As regular readers know too well, one topic Zero Hedge enjoys ridiculing with the disdain it deserves is groupthink of any form. The phenomenon, which is nothing but transference of laziness by those who manage other people's money with complete disregard for the consequences of their actions, was among the main reasons for the Great Financial Crash. As nobody was willing to engage in any form of critical thought, and with the market "only" going up, any investment thesis was predicated solely on what the "other guy" was doing. Of course when it all blew up, it was time to blame the evil rating agencies. After all, heaven forbid someone actually think about the logic behind the credit ratings of hundreds of billions in synthetic CDOs, or worse still, take responsibility for their own stupidity and laziness. We are now precisely in the same place we were when the market peaked last time around, with groupthink rampant, with any attempt at opposing thought squashed for fears it will end the party early, with sellside analyst optimism at all time highs, and with the administration actively encouraging rampant lies and perpetuation of the myths that take hold in the market with no factual footing whatsoever. The "conspiracy of optimism", as dubbed once by James Montier, has once again fully taken hold. As SocGen's Albert Edwards points out "despite another post mortem on forecasting failure, nothing has or will change": this is true... until the next crash. Then the finger pointing will begin anew, theatrics about the change in the Status Quo will resume, and once again the Fed will attempt to reflate the latest bubble crash. Only this time there will be no reflation, as the central planning committee's reign of terror will be over, and the fiat monetary system will have ended. Below we present Edwards' most recent solemn and very troubling thoughts on the latest break out of the great groputhink malaise, which will only last as long as the great chairsatan has some control over events. Luckily, with the amplitude from a stable market equilibrium shifting ever greater in either direction, and as the Fed's very existence (remember: the whole point of the central bank is to contain price stability) is repudiated, the time until the reset is now shorter than ever before in history.
I was leafing through a critical report into the IMF’s performance in the run-up to the financial crisis by the Independent Evaluation Office of the IMF (see IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07 – link).
"Groupthink” mentality effectively sums up the reports criticism in one word. In Chapter 4 entitled Why Did The IMF Fail To Give Clear Warning?, the series of sub-headings reads just like my erstwhile colleague, James Montier’s papers with pronounced cognitive bias being cited as the basis of the view that almost everything in the garden was rosy.
But suppose you were a dissenter – well ... “Staff incentives were not well aligned to foster the candid exchange of ideas that is needed for good surveillance—many staff reported concerns about the consequences of expressing views contrary to those of supervisors, management, and country authorities.” Or let’s shoot the messenger!
Dissenting voices were ridiculed throughout the mid-2000s as the US and UK housing bubbles defied the pessimists’ pronouncements of collapse. For the vast majority of the analytical community, the fact that the cassandras were proved wrong gave them more and more confidence that there was, in fact, no bubble to burst at all, whereas it was clear to many that the crash would end up being all the deeper when it eventually came.
But what has changed? The new groupthink is that the Chinese economy will not crash in the same way as the US economy did in 2008. China’s own Great Moderation has continued for so long, the mainstream will only extrapolate this into the indefinite future. And in developed markets, despite two gut-wrenching equity bear markets in a decade, QE2 has taken analyst optimism back to all-time highs (see chart below).
A topic Zero Hedge presented previously is that while companies are now getting more bearish, the sellside doesn't want the party to end, and its optimism is at an all time high. The same goes for economists, who following in the footsteps of Goldman's Jan Hatzius stunning reversal in opinion, are now deliriously bullish on everything.
None of this is of course surprising: it is a matter of national interest for the banks and their employees to promptly reflate the bubble at all costs. Otherwise, the great reset will send them all packing and looking for a job that actually involves doing something socially useful. As before, Edwards believes the great wind-down on groupthink will begin with China (despite Stephen Roach's optimistic view that the entirely export-led country can promptly shift its entire economic system to one driven by the consumer class : sorry, ain't happening... not without a catastrophic global economic realignment).
So we await some sort of correction in risk assets. But is this just a technical correction within a bull market for risk assets or something more?
Personally, I would categorize the entire move up in the equity market since March 2009 as a bear market rally which at some point will fall flat on its face. Investors seem to have forgotten that in a post-bubble world, recessions become far more frequent events. Certainly in the UK I don’t have much doubt that fiscal tightening is taking us back into recession, let alone now the increasing likelihood the Bank of England will soon raise interest rates.
But it is China and the commodity markets where I remain most concerned. Many seem to have forgotten just how vicious the collapse in prices in H2 08 was – i.e. they have forgotten just how all-persuasive yet wrong the prevailing groupthink was back then.
And for those who need a natural antidote to Roach's perpetual optimism on China, here is Edwards' punchline:
Far bigger brains than my own seem pretty sure that China is a bubble destined to disappoint. Most recently I was reading a piece by Edward Chancellor of GMO entitled Entranced by China’s Bubbling Economy (see Financial Times 7 Feb – link). He points out that bubbles can be identified before they burst by using simple valuation tools. China has all the characteristics of “a truly great bubble” with the housing stock set to exceed 350% of GDP this year, the same level of Japan at the height of its real estate bubble in 1990. Construction accounts for around a quarter of China’s economic activity which Edward notes is coincidently the same level that Ireland attained before it’s dramatic explosion. Oops!
Meanwhile, the major external imbalances that reflect the easy money policies that ruined the US, UK and Eurozone peripheral economies persist. The Chinese trade deficit with the US reached new highs in 2010 (see chart below). In many ways the persistence of the huge surpluses in China, Germany and Japan suggests that nothing much has changed. Economic implosion in the indebted countries has been prevented by the public sector simply replacing the excess debt of the private sector. The solution to the private sector debt excesses has been more debt and monetization of that debt. The real issues have been simply avoided.
But at least one consensus trend trade has just bitten the dust. Emerging markets had a fantastic decade run because they were cheap (see chart below). But as ever, this outperformance was extrapolated way into the future. Groupthink failed yet again.
The one traditional refrain on Wall Street has been to "never fight the Fed".. or by implication the great worldwide central banker cartel, which are now interchangeable as all the money printers are all in on the Ponzi. Yet with the massive moves in gold and silver, the market is telling us that ever more are taking the other side of that trade. Perhaps the only place where "this time it is different" is that the Fed is now losing. As Bernanke is now openly monetizing every dollar in gross issuance, what else does he have in his bag of trick? We contend that there is nothing left. And with QE3, QE4, etc. just a variation on a theme of dollar destruction, the end game is now here. Only this time even the Fed knows the outcome is given.
So let the groupthink have its last moment in the sun for a few more week, or months, or at even years. Those who wish a return to a normal and efficient market system are already putting in place the structural supports for a systemic "Volkswagen" on the lazy parade of groupthink Koolaid drinkers, who will "never see it coming." Only this time, the resulting squeeze, and subsequent reset, will make even the Volkswagen chart from late 2008 pale in comparison.