduced deleveraging. This has undermined confidence, weighed upon the economic fabric, and forced governments to lever-up to make up for private sector slack. Fiscal sector tailwinds are coming to an end. Financial markets are hanging on continuing monetary stimulus to prop up markets. Confidence is in short supply. The hope is that the monetary authorities, in conjunction with sufficient deferment, obfuscation, and can kicking from their fiscal partners, will get us through to the other side. With potholes everywhere (cue Europe, China, US problems), the future is still highly uncertain.
One scenario that could play out is a recovery in credit. US bank balance sheets have largely been rebuilt (the same is not necessarily true of their European counterparts). At some point they will be tempted to take advantage of the competitive opportunities, and in classic follow the herd fashion look to put money out the door. A devolution of reserves and rapid credit creation by financial entities could well be the catalyst that helps turn the corner. With confidence being the most lacking ingredient, wealth and prosperity illusions created by money creation could be just what the doctor ordered.
Will this scenario transpire? Possibly. When is it likely to happen? In 2013 if we continue on our current economic trajectory (many commentators have pegged 2013 as an inflection point of a negative kind). How long will it last? If it happens, I suspect 2-4 years. Will a renewal in growth trend be sufficient to overcome secular headwinds further out (rising interest rates, deteriorating fiscal profile, higher taxes)? It'll be a battle.
As yet, I don't think we have solved our fundamental structural problems within the global financial system. That having been said, if a blast of confidence comes flowing through the system on the back of banks being more willing to take a risk, there is a chance we experience a positive feedback loop that translates to real growth, and the possibility of getting out ahead of our problems. A major catalyst for that scenario is resolution of the developed world's fiscal financial path. Not only does it require confidence, but it also requires real leadership. Two traits in fairly short supply at present.
No signs of it yet. But keep an eye out for a change in conditions.
Thursday, July 19, 2012
Tuesday, March 13, 2012
The Most Critical Thing
Future prosperity and expansion are entirely dependent upon the ability of the central banks to keep the interest rate genie in the bottle.
I don't know how they have done it so far. But the potential effect of a normalization of interest rates would be massively deleterious.
The treasury market implies long term inflation of about 2%. Assuming a 3% term premium, then normalization would return rates to between 4%-5%.
The debt servicing burden would very quickly rise to an unsustainable level - 15% of the government budget and 12%-15% of personal income. Lock it in while the going is good.
I don't know how they have done it so far. But the potential effect of a normalization of interest rates would be massively deleterious.
The treasury market implies long term inflation of about 2%. Assuming a 3% term premium, then normalization would return rates to between 4%-5%.
The debt servicing burden would very quickly rise to an unsustainable level - 15% of the government budget and 12%-15% of personal income. Lock it in while the going is good.
The New Normal
While the 'new normal' might have originally been invoked to describe a more subdued economic growth path as the economy absorbs financial deleveraging.
I was thinking perhaps a better use of the phrase 'new normal' is in describing the manner with which we have grown accustomed to extraordinary monetary measures. What five years ago would have been unfathomable, now passes without a blink.
The extent to which the Fed and the ECB have expanded their balance sheets and reduced their own lending standards is staggering.
And yet, in the new normal, it is, how should we say, 'normal'.
I was thinking perhaps a better use of the phrase 'new normal' is in describing the manner with which we have grown accustomed to extraordinary monetary measures. What five years ago would have been unfathomable, now passes without a blink.
The extent to which the Fed and the ECB have expanded their balance sheets and reduced their own lending standards is staggering.
And yet, in the new normal, it is, how should we say, 'normal'.
Monday, March 12, 2012
Thank You Blogosphere
It amazes me the quality of blog content. I don't know how these folks do it, day in a day out. I really wish I could convey a genuine thanks to the following people:
Barry Ritholz
John Hempton
Jesse's Cafe Americain
Felix Salmon
David Merkel
TheReformedBroker
Cullen Roche
Tyler Cowen
Diary of a Mad Hedge Fund Trader
Macro Man
Naked Capitalism
Zero Hedge
Abnormal Returns
They are all must reads. I have learned alot from them. I love learning from very smart people, and it makes me wish that I was that smart.
