Strategic Investment Outlook Part II
Additional Reasons for the conclusion:
In Part I I concluded that I cant give a high conviction call to the overall strategic investment climate. In late 2008 it was much easier to make a conviction call, but in 2010 the recovery in asset prices (Australian residential property, Australian and Global Equities) means that there is no longer a sufficient margin of error to make such a bold statement.
Governments and central bankers around the world acted correctly by lowering interest rates, flooding the system with money and running loose fiscal budgets.
This was required at the time to give the economic and financial system time to heal.
The longer term economic impact though I feel is the increased probability of a longer ‘U’ shaped recovery (although asset markets I feel have a higher probability of displaying ‘W’ like returns, but not to the recent cycle low point).
Instead of allowing the excesses to be washed through the system by a severe depression, government and central bank intervention has transferred the corrective stage over a longer period of time. The net result of this will be a more muted net long term recovery.
I don’t think markets are adequately reflecting the risk of this.
Global equity markets have recovered, but part of this recovery is due to cyclical factors:
1) The carry trade with record low interest rates;
2) Closing out of record levels of short positions;
3) The economic rebound off the cyclical low (with large improvements in the forward looking indicators).
These factors whilst justifying the fact that equity markets didn’t deserve to trade at their low points, DO NOT JUSTIFY CONTINUED INCREASES IN EQUITY MARKETS.
The first point is an issue of relativity (in simple naïve terms dividend ylds vs interest rates), not an underlying reference to the intrinsic value of a company.
The second point is a reverse back of market manipulation.
The third point is more interesting. So far the forward looking indicators have been moving steadily upwards. But the key question here is for how long? If I am correct about a long term ‘U’ shaped recovery, then these forward looking indicators will start to slow in their progression, or even worse, dip (but not to the cyclical low points). In either cases the negative reaction from markets will be proportional to market asset pricing. The higher equity markets move the greater the negative reaction.
Now there are some underlying long term positive catalysts that will increase the long term intrinsic value of equities. These include:
1) Lowering of the fixed cost base.
2) Elimination of weaker players, which increases the market dominance of the remaining players.
3) Increased employee productivity.
However are these underlying long term positive catalysts of sufficient strength to offset the future removal of the current cyclical factors talked above (and with regards to equity pricing, ie asset price levels)?
Personally I think the catalysts remain for a continuation of the current cyclical bull market recovery, but there is insufficient data to prove a continuation of the secular bull market.
This question must be answered, especially for those investors who adopt a ‘buy and hold strategy’.
Additional Reasons for the conclusion:
In Part I I concluded that I cant give a high conviction call to the overall strategic investment climate. In late 2008 it was much easier to make a conviction call, but in 2010 the recovery in asset prices (Australian residential property, Australian and Global Equities) means that there is no longer a sufficient margin of error to make such a bold statement.
Governments and central bankers around the world acted correctly by lowering interest rates, flooding the system with money and running loose fiscal budgets.
This was required at the time to give the economic and financial system time to heal.
The longer term economic impact though I feel is the increased probability of a longer ‘U’ shaped recovery (although asset markets I feel have a higher probability of displaying ‘W’ like returns, but not to the recent cycle low point).
Instead of allowing the excesses to be washed through the system by a severe depression, government and central bank intervention has transferred the corrective stage over a longer period of time. The net result of this will be a more muted net long term recovery.
I don’t think markets are adequately reflecting the risk of this.
Global equity markets have recovered, but part of this recovery is due to cyclical factors:
1) The carry trade with record low interest rates;
2) Closing out of record levels of short positions;
3) The economic rebound off the cyclical low (with large improvements in the forward looking indicators).
These factors whilst justifying the fact that equity markets didn’t deserve to trade at their low points, DO NOT JUSTIFY CONTINUED INCREASES IN EQUITY MARKETS.
The first point is an issue of relativity (in simple naïve terms dividend ylds vs interest rates), not an underlying reference to the intrinsic value of a company.
The second point is a reverse back of market manipulation.
The third point is more interesting. So far the forward looking indicators have been moving steadily upwards. But the key question here is for how long? If I am correct about a long term ‘U’ shaped recovery, then these forward looking indicators will start to slow in their progression, or even worse, dip (but not to the cyclical low points). In either cases the negative reaction from markets will be proportional to market asset pricing. The higher equity markets move the greater the negative reaction.
Now there are some underlying long term positive catalysts that will increase the long term intrinsic value of equities. These include:
1) Lowering of the fixed cost base.
2) Elimination of weaker players, which increases the market dominance of the remaining players.
3) Increased employee productivity.
However are these underlying long term positive catalysts of sufficient strength to offset the future removal of the current cyclical factors talked above (and with regards to equity pricing, ie asset price levels)?
Personally I think the catalysts remain for a continuation of the current cyclical bull market recovery, but there is insufficient data to prove a continuation of the secular bull market.
This question must be answered, especially for those investors who adopt a ‘buy and hold strategy’.
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