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Bullish about America ....we aren't convinced.
Dear All
As I sit here with a wide variety of news providers delivering a plethora of bullish sentiment, I find my self both perplexed and confused. Over the last three months, I have attempted to offer an unbiased opinion on both the economy and investments but the current state of affairs seems to run counter to any logical or intuitive argument.
"Whether individual or collective, willful blindness doesn't have a single driver, but many. It is a human phenomenon to which we all succumb in matters little and large. We can't notice and know everything: the cognitive limits of our brain simply won't let us. That means we have to filter or edit what we take in. So what we choose to let through and to leave out is crucial. We mostly admit the information that makes us feel great about ourselves, while conveniently filtering out whatever unsettles our fragile egos and most vital beliefs"
Margaret Heffernan - Willful Blindness
Those who are bullish in the marketplace seem to be focusing on the more positive economic data and historically low multiples that are coming out of the US. However, I am not so convinced.
With regards to multiples, two things strike me first. Namely, analysts are blissfully ignorant to the effect of inflation on earnings and, more importantly, history is only as useful as the lowest common denominator. In this last point, I am referring to the idea that if the surrounding circumstances are different from that of history, is it such a good indicator? Only time will conclusively answer this rhetorical question. Personally, I see no reason why a stock should not trade at far lower multiples than those experienced post Lehman. We are in a fundamentally different crisis and the long term effectiveness of Central Bank intervention must be questioned. In the article by Nicholas Taleb that I disseminated last week, he argued that Central Bank intervention would result in far greater tail risk (or "Black Swan" events) - by this, he means that the probability of extremely unlikely events starts to increase. (Think about the far ends of the Bell Curve starting to invert). Although I agree with what Mr Taleb has to say, I don't feel that it offers any real indicators of where stress is likely to be felt. Personally, I would point you towards the M2 money supply and demand dynamic (Money demanded vs Money Supplied by Central Banks) which continues to develop a very strange formation.
Traditionally, a growth in Money Supply from Central Banks would increase the access for the population to borrow by lowering the opportunity cost of lending between different borrowers. This money is then disseminated through the system and the interest on borrowed money is actually created through increasing the monetary supply further. This is the basics of a fractional banking system. However, over the last four years, M2 money supply has increased significantly through policies such as Quantitative Easing and the demand has fallen with investor confidence. As I see it, the demand component is the main reason we have not seen "high" levels of inflation. Instead, we are currently experiencing deflationary tendencies. If the demand for these funds was to increase significantly, it would be fascinating to see if we have a high inflationary pull. Personally, I believe that we would.
Secondly, how do we quantify good economic data? On the first Friday of every month, all of us sit tentatively looking at our screens awaiting the Non Farm Payroll statistics. Usually, we see either pandemonium or huge sell offs in the market. Rarely, do we see an unchanged marketplace. However, when I look at the figure, I tend to see a lot of excitement about percentages. Up 2% or down 5%, these figures mean very little in a volatile environment. The real figure shows an average of 120 000 jobs created a month over 2011. This is around 130 000 short of what Economists believe the US requires for a sustained recovery and, as such, I am skeptical of any US recovery. The key difference between the current post recession phase and those that have been previously experienced is due to structural rather than cyclical unemployment. By this, I am referring to the permanent substitution of the US labour force in favour of those from Emerging Economies. Currently, the equity market is pricing in a 62.5% recovery from the situation in 2009. By the time you factor in Inflation, I would argue that this is very optimistic considering the world events.
In sum, I would be particularly wary of bullish hype. Even, if we manage to successfully rally and move past Europe, questions should be asked of how exactly Central Banks are going to cope with their new balance sheets. This must be a paramount fear moving forward. In 2007, we moved distressed real estate assets to CB balance sheets and today in 2011 we are moving more distressed government assets their balance sheets. If this is a successful tactic, why should governments borrow from the markets going forward? Surely, CB's would be a whole lot cheaper..... (Hint: Mugabe springs to mind)
Leaving you with that question, it is time to introduce a couple of articles that I believe are worth looking at. Number 1 is MUST WATCH AND READ. I cannot emphasise this enough.
1) The world in balance sheet recession: causes, cure and politics - Richard Koo (Click HERE)
Elaborates the deflationary and borrowing comments made earlier
2) Six Weeks in the Life of EURUSD - Tick By Tick (Click HERE)
An article that I wrote back in November. Should provide a sensible idea of how the EURUSD trade unfolds after Fridays "solution"
3) The (sizable) Role of Rehypothecation in the Shadow Banking System - IMF (Manmohan Singh and James Aitken) (Click HERE)
Rehypothecation has become the buzzword of 2011, this article by the IMF looks at the practice itself and will provide context into the ongoing discussion that has erupted about the process
4) Kyle Bass Interview with Business News Network (Click HERE)
Bass talks about how the current solvency of sovereigns being evaluated without the cost of recapitalisation and the topic of bank runs in the periphery.
Lastly, for those of you looking for a literary Christmas present for your colleague, friend or member of family, I would like to suggest the possible purchase of a few books that I have read over the twelve months that are well worth consideration.
Justice - Michael Sandel (Covers the whole realm of political philosophy - a thinkers book)
Street Freak - Jared Dillian (A traders honest account of his existence - Review available HERE)
Physics for Future Presidents - Richard Muller (The reality about physics - covers nuclear, solar etc)
More Money than God - Sebastian Mallaby (The A-Z story of Hedge Funds)
Please enjoy the articles and I look forward to any feedback that any of you may have.
Best Regards
George Adcock
Founder
@TickByTick_Team
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