The Infantilization of Markets

“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.

Comments

[JREwing]

That was a really interesting article.

I never understood, why the market pounded so much money into the EURO. We obviously live in a time, where the real money is made by commodity producers. Looking at the EURO chart, you would think the EURO-zone is the biggest exporter of oil and other commodities on the planet. Instead, it doesn't even have a positive trade balance.

[icandoitdon]

"former Treasury Secretary Paul O’Neill (admittedly perhaps one of the worst in the role in recorded time)..."

i don't know where you get this idea. john snow wins this hands down. the man couldn't even get a coherent word out of his mouth.

[bearfund]

Crossing, seems like it was more a case of having to buy something and the euro happened to be there. But look too at the Aussie dollar, which has done extremely well and has the characteristic you describe. Agree with the author's assertion that sterling is a disaster waiting to happen.