Too Much Gloom On The Markets
February 23, 2009 - Corporate earnings reports and economic data continue to be unrelentingly awful, just about anywhere in the world. But this is not unexpected, as we are currently experiencing the worst of the global recession. At the same time, faith in the ability of the authorities to turn things around is somewhat shaky. There has been quite a bit of fumbling and bumbling by those who are supposed to get us out of this mess, be they in Europe, the US or Japan.
As a result, a sense of gloom pervades the financial markets and we are seeing a spate of strong risk aversion. Riskier asset classes have been hurt as investors head for supposedly safer ground. An asset class that has been doing well is the general category of government bonds.
People appear to be grateful for the meagre returns offered by government-issued securities. But it may be a dangerous place to park our money, specifically if it is placed in longer-dated maturities. Governments everywhere are in the process of running up huge fiscal deficits and issuing debt in vast quantities.
If no other policy actions are implemented, it would take rapid growth over a very long period for the deficit to diminish. Alternatively, taxes could be raised to reduce the debt burden. But this would slow down growth and is politically very difficult to implement. So there is little confidence that this is the route that politicians would follow. Inevitably, the suspicion arises that they would be tempted to monetise the debt by printing even more money.
Worries about such prospects have helped to push gold sharply higher. In fact, the gold price has become disengaged from factors that have been important determinants in the past, namely oil and the US dollar. Currently, oil is weak and the greenback relatively strong, both of which should have weighed down on the price of gold.
The safety of government bonds in a tumultuous environment may turn out to be a temporary refuge unless a long period of severe recession is in the offing. We are reminded of the story of Sinbad, from the “Thousand and One Nights”. Sinbad’s ship broke up in a storm and fighting the waves in the dark he managed to crawl onto a small island, only to find that he had climbed on the back of a giant whale.
We have stated in the past that we do not believe in the eventuality of a depression-like outcome for the US or the global economy. Reference to the period of the nineteen thirties is misleading because there are so many differences in economic structure and policies that a comparison is not really relevant.
There are lessons to be learnt, of course. The most important of which is that protectionism must be avoided at all cost. If there is one thing that could sabotage a rebound in the global economy, it would be the implementation of protectionist measures. Politicians and their advisers seem to understand the dangers of erecting trade barriers. But ultimately, actions matter more than words and it would be wise to monitor developments in this area.
Across the world, there is a great deal of uncertainty about the economic outlook and visibility is low. This deepens a general mood of gloom. As a consequence, people are vulnerable to being persuaded by stories that take on momentum and build up like an avalanche. As an example, a recent story was being propagated about the problems of Eastern-European economies, and it spread fast and furiously across the financial media.
But the challenges faced by many economies in Eastern Europe have been evident for a long time and there is little indication that they have suddenly become insurmountable. And, then again, there are differences about the extent to which individual countries in that region have been affected. However, the financial markets didn’t waste any time to do deeper analysis. The negative news had an impact on European banks, the euro and emerging markets far from Europe.
The moral of this entire story is that we should not allow our good judgement to be affected by sudden surges of fear in the markets. Unfortunately, the current situation is particularly conducive to generating herd behaviour. Meanwhile, there are positive developments taking place such as an upturn in the global liquidity cycle, which will eventually support asset markets.
Nathan Rothschild famously said that the time to buy is when there is blood on the streets. Well, with the recession deepening there is plenty of blood on the High Streets - - that of retailers. Many of them have gone bust and others will follow suite. But the survivors may come out of the recession in a stronger position, having trimmed their costs and improved their competitiveness. In the UK, one of the hardest hit economies, retail stocks are actually performing better than banks, which face more daunting challenges.