Market View - March 2013

“Well when events change, I change my mind. What do you do?” is the famous comment attributed to Nobel Laureate Paul Samuleson in a television interview in the nineteen seventies, but history suggests that its origins may well have been much earlier from John Maynard Keynes!

Regardless of the facts, it is a statement that arguably many of today’s practitioners in the so called “dismal science” of economics could benefit from considering! Especially when evaluating the impact of all the trillions spent on quantitative easing in the western word (including the current on-going $85 billion a month in the US alone), and yet unemployment remains stubbornly high, government debt remains at unprecedented levels and savers and pensioners continue to tolerate vastly lower income levels or have to seek potentially higher returns for much greater risk in non-cash based investments thanks to the far reaching implications of the zero interest rate policy (ZIRP) that has now been in place across developed economies for a number of years!

Many argue that central bankers pay lip service to the needs of many hundreds of millions of middle class savers and pensioners, while really caring only about ensuring interest rates are low enough to ease the pain of the massive debt obligations of the too the big to fail investment banks and other institutions caught in the subprime credit scandal! Central banks however argue in turn that without quantitative easing (QE) and ZIRP, the nightmare scenario of the thirties style depression could have become a reality, due to the massive deleveraging that has taken place since the credit crunch began.

Much of the Fed’s battle against deleveraging of course has been with the little known (outside of Wall Street and the City of London) shadow banking industry which was largely unregulated and had no banking deposits to offset loans against! At its peak in early 2008, total shadow banking liabilities totalled more than $20 trillion in the US alone, while traditional banking liabilities stood at just $13 trillion, but since Lehman, the shadow banking sector has collapsed to less than $15 trillion with most of the reduced liabilities (except for a $3.7 trillion credit hole that the Fed is desperately trying to plug) having been transferred over to the traditional sector and this process arguably is what is stopping all the QE that central banks have pumped into the system from resulting in out of control inflation!

The jury remains out therefore as to whether the actions of the Fed and other developed market central banks following the collapse of Lehman Brothers in September 2008, were the correct (or least bad) choices, and helped avert another thirties style depression, or whether their actions have simply postponed what eventually will be an even greater fallout as a result of the many institutions that were bailed out by taxpayers as a result of being supposedly too big to fail, next time round having become too big to bail! However in a fascinating International bestseller titled “23 things they don’t tell you about Capitalism” by Ha-Joon Chang, a Cambridge University Professor, many of the accepted wisdoms and benefits of the so called “free market” which most of us in the West have been brought up to believe is at the very heart of capitalism, are challenged and shown in many cases to be erroneous and that incredibly market intervention by governments have often proven to be more successful than leaving economies to private market forces!

These revelations will certainly come as a shock to those of us of a predominantly libertarian free market disposition, and at the very least make us re-evaluate whether some of the market manipulation by agents such as the Fed will prove to have been the least harmful actions after all? Of course it is unlikely we will ever know definitively since it will be impossible to show what would have happened had the alternative course of laissez faire economics been adopted post Lehman!

Regardless of the pros and cons of the macro level economic debate, including the often unfortunate unintended moral impact of these actions, we as investors have to focus upon the implications of the decisions that have been taken over the past few years in response to the credit collapse and in particular to what the policymakers have done most recently. In that regard, the Bernanke Asset Bubble would appear to be gathering momentum as evidenced by the stock market in America hitting nominal all-time highs at the beginning of March in response to improving economic data from the US and a commitment from the Fed in its monetary report to Congress on the 26th February to continue with its QE and ZIRP policies.

In its statement to Congress, and in reference to its last Federal Open Market Committee (FOMC) meeting, the Fed advised “At the conclusion of its January 29-30 meeting, the Committee made no changes to its target range for the deferral funds rate, its asset purchase program, or its forward guidance for the federal funds rate. The Committee stated that, with appropriate policy accommodation, it expected that economic growth would proceed at a moderate pace and the unemployment rate would gradually decline toward levels the committee judges consistent with its dual mandate. It noted that strains in global financial markets had eased somewhat but that it continued to see downside risks to the economic outlook. The Committee continued to anticipate that inflation over the medium term likely would run at least at or below its 2% objective.”

Here in the UK, a recent Financial Times headline read, “Osborne to hand Carney powers to kick-start the economy” in reference to the Chancellor looking to pave the way in this month’s budget for looser monetary policy from the Bank of England under the incoming new Governor Mark Carney! So the likelihood is that we shall see even more QE, continuing low or zero interest rates and monetary policies that are likely to continue the race to debase currencies from the developed markets, in an effort to encourage exports, and boost activity.

“It’s a bull market you know” is another often used famous city and Wall Street quote taken from the biography of Jesse Livermore (arguably the greatest private trader in history) titled Reminiscences of a Stock Operator by Edwin Lefevre , and it appears more and more market commentators whom were previously sceptical are conceding that this current bull market run in equities is the real deal! Statistically the current rally in US Stocks that began in March 2009 is the sixth best on record since 1929 having risen 127% as the S&P 500 went from a low of 676 in March 2009 to more than 1540 at the beginning of this month!

For now at least we totally agree that it is a bull market in stocks, notwithstanding that valuations on the American market are not cheap (although UK stocks are relatively good value and European ones near historic lows), but the obvious alternative asset class in developed market government bonds is dangerously overvalued (arguably in serious bubble territory) and the long commodity bull market (with the possible exception of gold and silver) looks likely to have ended! As ever while there are sound reasons for optimism, a cautious and considered approach to investment is always advisable in order to ensure the optimal risk adjusted results!