Huh. So it was not different this time after all. Who could have possibly seen this coming?
…
Let us take stock of some of the things that are going on right now. Simultaneous bear market in equities and fixed income. Elevated inflationary pressure, both headline and core, in every country. Rising nominal interest rates in most major economies (notable exceptions Turkey, China). Recessions across Europe, the United States, and China. War in Ukraine. Energy shortages. China still in political lockdown, its real estate sector melting down, marginal rural banks collapsing. Heavy sanctions regimes on semiconductors, military tech, commodities, capital flows. Disregard for property rights and legal formality. Historically large fiscal deficits in the major economies, massive central bank balance sheets, some very unhealthy government debt markets and debt levels. A significant contraction of corporate earnings looming. Overt Minsky moments in the UK and elsewhere. The list could easily go on for several more paragraphs.
And yet. Investors by and large have not panicked, the VIX has remained at benign levels considering the implications of the end of this 40-year credit cycle. This is simply delusional.
Quick tangential anecdote here. Not too long ago I had lunch at a rather nice and well reputed Hotel in Zürich, listening to a number of asset managers pitch their fixed income funds. They shall remain unnamed, but suffice to say that they were very large and well-known firms. One of the presenters, who shall remain especially anonymous, without any hint of sarcasm or sentience announced that with the previous day’s ECB hike to 1.25% we were now at the neutral rate (the previous month’s Euro Area core inflation rate stood at 4.3% by the by). I nearly succumbed to a piece of potato’s ambition to explore the far reaches of my lungs.
Yes, there are occasional bear rallies – the result of positioning. In the short term the positioning of market participants dominates price moves (e.g. simultaneous covering of significant short positions), but we know that ultimately market trends must end up reflecting fundamental trends. The nonlinearity of the path there does nothing to alter the outcome. It is a bit like observing a riverbend, noting that it seems to be turning away from the ocean and to confidently conclude it therefore must never meet the sea. The aggregate global economy is not like Gamestop, Tesla or AMC, which may indeed have altered their ultimate fate with having had the opportunity to raise irrationally cheap equity capital (though I think folks underestimate just how easy it is to burn through that money without changing the economics of the business to a sustainable trajectory and simply failing a few years later). Whom is the global economic system going to be raising cheap capital from? E.T.’s well-to-do aunt?
To even have a chance to understand what is happening, it is absolutely utterly completely totally (!) crucial to acknowledge the singular driver of this mess: multi-decade inappropriate monetary policy across developed markets. The Neo-Keynesian interventionist conceit of being able to smooth the business cycle without paying for it in long-term real growth, even to claim an augmentation of the growth and productivity trajectory in the aggregate, is, and always will be, an ideological perpetuum mobile. That is to say, completely impossible. A fabrication. A falsehood. A lie.
The constant bailing out and rewarding of leverage and misallocation of resources across all segments of society has led to the metastasizing of moral hazard into the very bones of public and private institutions, worsening state capture and decline in public service merit. Markets, economies, and even entire societies cannot be driven largely by sensible decision making when shocks and recessions are not allowed to cull the unfit and truly foolhardy. This intense dependency on unnaturally easy capital and general learned helplessness in the face of even the most minor of volatility will only become more painful the longer we fight not to reverse it. Will we have the stomach and the clarity of purpose for the chemotherapy of positive real interest rates for a decade, the surgical excisions of QT, and the radiotherapy of reduced monetization of unproductive deficit spending? How I wish I could lay claim to belief in our collective lucidity but cannot but confess the lack of faith betrayed by my first name.
Instead of turning the page, we appear to be well and truly following the path to Japanification (were they not recently busy using their ‘unlimited resources’ to stabilize the yen to be able to continue their completely appropriate yield curve control or was that just a flight of mine excitable fancy?). Unless we accept meaningful net immigration and invest in effective integration, we will soon have the demographics to match to boot.
Ah but the most important take away for my personal investing is simply this: whether we reach for the bitter leaf of positive real rates or drink from the sweet cup of financial repression, neither is good for financial asset price performance in real terms. The groundwork for the value of future years is beginning to be laid today.
To the sufficiently patient and careful observer, genuinely attractive valuations will appear in time.
Tom
The Financial Flâneur 