What remains to be seen is how long they can maintain it. Without a business model or the ability to leverage their content, it is a lot of hard work for little monetary return.
Barry Ritholz
John Hempton
Jesse's Cafe Americain
Felix Salmon
David Merkel
TheReformedBroker
Cullen Roche
Tyler Cowen
Diary of a Mad Hedge Fund Trader
Macro Man
Naked Capitalism
Zero Hedge
Abnormal Returns
They are all must reads. I have learned alot from them. I love learning from very smart people, and it makes me wish that I was that smart.
What remains to be seen is how long they can maintain it. Without a business model or the ability to leverage their content, it is a lot of hard work for little monetary return.
Friday, December 23, 2011
There Is A Price To Be Paid
No economic law is more immutable than, "there is no such thing as a free lunch!" Actually, a more immutable law (at least in my mind) is you can't spend more than you make (at least not for very long). Not surprisingly, the two laws are related. And the truth be told, there are such things as free lunches, but they usually come with strings attached (which is the usual application of the idiom). But in the economic realm, there is a simple reason why there is no such thing as a free lunch and relatedly why you can't keep spending more than you make. It is because the production of a lunch costs something. Whoever is handing out free lunches is limited by how much capital they have. Ergo, there are limits to free lunches (and deficits), and the economic law holds true.
And so it seems with the massive government and monetary interventions we have experienced in the post-GFC world. We have become desensitized to the scale and the scope of the operations, and don't think twice anymore about new initiatives or new "solutions," largely because we have not seen too many deleterious effects. It seems that because none of these actions have led to immediate calamity, then maybe they are alright (perhaps even a free lunch). People who would traditionally and historically have been aghast at the actions proposed and undertaken, are now much less squeamish about each new initiative. We are becoming more comfortable with and more complacent about government interventions. And if that doesn't sound familiar, you may like to remind yourself of the pre-conditions to a bubble* (comfort and complacency are important ingredients).
There is a cost to artifice, and there is a price to be paid for attempts at muting the laws of economics. You can't simply wish new liquidity into existence, or make interest rates whatever level you want, without some cost. We have yet to see or feel the full effects of those costs, and therein lies the danger. The bigger the cause, the greater the effect. Ultimately it will be the encroachment of the previously contingent liabilities that sink us (unless we make the necessary painful changes). Rather than smoothing over the effects, the passage of time may in fact accelerate our day of reckoning.
*Bubble is being used here in the sense of something that is isn't sustainable, and for which there is a rude awakening.
And so it seems with the massive government and monetary interventions we have experienced in the post-GFC world. We have become desensitized to the scale and the scope of the operations, and don't think twice anymore about new initiatives or new "solutions," largely because we have not seen too many deleterious effects. It seems that because none of these actions have led to immediate calamity, then maybe they are alright (perhaps even a free lunch). People who would traditionally and historically have been aghast at the actions proposed and undertaken, are now much less squeamish about each new initiative. We are becoming more comfortable with and more complacent about government interventions. And if that doesn't sound familiar, you may like to remind yourself of the pre-conditions to a bubble* (comfort and complacency are important ingredients).
There is a cost to artifice, and there is a price to be paid for attempts at muting the laws of economics. You can't simply wish new liquidity into existence, or make interest rates whatever level you want, without some cost. We have yet to see or feel the full effects of those costs, and therein lies the danger. The bigger the cause, the greater the effect. Ultimately it will be the encroachment of the previously contingent liabilities that sink us (unless we make the necessary painful changes). Rather than smoothing over the effects, the passage of time may in fact accelerate our day of reckoning.
*Bubble is being used here in the sense of something that is isn't sustainable, and for which there is a rude awakening.
Friday, November 18, 2011
Global Socio-Politico Trends
Post the Great Depression the global socio-economic trend among political elites was toward greater government involvement in the economy. That trend finally came to an end, shipwrecked on the rocks of the 70s recession. But by the time it had run its course, it had blended opposing socio-economic ideologies into indistinguishable political forms. Turning, so-called "conservatives," such as Richard Nixon, Edward Heath, Helmut Schmidt, Valery Giscard d'Estaing, Malcolm Fraser, and Robert Muldoon into quintessential socialists. Such is the pressure of a trend and a supportive ideology (Keynesianism).
