Perception might be the reality in your retina, and the only relevant factor when working to push the ballot count in your favor. But in real life, sooner or later, it is reality that inevitably prevails. That goes for economics as well, regardless of the easy fixes offered by Trump’s economic program, and others. Our present global economic reality is, at best, worrisome -and with a sad prognosis for the next couple of years (or more). That is a fact that can be perceived in many different ways. Make it opposite ways if you wish. But a fact after all.
In this world of relative beliefs, and prevalent wishful and/or politically correct thinking, finding the truth should still be the underlying quest. Learning the (economic) truth takes time and effort because it is complex and difficult to fully grasp and comprehend. It is so tiring, that we have come to accept that there is an infinite amount of truths for the same fact -depending on the color of the lenses of the viewer. Can’t find the underlying truth? Don’t stress out. Relative values have long faded absolute ones. Most think there are different truths depending on the eye of the observer. Nobody wants to find the naked truth anymore. It might be sobering, and it is not worth the effort involved. Or is it?
Bearing this in mind, we have to take the recent Trump event with a grain of salt. Here comes “the Donald”, now Mr. President, stating the obvious to all (by now): that monetary policy with its reiterated tools of financial repression, and abundant printing and lending, was not the way to go (Of late, Theresa May apparently also got that message as well). The issue is, for both, and for the rest of us, that despair and depression (of the economic kind) are not a great alternative to Keynesian wishful thinking. Nobody dares mention them.
Thankfully, “the Donald” and team have thought up something “new” in order to inject some badly needed optimism. A good old bricks and mortar revival conveniently sprinkled with some fresh lending. That ought to help him pull it off! After all, he knows both sectors well, his life has always been full of bricks and mortar, and debt -lots of it. I wonder why prolific Paul Krugman hadn’t thought it up beforehand (maybe too many vested interests in the Keynesian priesthood monetary cause).
We live interesting times. Hence, it was unsurprising to see a post-election healthy bid for Caterpillar and the Banks, while Alphabet, Amazon, and Microsoft were sold with disdain. The Dow up big, and the Nasdaq down correspondingly. Animal spirits are all over the place once again, because brick and mortar spending will save the day. Hip Hip Hooray!
Inadvertently, we are getting used to all this nonsense. A couple of months ago, just after Brexit, it was the promise of infinite NIRP and helicopter money taking equity markets to a new, if marginal, top. Now, it is the reflationary program that will allow the present economic cycle to endure. Only our species can be stupid enough to move from fiscal to monetary policy and then back again, reiterating the same mistakes “ad nauseam”. Whatever they do, they never try to fix the supply side. See (above) what infamous Yogi Berra had to say for situations of the sort. It always pays to smile when facing such a serious issue for mankind, particularly when high doses of Prozac are the only alternative.
Let me begin by offering some help. Most Spanish economists could sure provide some additional expertise to implement Trump’s economic policy. After all, it wasn’t that long ago we built more condominiums per year, than in the rest of Europe combined. We know how this model works, and where it takes you. We know full well. Nowhere.
Yes, of course, I am aware that, in Spain we built condominiums, whilst The Donald will rebuild motorways. US infrastructure is, for certain, in desperate need of repair and upgrading. But that is a prerequisite for growth enhancement, not a Keynesian panacea, or a strategy -much less a (Summers labeled) “free lunch”. You have to pay for that -with money, we don’t have. The true content of Keynesian fiscal stimulus is not “infrastructure rebuilding”, but “more credit and debt”. And more debt will not propel us out of this mess!
The real priorities are Schumpeterian creative destruction, deregulation, putting an end to NIRP and ZIRP, workforce education, and productive investment. Why? Because there is only one way out: fixing aggregate demand in full compliance with Say’s law. And after a long, CB induced interruption to Schumpeterian creative destruction, we have an infinitely long list of supply side enterprises and sectors to be eliminated, or at least greatly reduced. Not to forget are bloated government payrolls almost everywhere. Replacing those jobs with new ones will take time, and it is not feasible in the short run:
- The new economy has a low propensity to hire. We need dozens of Facebook’s or Amazon’s to replace the employment provided by traditional Banks, General Motors, US Steel, and the likes (old economy sectors).
- New jobs are skilled jobs. We need to invest in education in order to preclude human “ghettos” loaded up with economically obsolete individuals. We are relentlessly gathering up a legion of unemployable unemployed. It will take a change of attitude, time, and money.
- We need Aggregate demand in order to generate new supply, but without productive investment, we will not get it going. It is a classic chicken and egg problem. Productive investment will only grow if aggregate demand heals itself, and a healthy aggregate demand requires supply-side improvement. It will be a virtuous circle once it’s started, but it will take a long time thereafter.
