Shattered nerves. Jumpy markets. The long hangover from the financial crisis is making everyone nostalgic for the bygone days of financial market stability.
The plague of uncertainty stalking the market today has been spawned by two violently opposed economic forces. On the one hand, we have the deflationary pandemic of deleveraging and debt reduction that followed the burst credit bubble. On the other, we have monetary and fiscal resuscitation measures of such astronomical dimensions that, without the context of a financial crisis, a tsunami of inflation would be a certainty.
One victim of these unprecedented circumstances is economic analysis itself. Forecasts and outlooks are, frankly, all over the place, which makes them even less useful than usual. The more extreme the scenario, it seems, the more space it wins in the media and the blogosphere.
Apocalyptic economic prophets are prospering in these untethered times. About the only point economists can agree on is that a return to “normality” is unlikely. What do we mean by normality? For the US it would be growth slightly above 3% and for Europe closer to 2%, with inflation for both regions at between 2 and 3%. Paradoxically, such an improbably rosy scenario – one that most people would welcome – could prove disastrous for many assets that have lately been appreciating. Why?
We often hear that investors are driven by one of two emotions – fear or greed. Today, those who are fearful focus on preserving their wealth by investing in what have traditionally been the safest of assets: gold, the Swiss franc and US Treasuries. Each of these assets has surged this year, making some pundits worry that they could be forming bubbles.
The greedy investors take another route. They pursue yield anywhere they can find it in today’s low-interest-rate environment. And lately they have extended their activities far beyond their normal boundaries, moving briskly into emerging markets and even into “frontier” markets.
This leads to some interesting paradoxes. For example, despite ever-bigger current account deficits, Turkey and Brazil are seeing foreign exchange reserves at their central banks soar, lifting their currencies to new highs against the US dollar and the euro. This phenomenon can be explained by one common factor: the massive inflows of foreign capital into these emerging markets.
We want to make a small observation here: The return to a “normal” macroeconomic environment would weaken the assets of both the wealth-preservers and the yield-seekers. With normalization, investors would return to more traditional assets and the funds now flowing into the crisis-driven investments would dry up.
Investors who do not fully embrace the pessimism currently espoused by many economists should be even more cautious than the fearful investors. We think they should diversify wisely now, to ready themselves for the perils of normality’s possible return.
No comments:
Post a Comment