The natural backlash to the expanding Statism of the 50s, 60s, and 70s, was the countermove toward deregulation and financial liberalization in the 80s and 90s, led by Margaret Thatcher and Ronald Reagan (supported incidentally by ideological liberals Francois Mitterand, Bob Hawke and David Lange in France, Australia, and New Zealand respectively). This trend now appears to have run its own course, shipwrecked on the shoals of the Global Financial Crisis, with Tony Blair and Bill Clinton the best examples of political actors who melded their opposing ideological disposition to the dominant ideology of the time (monetarism). Whether Democrat or Republican, Labour or Liberal, the times and the culture might change, but the dominant political parties seem to move symbiotically together.
Interestingly, the role that President Carter played (serving in the transitional flux between periods) might serve as a template for the role that President Obama is playing, as socio-political forces work out a new direction.
"plus ça change, plus c'est la même chose"
The natural backlash to the expanding Statism of the 50s, 60s, and 70s, was the countermove toward deregulation and financial liberalization in the 80s and 90s, led by Margaret Thatcher and Ronald Reagan (supported incidentally by ideological liberals Francois Mitterand, Bob Hawke and David Lange in France, Australia, and New Zealand respectively). This trend now appears to have run its own course, shipwrecked on the shoals of the Global Financial Crisis, with Tony Blair and Bill Clinton the best examples of political actors who melded their opposing ideological disposition to the dominant ideology of the time (monetarism). Whether Democrat or Republican, Labour or Liberal, the times and the culture might change, but the dominant political parties seem to move symbiotically together.
Interestingly, the role that President Carter played (serving in the transitional flux between periods) might serve as a template for the role that President Obama is playing, as socio-political forces work out a new direction.
"plus ça change, plus c'est la même chose"
Thursday, November 10, 2011
Sovereign Debt Crises Have A Long Fuse
About the only thing Greece* has shown us is that sovereign debt "crises" have a long fuse. The Greek crisis erupted in early 2010 and has yet to reach its ultimate zenith.
In recent days, Italian bond yields have risen above 7%, throwing into question the sustainability of Italy's fiscal position, and the potential collapse of efforts to bailout the eurozone.
Equity markets have appeared to ignore the current "crisis." I suspect it is because they see it as a long term problem, with only a small likelihood of a catastrophic collapse any time soon. With Greece as the blueprint for this thinking. This may, or may not, prove correct, but it has frustrated the bears no end. They have been betting upon a rapid conflagration, and are perplexed by the market going up in the face of supposedly rising risks. The greater possibility is for more "can kicking" and the prospect of a long dripfed erosion in confidence. Periodic fires (aka crisis of confidence) are likely break out, but the system can go on for a long period of time before the piper ultimately comes calling.
The real problem in this whole equation is structural fiscal/current account imbalances co-mingled with massive long term contingent liabilities due to generous promises made at various points in the past. In the absence of any serious address of those problems, we know how this story will end. Even when the market is signalling the ultimate end, a bankrupt country can make interest payments on its debt for a long period of time before it eventually calls it quits.
*And let's not forget Japan.
In recent days, Italian bond yields have risen above 7%, throwing into question the sustainability of Italy's fiscal position, and the potential collapse of efforts to bailout the eurozone.
Equity markets have appeared to ignore the current "crisis." I suspect it is because they see it as a long term problem, with only a small likelihood of a catastrophic collapse any time soon. With Greece as the blueprint for this thinking. This may, or may not, prove correct, but it has frustrated the bears no end. They have been betting upon a rapid conflagration, and are perplexed by the market going up in the face of supposedly rising risks. The greater possibility is for more "can kicking" and the prospect of a long dripfed erosion in confidence. Periodic fires (aka crisis of confidence) are likely break out, but the system can go on for a long period of time before the piper ultimately comes calling.
The real problem in this whole equation is structural fiscal/current account imbalances co-mingled with massive long term contingent liabilities due to generous promises made at various points in the past. In the absence of any serious address of those problems, we know how this story will end. Even when the market is signalling the ultimate end, a bankrupt country can make interest payments on its debt for a long period of time before it eventually calls it quits.
*And let's not forget Japan.
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