Interesting Times – My Say No 58

I would like to thank subscribers for their patience. It has been almost 20 years since I left the industry to tread my own path (with acknowledgement to Scott Pape for the quote). The website has aged and was well overdue for an update. Amongst other things, it was not compatible with any format other than desktop which made viewing problematic for most people. The revamp has now been launched to address the issues of age. In the changeover, files from the old site have been transferred. The potential consequences are that some people who have previously unsubscribed from this newsletter may receive this current edition. If so, I apologise and ask that you hit the unsubscribe button at the bottom of this current edition and I give you an assurance that it will be processed. For now, lets approach the long overdue latest edition INTERESTING TIMES.

“All the notions we thought solid, all the values of civilised life, all that made for regularity in the economy … all this seems badly compromised … Never has humanity combined so much power with so much disorder, so much anxiety with so many playthings, so much knowledge with so much uncertainty.” Paul Valery (1871-1945) French poet and critic

The article above is engraved on my mind. Despite the dating, it is as relevant today as when it was first written. I am becoming increasingly aware of the fact that my naturally pessimistic nature about the affairs of the human race appear to be shared by others. Two articles in a row were sufficient to trigger this.The first was an edition of Cuffelinks where the editor, Graham Hand, eloquently spelt out my own lingering concerns about the global economy. https://mailchi.mp/cuffelinks/edition-284 The second was an article by Peter Hartcher in the Sydney Morning Herald. Whilst domestically focussed it resonated. https://www.smh.com.au/national/australia-has-much-to-celebrate-and-to-fear-20181214-p50ma0.html Despite the positive spin on several issues, all local, it was the bigger global issues that concern me. Don’t get me wrong, all clouds have a silver lining and I have said many times that two global financial crises in a lifetime would be a blessing beyond belief. Post the GFC in 2007-8 I’m on record on a podcast, when asked what was on my wish list for the coming weeks, responding with a request for another financial crisis. When the interviewer recovered and asked why, I said that I would like to buy more CBA at $26, more Wesfarmers $13 etc.

Black Swan event is an event in human history that was unprecedented and unexpected at the point in time it occurred. However, after evaluating the surrounding context, domain experts (and in some cases even laymen) can usually conclude: “it was bound to happen”. What Black Swan event will trigger the next downturn; US – China confrontation, Brexit, Russian imperialism and so on? Whatever, no doubt after the event it will be declared as ‘bound to have happened’. In all my presentations I am at pains to point out that as humans fail to absorb and apply the lessons of history, they are doomed to repeat the cocktail with twists added by technological advances. As always, these are both a blessing and a curse in the affairs of humans. Technological advances resulting from two world wars enabled us to lift the number of those killed from around 40 million first time to around 80 million. Technology enabled the US to export its fraudulent mortgage lending virus around the world wreaking havoc on financial markets culminating in the GFC. This event raised the bar on government intervention to levels not experienced in living memory. We are now microbes in a central bank/government experiment. Interest rates having been cut every time markets wobbled has put us in uncharted territory.

Prior to the GFC we had the Dotcom fiasco; headlines were as follows. “The NASDAQ index had fallen 78% by October 2002.  “The ‘FED’ cut interest rates to 1% to stimulate economic growth”.

This was preceded by the first Gulf war in 1990 with the appropriate headlines. “Airlines face fivefold increase in insurance”.  “Bush Administration moves to distribute crisis across International community”. “US unemployment rate rises to two year high in August”.  “US Rate cut sought”

The 1987 crash remains fresh in my mind as it coincided with my return to Australia. U.S.-Largest peacetime one-day fall of 22% on 19th October 1987 Triggered by concerns over ‘insider trading’ and company takeovers using borrowed money. Concerns led ‘Fed’ and other central banks to lower interest rates sharply.

Conventional economic theory has been applied on every occasion leading us to the cul-de-sac we are presently in. No reference at all to the increase in moral hazard every time the authorities reacted in this way, cutting interest rates; on the contrary, much back slapping and high fiving as they congratulated themselves on rescuing their economies from the down swing on each occasion. The smugness has been palpable. There is no acknowledgement of the asset bubbles this strategy has created.

The element I find intriguing is the ongoing fixation with the security of government bonds. Every second day I am being made to feel irresponsible for an asset allocation that doesn’t include fixed interest investments. This brings me to the issue that exercises my mind in the current climate. I don’t want to go through the detail of the relationship between bond yields and bond values; suffice to say that as interest rates fall, bond prices rise and vice versa. This means that with interest rates at current levels we have had a bull market in bonds of unprecedented magnitude. As a gentle reminder for those old enough to remember, the interest rate rises in the late 80’s and early 90’s led to a collapse in bond prices which led to many ‘capital stable’ managed funds becoming unstable.

The following is the opening paragraph of a 1994 Fortune magazine article. “Wasn’t this supposed to be the year Alan Greenspan got to triumphantly parade down Wall Street to the cheers of bondholders big and small? In many ways the circumstances seemed right. In January 1994, the 34th month of economic expansion, bond yields were historically low and inflation seemed negligible: Wages were going nowhere, and companies dared not raise prices. But within seven short months of that promising start, something fairly unusual happened: 1994 became the year of the worst bond market loss in history.” Does any of this sound familiar? If you are interested, here is the article: http://fortune.com/2013/02/03/the-great-bond-massacre-fortune-1994/

In the current climate, how do central banks and governments ‘normalise’ interest rates without triggering the next biggest “bond market loss in history”. Unless of course, interest rates never go back up, so we can all rest easy! What does this mean for me? I remain, as always, sanguine, alert but not alarmed. Aware that if the bond markets tank, the inevitable reaction of the share market will be panic. Spend less than you earn and borrow less than you can afford: Lock and load for the amazing bargains that will present themselves. Merry Christmas and a Happy New Year to all.

 

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