And now for the G20’s next trick ...
Ian McGugan,
What a magic act! Over the past year, despite the biggest economic
crisis since the Great Depression, central banks around the world have
managed to create an environment in which just about every type of
financial asset - stocks, bonds, gold, has headed straight upward.
The result of this great levitation is an environment that makes
absolutely no sense from the viewpoint of standard investing logic.
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Two demonstrators protest during the
G20 Finance Ministers meeting in St Andrews, Scotland this
past weekend. David Moir/Reuters |
A big run-up in the stock market, like the one we’ve seen over the
past few months, would usually be seen as a bet on a strong recovery
that will boost profits. A surge in bond prices, such as we’ve
experienced over the past year, implies the opposite. It suggests buyers
see a weak, faltering economy ahead and want the security of fixed
payouts.
Things get even stranger. Bonds are supposed to be at their best
during times of deflation, when prices fall and the purchasing power of
a bond’s distributions goes up as a result. In contrast, gold is
supposed to shine during periods of inflation, when prices climb and
people want the security of owning a real asset that can keep pace with
rising bills.
So, according to the market trends of the past year, investors expect
both a strong recovery and a weak one, both inflation and deflation. You
thought you were confused? It’s nothing compared to how Market feels.
Perhaps the market is baffled. Or, more likely, it’s responding to
the unprecedented level of government intervention during this
crisis.Some of the most notable interventions are low, low interest
rates. Another is ‘quantitative easing’ in which central banks, such as
the US Federal Reserve and the Bank of England, have created massive
amounts of money out of thin air to buy risky assets. (Andrew Smithers,
a British economist, estimates these purchases total a staggering 5
percent of US GDP and 8 percent of UK GDP.) Finally, of course, there is
deficit spending on a galactic scale.
The US federal deficit is expected to hit 13 percent of GDP this
year, its highest level since the Second World War. Canada and other
members of the Group of 20 rich and developing nations are also spending
heavily and most are maintaining their low interest rates. After a
weekend meeting in St. Andrews, Scotland, the finance ministers of the
G20 pledged to ‘continue to provide support for the economy until the
recovery is assured’.
To investors, a statement like this is a Zen riddle, capable of
multiple interpretations. On one level, the G20 seems to be saying that
the situation is still dire and interest rates will remain low for a
long time. That suggests buying bonds is the smartest idea.
On the other hand, the size of the stimulus spending suggests
corporate profits will be buoyed by a tidal wave of Government spending.
That amounts to a vote for stocks.
Yet another way to look at the situation is to wonder how countries
will ever pay for the massive stimulus they’re doling out. Rather than
raise taxes to pay for it, Governments may inflate away the debt they’re
running up. That would suggest that gold is today’s asset of choice. All
three interpretations have something to be said for them, but all of
them can’t be right.
The eventual winner may be decided by yet another factor, the US
dollar. Nouriel Roubini, a professor of economics at New York
University, believes that low interest rates in the United States are
fuelling what he calls ‘the mother of all carry trades’ in which
investors borrow money in the United States and use it to buy risky
assets around the globe.
Roubini, who has earned the nickname Dr. Doom because of his funereal
(and accurate) pronouncements on the global economy, says this will all
end in tears. At some point, the US dollar will stop falling, the carry
trade will lose its attraction, traders will rush to sell assets and
repay their carry-trade loans, and one of the forces propelling all
assets upward will start to drag them down instead.
So is there any safe place to hide? Jeremy Grantham, chairman of
money manager GMO in Boston, has been one of the most prescient
investors of the past few years.
He is a big fan of what he calls high-quality US stocks such as
Johnson & Johnson, Wal-Mart Stores Inc., Microsoft Corp. and Coca-Cola
Co.
“Quality stocks, simply look cheap and have gotten painfully cheaper
as the Fed beats investors into buying junk and other risky assets”,
Gratham writes in his most recent letter. These companies don’t carry
large amounts of debt so they’re not going to be sunk by deflation or a
slow growth economy. They enjoy some pricing power so they can hike
prices if inflation roars.
They also have large sales in foreign currencies so the relative
strength or weakness of the US dollar is not a huge factor over extended
periods.
Unlike just about everything else, they haven’t gone up much in
recent months, and that may be the best recommendation of all.
Financial Post
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