- Demographics will decrease the active segment of the population. We will have a higher proportion of students and retired individuals. The percentage of individuals in their working age will continue to decrease. On top of the population pyramid inversion, education will take longer as job skill requirements soar. Low levels of employment will be compatible with unit labor cost growth unless we improve education, and with it, we obtain abundant skilled labor supply. And we ought to get productivity moving significantly in the meantime.
- We have to offload debt to remain afloat. We will not dilute it with growth because debt impedes growth (another chicken and egg problem). We can only dilute it reflating the economy (with the associated rise in interest rates that will take us to defaults later on), or accepting deflation and the concomitant defaults. Both roads take us to a dead end. Creditors will not get most of their money back.
Fixing aggregate demand in a Say compliant way implies fixing inequality (distributing wealth properly enables hidden aggregate demand), unemployment (salaries are the sustainable vehicle for personal consumption), and the supply side infrastructure (we have to reorient production and enhance productivity growth). A daunting task. But, alas, the only viable strategy to fix our economic maladies for good.
Aggregate Demand comes from labor (wages), land or capital income (interest rates have to go up), credit (debt), or welfare (entitlements). Other than paying labor and capital their dues, there is no other way to grow that doesn’t generate a debt overhang. It is irrelevant that you allow people to incur in debt to consume, or you become indebted as a government in order to provide entitlements to aid consumption. Respecting Says law is a prerequisite for sustainable aggregate demand. Debt-financed entitlements can only provide some short term relief.
We must change course. We have to renounce monetarism and debt growth, and enable a supply side revamp, changing sector weights, and uninstalling all units that are not fit for survival in a normalized cost of capital and labor environment (nominal rates close to nominal GDP growth). Rates have to go up to clean up economic zombies. New supply side nodes have to flourish. We have to deregulate (I share that need with Trump), and thus entice individual entrepreneurs to do their job.
In the meantime, and while the establishment slowly understands the inevitability of all this, the investment game is becoming more and more interesting. Thrilling I should say. Some unsolicited advice related to the investment game.
First of all, market noise is going through the roof. Noise includes all price moves that are unpredictable because they are not based on macro or micro economic trends or valuation. Event driven volatility is growing exponentially. I sense there is more to come.
Some excellent fund managers have seen some savage drawdowns in their NAVs because of this unpredictable event noise eruption (Brexit, Trumpocalypse, tapering of QE, massive NIRP policies in different countries etc). Only recently, some very smart managers were long bonds and short stocks (for a good reason). They have been massacred. I was spared because I was heavily short stocks, but long USD and didn’t hold any duration in bonds. That leveled me out for a slight gain. I was lucky this time around.
But chaotic disruption could take place again, following the Italian referendum or any other black swan event. Prices of the different asset classes would move wildly in unexpected directions. It is 100% impossible to outguess the other managers in all the unpredictable moves that await us. You are not going to be always lucky. So your only option is to reduce your leverage and beware crowded trades.
I run a moderately leveraged fund (400% maximum) and have decided to reduce my VaR to roughly 200%. Unwanted volatility will crash your Sharpe, and induce some sleepless nights, so I am trying to keep my NAV stable -in this crazy market environment. Return of your money is always a priority when evaluating your choices for the return on your money.
Second, getting the direction right is now a must. You can’t afford low conviction trades. High correlations make it hopeless to try to mitigate risk with traditional portfolio theory diversification. You are better off with a limited number of high conviction trades. And they must all be liquid enough. It´s bad enough to depend on what CB’s might do or not. Having problems to exit your positions can be a killer in times of stress.
Third. Credit risk and systemic risk are to be avoided at this point. They are not very well rewarded at current prices. Credit spreads are still low for sovereigns and investment grade. High yield spreads are preposterous. Systemic risk implies balancing the risks of being left behind by long-only portfolios, against the chances of losing big in a black swan event. In both stocks and bonds, long portfolios have limited upside, and huge downside (linked to the beta of the individual stock, and the duration of your portfolio). Your long alpha portfolio has to be well hedged against market risk.
Fourth. We have to be patient. No need to be fully invested all the time. Career risk is tough to live with, but massive losses are a terrible proposition if you remember the basic rule of compounding: never ever lose money significantly. It takes a long time to get it back -if you do at all.
I am now 6.40% up YTD (4.30% in a first tranche, and 2.1% in a second tranche beginning in September with a different investment vehicle). I have a tendency to be greedy and hyperactive most of the time, but today’s market noise begs to remember that bulls and bears can make money (it is easier being a bull), but pigs mostly get slaughtered. You don’t want to be a pig, do you?