Musings on Markets and Mayhem


So here we are, either standing at the brink of a precipice or at the first step of a rising market. Which one is it?

For most of the working and investing lifetimes of those alive today the answer would have been relatively easy. “We are at a particular cycle in a long-term rising market”. Is it possible that we are at a paradigm moment – some chaotic watershed moment from which all that we have known may never recover?

The problem for investors today is that there are many very talented people offering some fairly divergent views on the future of all things financial. Although it is simplistic to suggest that the mass of commentators and participants in the global markets could be distilled into only two camps of thought, i intend to do just that. These camps are:

  1. Things are bad but they will get better, and
  2. Things are bad but they are going to get worse.

Of course, it is never set out that clearly. The discussion is confused by big words, strange economic concepts and further distorted by the authority which we give to the person making the utterances.

However, my thoughts are that it really IS that clear. If we stand back and look at the society in which we live in (and from my desk that is a rather parochial view over the business district of West Perth in Western Australia) then we can see that there are a number of basic needs that must be fulfilled for the society to retain any semblance of its current persona. That is, we are going to assume that our cities and towns will have systems in place for infrastructure and that this infrastructure will be maintained in good order. We can further assume that the size of the major population centres will continue to grow (consider the Australian Bureau of Statistics “Population Clock” which suggests the national population grows by 1 new person every 90 seconds). There are roads that needs maintaining, electricity and water services, and a massive store of homes / offices / warehouses that will need to be looked after and improved. All of these things will require big bags of that currency of exchange that we call “money”. A lot of assets in Australia are partially or fully owned by overseas investors, and a lot of the things that Australia has to offer are bought by overseas customers.

In other words, our society is based on a fully functioning international monetary system and a steadily growing population base.

The Doomsday merchants that i have encountered in my voracious reading of all things financial, suggest that the fabric on which this society operates has not only frayed – it has been torn asunder, and it is only blindness or ignorance that stops people like me from seeing it that way.  As just one example, the International Monetary Fund (IMF) has been keeping all and sundry up-to-date with the calamitous state of affairs for the global financial system. It’s January 2009 “Global Financial Stability Report Market Update” sets out a number of the systemic risks threatening us all. Professor Nouriel Roubini has earned himself 284,000 Google links by carefully pouring boiling water on any attempts of a positive outlook for the world of money. I am probably being overly harsh there but if you have spare time, the professor’s blog is well worth a read.

Which is all well and good – but where do you go from there? Have you ever really sat down with a glass of your favourite bevvy and pondered that one?

Everyone has an angle. i probably have one too – it’s just that i am too arrogant and ignorant to be able to elucidate it to you. When i read all of this gloom and doom, a great deal of it is on the basis of trying to make money out of it – or to manage some amazing high-wire act of capital preservation through all of the turmoil.

Now you might say that this is no more than doing exactly what a logical person should do. i’d say “maybe”.

The assumption that you are going to be able to manipulate your capital and your finances in some way that allows you to no only avoid the biggest financial mess of our lifetimes but to profit from it – is fundamentally flawed. This is, in fact, the key issue that investors need to assess their approach to. If you believe that all of these things can be done in some incredibly effective way, and if you believe that it is possible to determine the “best” set of data to interpret and make future decisions on – then you would logically pursue the most profitable way to navigate through the current turmoil.

However, this is where regular readers of Michael’s Musings can step back and have a big breath of air. They would be aware of the very long term concepts that underlay the observations in the Musings. Here are a few of those repeated:

  1. The basic strength of your financial position is your ability to earn income. If you are working for a living then your investment decisions are unlikely to be as important as your income-earning career decisions.
  2. The only secure investment is very short term cash – and even then, only cash held in rather standard bank accounts (this has been tested with the ongoing failing of banks in the United States and elsewhere but most Governments have come to the rescue and have offered various levels of guarantees to back those basic accounts).
  3. The moment you leave the security of cash you must accept that you lose control of your capital. This is a toughie, as all of the very clever research, knowledge and output of ranks of very clever people and institutions is based on the idea that they can help you to control your capital. To state my bias – i totally disagree that this is possible to do. The more you try, the greater the layers of sophistication and wizardry required, which leads to greater levels of unknown and unmeasurable risk.
  4. The best research, knowledge and experience will not be able to identify where markets are at from a timing point of view. If anyone does, your or my ability to identify that person/group is highly questionable. Further, if we could identify them, our ability to stick with their particular approach in the face of contrary evidence is doubtful.
  5. Diversification for diversification’s sake is simply adding a layer of complexity to your approach to money. Be wary of spreading things so wide that you don’t have a good grip on what you have, or how the individual components react with each other.
  6. Most financial measures eventually return to an average (although the “black swan” author Nassim Nicholas Taleb would shudder at my lack of academic scope with that comment!).

What generally holds true is that the long term growth of an economy is reflected in the long term returns of its markets. If you hold exposure to those markets over a number of business cycles then you have some hope of extracting the “risk premium” that should apply to capital that is put at risk.

Why is this the case?

Because debt (an interest return on your money) is based on the idea that someone is going to take that money and go off to make more money with it – hopefully enough to be able to pay you the interest rate asked for, give you back your money and make a profit on top of all of this. If this cannot be done then no-one is going to borrow money from the holders of capital which means no interest will be earned on cash, which means there is no point holding it (other than as a currency of exchange).

It sounds ridiculous but it isn’t really. The situation under which this would occur is so drastically different to the society i am looking out the window at, that if your perspective allows for that as an eventuality then you need to buy a farm, a gun and subscribe to a few of the conspiracy theory websites out there.

If we can see that our society is going to be an ongoing concern then it stands to reason that the bulk of the institutional edifices on which it is built will continue to operate. If that occurs then we can look upon all of the latest ructions in global economics as a period of adjustment. Harsh in some places but nevertheless it is just a period of adjustment. Unrealistic expectations will be reeled in and long term rates of return will move to achievable figures.

Again, this is a parochial view. If you were sitting in an Icelandic cafe, pondering your finances right now then the chances are that you would consider my comments particularly arrogant and ill thought out. In fact, i could argue that case for you – but the facts are that bubbles eventually get popped. Even here in Australia we have had a property bubble not too dissimilar to that of the UK, US and others. However, there are dynamics in the local world that have kept the falls in residential property values quite muted. We can cover that issue in more detail another time but the key point is that even the person in Iceland will be able to get up from the coffee-shop chair and set their financial world in order eventually. It may entail selling long-cherished assets at reduced prices. It may involve moving into bankruptcy but it is not the end of the world. Even a bankrupt person can start again, and with hard work and lots of thought they could build themselves a good life again. 

So i will again say that this is a period of adjustment. If the capitalist system survives the mayhem then the relative values of cash and income generating assets will move back to something like their long term record. We can argue about those long term figures some other time but for the moment i am just putting my opinion out there – ie, i don’t see this as the end of the financial world.


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