James Sullivan ponders a misplaced sense of insulation created by the Central Banks.
The Tullock Spike was the thought piece of the economist Gordon Tullock.
Tullock, at the time seatbelts were made mandatory in cars, suggested that such a safety measure made drivers more careless, and installing a spike protruding from the steering wheel would be more of a deterrent to reckless driving. The argument centred around the driver becoming more insulated from the inherent risks of driving a ton of metal around at speeds of 70mph or more. It was observed that motorists drove at greater speeds when wearing seatbelts.
In the market we operate, it could be argued that the central banks have become the seat belts.
We have recently witnessed the 9 year anniversary of the bull market in the Dow Jones, marking the longest ever and the greatest percentage gain since WW2. However, we must not lose sight of the manner in which this has been achieved. Yes, one can attribute some of this recovery to an economic expansion post crisis, but it’s the almost uninterrupted fluency of the recovery despite a less than perfect economic and political backdrop that is the observation.
The support of central banks has created a heightened sense of protection and has taken the ‘Greenspan put’ to a new level. From the moment QE1 was rolled out, the entire investment landscape changed.
Including China, $21 trillion dollars of central bank easing, which is expected to climb towards $24 trillion by year end, has been pumped into the global system since November 2008. It’s easy to become nonchalant of such numbers, but one must not lose sight of just how phenomenal that number is. With that injection of liquidity came a complete suppression of interest rates, influencing investors to seek bond like characteristics elsewhere along the risk spectrum.
The market probability of a Bank of England rate hike in May was as high as 90% just a few weeks ago. Today, that same indicator is close to zero after Mark Carney suggested the market was wrong to take it as a foregone conclusion following some rather underwhelming GDP data.
Admittedly the data across much of the pan European market was underwhelming in Q1, but Whitney Houston may have accurately suggested ‘it’s not right, but it’s ok’. The equity market had all but priced in a rate rise and yet had showed very little signs of stress. It feels as if this may be a huge missed opportunity to start normalising policy, and thus giving the banks something of a yield curve from which they may feel encouraged to lend money into the real economy. We think it’s fair to say, the vast majority of the $21trillion printed has not reached the real economy which may go some way to explaining the subdued GDP figures. Something akin to a negative feedback loop. Something needs to change if we are ever going to return to ‘normal’.
We are not attempting to find fault in experimental monetary policy, nor do we suggest the alternative to QE was palatable, but we cannot help but feel a misplaced sense of insulation has been created, permitting some market participants to act in rather a ‘less careful’ manner.
The time for Carney to right the ship is now; he would be foolish if he were to let this moment pass.
We would be imprudent not to acknowledge changes in market behaviour and subsequent momentum trades, but we will not rely on monetary policy to unduly support our investment thesis. In pursuit of risk adjusted returns, we build in our own valuation driven protection, attempting to buy assets that are supported by their own fundamentals, and trading at valuations that reduce susceptibility to central bank policy.