Submitted by Paul Brodsky of Macro Allocation Inc.
Get Angry
Wall Street looks a lot like Lake Wobegone, where the women are strong, the men good looking, and all children are above average. We have always been happy warriors, but it is difficult not to resent the passive nature of investing foisted upon the markets by economic policies that backstop and boost asset prices beyond reason, which in turn diminishes the value of investment intelligence and experience. Passivity implies the markets will always produce positive real returns and real economic growth over all time horizons. It is an illogical and preposterous notion, and yet it is the zeitgeist – all above average.
Fertility rates among wealthy and educated cohorts in advanced economies – from which the investor class is comprised – have already begun to decline, as has the demand for manufacturing output among the working class in most advanced economies. Not a good situation. This reality begs fundamental questions: “are increasingly digital, indebted societies being served well by analog economies” (no) and “why is growth the unquestioned objective of policy makers and political economists” (because growth is necessary to sustain nominal asset and liability prices, which in turn is necessary to avoid credit deflation, goods and service price deflation, and bank and portfolio insolvency)?
The counterfactual to this practical yet insidious economic framework would be an economy that actually economizes, that works naturally to drive prices lower and the purchasing power value of savings higher. Since savings are ostensibly obtained through production, the incentive of workers would be to produce at a competitive global wage scale. Economic right sizing would not be feared and economies would shrink to profitability. Deflation would not be feared either; in fact it would be welcomed. Workers would actually benefit from increasing productivity, innovation and automation. They would be more productive, have more stable income and more leisure time, and be able to save for the future at a positive risk-free real rate of return. Alternatively, rentiers would not be able to reduce the value of production and increase the value of assets by issuing unreserved credit. Alas, such an economy no longer exists.
Our idealism is not entirely bitter or impractical because the counterfactual is supported by math, history and, now, current trends. Baby boomers across developed economies have begun to downsize and spend less. No amount of real growth ever sustained in the past can lift them out of debt or transfer it smoothly.
Something has to give. Central banks and governments have had to fill the void to generate growth that helps reconcile nominal asset and liability prices. While they have unlimited balance sheets with which to synthesize nominal output growth and assume others’ liabilities in perpetuity, the process of transferring the burden of growth from the factors of production to non-productive financial statements creates very wide wealth and income gaps and social unrest. Such theory closely resembles current reality.
We are angered by the elite conceit still on offer from parties benefitting from this unsustainable state of affairs and the collective passivity of public intellectuals and investors unwilling to think for themselves, identify obvious problems, and take action. Their benign neglect or, worse, near unanimous intention to exacerbate the problem through fiscal profligacy, actually evokes excitement among economists and investors. Lost in the frenzy is recognition of a dangerous financial and social setup. The preponderance of “free market” investors and allocators are betting their performance, compensation, careers and sense of self-worth on the hope that Trump Keynesianism and reforms will get them one or two more bonuses, and, failing that, that central banks will monetize financial assets at full value in real terms.
This discussion should offend blithe extrapolators posing as fiduciaries, those that leverage popular opinion without considering the potential devastation from necessary structural change. Institutionalized trend-following investors, proud of themselves for abandoning original thought and reducing the costs they pay to have their assets managed to nine basis points, are being penny wise and oh so pound foolish.
Warren Buffet’s recent attack on high fees is well-founded, but his always stay long mantra is not. Of course high fees detract from returns, and of course investors not always balls-to-the-wall long will reliably under-perform a market that only rises. Given the current setup, however, US real growth and equity values can only be perpetually strong relative to other markets; not real wealth creating on their own.
Corporate equity and property markets are confidence games that rely on promotion and debt assumption. They need a willing conspirator in the form of financial media. Bull markets and ad rates have historically been correlated, and so we should always expect financial media to promote hope in the face of a market trading 22-times earnings, 3-times book and 13-times cash flow.
A dignified spokesperson will reliably extrapolate five cases where investors would have been foolish to worry, and so thoughtful active managers are in the process of being disintermediated by passive vehicles. New heights of consensus-ness have made idiots of thoughtful analysts, investors and allocators. The meaning of “fiduciary care” has shifted from understanding the future needs and risk tolerances of one’s charges to the process of locking in negative real returns while retaining plausible deniability through compliance with regulatory best-practices.
Being content and un-prepared is unconscionable, dear fiduciary. Markets are always risky and they are getting riskier. They are not to be trusted as homes for risk-free saving. Investors at all levels are being deceived on an epic scale and most of the investor class will suffer. It never pays to bet against nature for too long, which presents a wonderful opportunity for free thinkers. The efficient investor today that methodically sets market traps to capture foolish bulls (and bears) will be the dignified investor tomorrow.
Recommendation: Uncross your fingers. Turn off the TV and find your calculator. Remind yourself why you initially got into the investment business. Change your investment objective to “seek positive real returns regardless of economic conditions”. Show your spouse why she fell in love with you. Show your kids – actually demonstrate to them – what it takes to be an adult. Be human. Think. Get angry.