Today's FT (Septermber 18, 2012) reports a jump of the market expectations for the US inflation. I have found a nice chart on bloomberg.com of the development of expected inflation (calculated using 5-year treasuries):
Break even rate: difference between the yield of treasuries and the inflation protected treasury debt
The FT sports another graph over a longer time period:
The market sees a higher risk of increased inflation over the coming years because of the ultra expansive monetary policy of the Fed (QE3). The Fed seems to focus more on unemployment than on inflation. Accordingly the US Dollar traded lower and gold higher.
On June 3rd, 2012 the FT reported an even worse development taking place in secret: Debt cancellation by central banks
US, UK and Japan's central bank would cancel government debt on their balance sheet to reduce the outstanding government debt:
Just look at the amounts. They are just breath taking! What this means is a permanently increased monetary base, which will lead to higher inflation, if the central banks cannot take the liquidity out of the system in due time. Remember that there is a significant time lag of six months between central bank action (e.g. raising interest rates) and its effect on inflation.
I guess the Euro area will face inflation too, since Mr Draghi's recent declaration go in the same direction.
Investors have to protect themselves against these inflationary risks: long term bonds will be hit hardest. Stocks will also be hit, should inflation be above 4.5%. Only gold, commodities, and maybe real estate as well as gold mining stock will provide cover.
Montag, 17. September 2012
An overview of the macroeconomic challenges the U.S. faces:
The financial crisis of 2008 is similar to the 1929 crash. As a consequence,
we are lucky that we have no global depression and deflation. Therefore, it is justified to pursue an expansionary monetary policy in order
to ensure that no deflation will take hold.
Monetary policy alone cannot boost the economy in a severe recession /
depression, because of the so-called liquidity trap,
according to Keynes. Expansive monetary policy does not work because
"pushing on a string" does not work. Effective demand-side policies are much much more effective in the aftermath of a financial crises. Tax cuts (the supply side)
will not help because they do not drive consumption. Joseph Stiglitz argues in
his book Freefall against the of trickle-down theory, and the invisible
hand of Adam Smith (the hand is so invisible because it does not exist).
However, the U.S. is now too indebted to initiate further big stimulus
programs. In addition, U.S. citizens must first rebuild savings,
before they can increase consumer spending.
In recessions / depressions psychological factors play an important
role: The willingness of consumers to spend and the willingness of
companies to invest depend on expectations about the future economic
development. These expectations are formed only partly on facts and
partly influenced by moods. A paper by Woodford at the meeting of Jackson Holemakes this point: Verbal Commitments by the Canadian central
bankers that they guarantee low interest rates, on the condition that
the economy does not grow, were more effective than programs such as
quantitative easing. Another example of the effect of psychology is the
paradox of thrift, which states that efforts to save of the individual
lead to a collapse of aggregate demand. Another example of psychology is described in an article of UBS economist Drew Matus, who describes the reduction in the capital
stock in the United States: companies invest too little because they
expect a weak future demand.
My guru in economics, Joseph Stiglitz, writes in an article in Vanity
Fair January 2012 about structural change: In
the 30es, technological progress increased agricultural production
(for example through the use of fertilizer) which could feed more people and led to the population
explosion. The use of machines in farming required less manpower. The result
was a poor rural population, who could not buy anymore products from the
manufacturing industry, which in due course also came into
diffuculties. Only the preparations for war saved the economy and
unemployment declined. Today,
we have been also experiencing a structural change for 20 years: the
globalization of outsourcing the jobs of the industrial mass production
shifted to the emerging markets. Stiglitz
says we must invest in the U.S. in infrastructure, technology and
training in order to increase competitiveness. However, he stays silent
regarding the ballooning US government debt. Neoliberal economists doubt
the effectiveness of these measures. Although, I would like to point
out that in all successful Asian emerging markets like Korea, China, Taiwan etc., these kind of economic policy is very pronounced.
As
long as the consumer in the United States has not brought his finances
into balance, the economy cannot grow sustainably. This takes time. The economy could benefit in the long run from measures to increase
competitiveness mentioned by Stiglitz. In the mean time, the US could
mitigate the symptoms with monetary policy, fiscal policy, and
psychological measures. A way out of the sovereign debt problems is
inflation, which could take place in a few years because of the inflated
money supply. This will be quite unfavourable for savers, as they will
suffer a severe loss of their purchasing power.
