Let’s Do the Time Warp Again …
By Eben Maré, ABSA Asset Management
“Out of all the things I’ve lost, I miss my mind the most …”
Think back carefully about your career - for those of us who have been around for long enough, what has really changed in the last twenty/thirty years? Personally, I find the flow of information astounding and that certainly stands out. As a fund manager, I recall the early 1990s when clients would receive investment statements quarterly (by snail mail); today, instantaneous electronic access has changed client behaviour, forever, in many ways.
It is certainly positive that clients have direct access to performance, but it is interesting to note that client holdings and investment patterns have changed materially as a consequence - in the 1950s to 1980s the average holding period of a stock was of the order of several years; in current times average stock holding patterns have changed to days ... investors react to news-flow rather than assimilate and assess fundamentals.
We are addicted to news-flow - please raise your hand if you have never had a nervous pang when you couldn’t access your e-mail. Companies thrive on this, we are all ‘connected’ 24/7. Politicians do, too - regular bouts of Twitter fodder have become mainstream. As an example, I struggle to count the number of times the chairman of the US Federal Reserve has recently come under attack in this way. Markets rapidly derive direct reactions without due analysis - the end result is a vicious circle of feedback, with participants craving more news and harder (or stranger) actions. Who saw election results being influenced through social media twenty years ago?
Yet, despite this exponential surge of news-flow, do we really feel better off? At the time of writing, roughly a third of all investment-grade sovereign fixed income bonds have negative yields - which means that investors are desperate enough to pay just to get their money back!
Why, you might ask? We can measure economic policy uncertainty using big data. This technique would typically look at newspaper articles, worldwide, which mention economics and uncertainty together to create an index of policy uncertainty over time. These measures are at their most elevated levels, currently, compared with history spanning a full twenty-year period. Policy uncertainty breeds bad economics and the bond markets are shouting that loudly. To take the idea further, at the time of writing, approximately 3% of corporate debt is negative yielding … investors are ostensibly ignoring the risk of corporates defaulting on their obligations.
The Austrian republic recently issued 100-year bonds in a repeat of 2017 issuance. The yield, a meagre 1.17%; did I mention that the Austrian republic is a mere 101 years old? Investors clearly believe they can see a century ahead with crystal clarity. But here’s the problem: in equilibrium, long bond yields serve as a proxy for long-term growth. Can you spot the conundrum? At roughly 1.1% nominal growth, investors are betting on non-existent inflation. In 1923, for example, we had hyperinflation in Germany – an initial cost of 1 mark at the start of the period inflated to a staggering 100 sextillion marks (1 followed by 23 zeroes) barely a year later. (Let’s not forget our neighbour Zimbabwe’s hyperinflation either.) These rare, but realistic events could see bond investors wiped out; but the market attaches no weight to this possibility at present. On the other hand, without economic growth the cost of debts will balloon. How do we commit capital to periods of 100 years – somehow I’m wondering if we’ve lost the meaning of the word ‘responsible’?
Let’s consider an example of current policy uncertainty that troubles us all. We have had trade policy uncertainty between the USA and China from the early part of 2018 - there is no doubt that this has more recently fed directly into growth slowing, in an already aging business cycle, as a result of businesses choosing to sit on the sidelines. Failing discussions to resolve policy made politicians turn on the Federal Reserve - rates need to be cut to create a growth impulse and the markets love that. However, that doesn’t resolve the trade policy uncertainty.
The problem here is again one of feedback - more Twitter feeds and improperly substantiated news-flow create more uncertainty, which breeds lower economic growth prospects. Lower rates will not remove uncertainty; hence investors are content to pay for mere return of capital. European uncertainties and Brexit woes also prove the point. The news, and associated folly, however, has always existed; what has seemingly changed is the speed of information flow and public reaction.
The relative game of currency
So we are effectively back to a situation where we have currency wars. In a low rate environment, the so-called carry-trade rules. Investors seek yield and the highest yielding currency (given constancy of sovereign risk, for example) will become stronger. Remember, currency is a relative game, which explains a lot of the rhetoric pertaining to lower rates: it’s actually about getting the currency weaker, but this becomes a race to the bottom. There’s nothing fundamental about negative rates, sooner or later we will need to ‘pay the Pied Piper’ - I’m betting that’s not going to be a pleasant experience.
I repeatedly ask myself the question “What happens when we next have a proper crisis?” knowing that one will appear sooner or later ... what is the solution mechanism, bearing in mind what we are throwing around at the moment, just to sustain the current momentum?
I’m not against change; however, disruption has become all the rage. Yes - let’s find better ways to do things but have we established consequences? Take the newest crypto-initiative being launched by Facebook, namely Libra. Facebook has roughly 2.4 billion active users – it stands to reason that Libra could gain wide acceptance if even a fraction of these users start adopting the payment system. As part of a payment system the idea is great; but how are we going to get a multitude of central banks to work with a public company, which now controls a currency of its own? Think about the effects this could have on monetary policy, worldwide. Central banks are mandated to control inflation, the tools they have at their disposal are policy rates and reserve ratios to mop up some of the money in circulation. Surely the effectiveness of such actions could be undermined if a private organisation becomes a money creating entity on its own. We were not able to fully stabilise the euro area in the previous ‘attempt’ at such an endeavour, so what happens when we have an international risk event? Who takes effective control of a cyber-based ‘sovereign’ entity?
I am particularly concerned about the effect of low rates and low expected asset returns, in general, on retirement funding costs. The effects of lower rates have buoyed risky asset classes but we have been slow to recognise the liability side of the balance sheet, so to speak. We are seeing longevity increase world-wide and we are yet to observe the disruptive effect of genomics playing a role – the issue of retirement funding will become more and more pertinent amidst increasing infrastructure costs and slowing growth. We have delayed our economic problems by creating ample liquidity and ultra-low interest rates; the after-effects will be felt for years to come as the economics of these low returns (with higher risks) affect and filter through to retirees.