Starting in 2007, global markets were buffeted by a series of financial and economic crises that created the greatest deflationary scare since the Great Depression. We have left out-and-out crisis mode. But the challenges are still considerable, especially politically.
The primacy of monetary policy continues unabated as central banks go further and further down the rat hole of increasingly desperate measures to boost demand. First, it was quantitative easing. Now, the latest scheme is negative interest rates. They tell us that monetary policy is not exhausted and that still more policy initiatives lie ahead, particularly helicopter money. However, we should be sceptical that any of these policies will gain meaningful traction before another economic downturn. Brief comments below
Mean Reversion of Wealth is one of the six structural mega-trends that we have identified. As is pretty obvious when looking at chart 2, wealth creation during the great bull market of 1981-2000 was quite extraordinary and, in our opinion, unlikely to be repeated anytime soon. Wealth simply cannot outgrow GDP indefinitely, as it has done in most years since the early 1980s. It is only a question of time before mean reversion kicks in.
The Absolute Return Letter, July 2015 “In a world that is changing really quickly, the only strategy that is guaranteed to fail is not taking risks.” Mark Zuckerberg Greece on the brink A Greek, an Irishman and a Portuguese walk into a bar and order a drink. Who picks up […]
One of the great things about markets and economics is that there is a lot of uncertainty built into them because, unlike traditional macroeconomic modelling assumptions, real people are unpredictable and irrational. This makes life uncertain, and at economic and market extremes it introduces Knightian uncertainty that just can’t be modelled with mathematical models. We are in one of these times in which Knightian uncertainly is everywhere. In that vein, I am going to put down a few thoughts on how behavioral economics might inform us here.
While I try not to be too alarmist here, it is clear now that the drop in oil prices has been both precipitous enough and long-enduring enough that we should start talking about this as a crisis in the making. We have an interconnectedness here of a strong dollar, weak oil and commodity prices, a move into safe assets and a flight from risk driving volatility and global asset allocation. Emerging markets, energy high yield and Greece are the flash points right now. Some thoughts below
Having just given you a mental model for thinking about tail risk, the natural next analysis is where the tail risk might be. Here are a few candidates.
Earlier today, yields for 10-year bonds in Greece shot up 200 basis points as investors contemplate the risk associated with a potential government transition. European Commission head Jean-Claude Juncker has waded into the domestic political debate warning Greeks against voting for “extreme forces” and instead going for “known faces”. These are signs that we are in a major crisis in Greece. And so I want to flesh out some related thoughts on tail risk and why I have been saying risk reduction is an appropriate strategy right now.
Last week, the ECB announced that it would begin purchasing securities backed by bank lending to households and firms. Whereas markets and the media have generally greeted this announcement with enthusiasm, this column identifies reasons for caution. Other central banks’ quantitative easing programmes have involved purchasing fixed amounts of securities according to a published schedule. In contrast, the ECB’s new policy is demand-driven, and will only be effective if it breaks the vicious circle of recession and negative credit growth.
Ukraine will have global impact
More sanctions are coming but will be somewhat limited
The global financial system is moving away from the US
US auto subprime is going to blow up
Money supply and LEI in the US are pointing down
Fed hawkishness is increasing
Credit excesses continue in high yield
There are widespread signs of credit market froth. This is a telltale sign of top of the cycle or near top of the cycle excess. Think 2005, 2006 or 2007. The key bit here is that credit markets transmit distress in a way that equity markets do not because when the credit writedowns are forced onto banks, the knock-on effects are severe. Let me go through some of these signs of excess with you. As I do so, let’s be clear that the froth is largely due to investors reaching for yield due to excessively low nominal and negative real interest rates. Financial repression has consequences.