Today, the housing market however is recovering slowly. Prices are rising slightly although from a very low level.
The Financial Analyst Journal of July/August 2012 includes an interesting article about underperformance of institutional money (pension funds etc.): Murder on the Orient Express: The Mystery of Underperformance by Charles D. Ellis. He explains the mystery why institutional investors underperform their benchmark, although they are supposed to be professional and have the best experts at their disposal.
One important driver are the costs of active management: costs for an active equity mandate have risen from 0.1% to 0.5%. Fixed income mandates will be significantly lower, while alternative investment mandates considerably higher.
I have written a post about
investors underperforming the mututal funds they are selecting. It is very similar here:
The clients fire underperforming managers and hire managers who have outperformed in the past, expecting the outperformance to continue. Unfortunately, past performance says nothing about future performance.
Suspect # 1: Investment Managers
Client-manager meetings are unfortunately sales meetings. Manager who had a lucky streak the past few years seek prospective clients and present them with their fabulous track record to gain new clients. No manager will admit that markets today are very efficient and competitive, and that it is hardly impossible to beat the market consistently over time. They present their performance as a product of skill rather than luck.
Suspect # 2: Investment Consultants
Institutional clients often employ investment consultants who help monitoring hired managers and help selecting new managers. Since no consultant can consistently identify the future winning and losing managers, the consultant will want to diversify into different managers. And the more managers he oversees, the more work he has and fees he can justify. The consultant will want to develop a personal service relationship by increasing the amounts of emails, phone calls etc.
Worse, as a consultant, you will not present managers whose investment style suffered in the past few year. You will want to present the investment committee the "winner", but will not tell him, that you are in no position to separate consistently winners from losers. Result: The consulting firm's client will select manager after their best years, and fire managers after their worst years.
Suspect # 3: Fund Executives
Fund executives are usually cautious processing people. But the representatives of investment managers are socially dominant people who are "skilled at closing transactions" with fund executives, called gate keepers among investment managers. Hence, fund executives will be overwhelmed by consultants and the managers sales people.
Suspect # 4: Investment Committees
The committee hires usually the the managers whose past performance was most compelling and made the most persuasive presentation (sales skill!)
Committees' member suffer usually following handicaps:
They believe, it is their duty to select top managers and that past performance is a guide for future performance.
Bevioural finance aspects, like overreacting to recent events and neglecting long term facts (like returns reverting to the mean).
Listening to closely to an investment consultant, who is primarily following hits own interest.
Being too much hands on in fields they shouldn't meddle (like investment management decisions) and having not enough time for the important questions of the funds governance.
Conclusion
All involved parties are to blame, yet none will recognize "its own role in in the crime".
In my opinion, it is important to keep costs in check and not choose a manager because of his fabulous short term performance. On the contrary, I have recently bought the Julius Baer Multipartner - Gold Equity Fund precisely because their recent performance (this year in USD -17.3%) was bad and knowing that the management team of this fund is very skillful. Also keep in mind, that although capital markets are efficient most of the time, but not always: In the world of efficient markets there shouldn't be any bubbles, and behavioural finance explains why humans often create market anomalies through their irrationality.
According to Walter Wehrli, Erich Meier and Marc Gugerli of Konwave AG, manager / adviser of various gold equity funds, costs have gone up due to increased energy prices, the treatment of lower grade ore (which became profitable due the higher gold price), and higher equipment costs. They expect costs to decrease in the future.Hence, the situation is now very favorable for gold mining stocks:
Gold remains high due to the risks of inflation and the risk of instability of the world economy.
General investors have abandoned gold stocks, but they are expected to buy mines as the quotes move higher from the lows of May 2012. Low M&A activity also points to a market low.
Mines are valued favorably with low PEs, nice dividend yields, and deliver growth opportunities.
Gold miners have lower debt on their balance sheets and are more cautious with new capex programs, decreasing the risk of unsuccessful investments.
