Global warning

“No bubbles. Because it’s normal for large liquid asset classes to nearly double in value over less than a year and then drop 10% in a day.”

– Tweet from financial journalist Alen Mattich, 23 May 2013.

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

– Benjamin Graham and David Dodd, ‘Security Analysis’.

“No warning can save people determined to grow suddenly rich.”

– Lord Overstone

At the height of the financial crisis (i.e. 2008) it was easy to despise just the bankers for their serial and colossal ineptitude and rank hypocrisy. Now, five years into one of history’s most alarming bubbles, it’s easy to despise just about everyone in a position of financial or political authority, and for the same reasons. Take the FT front page from last Wednesday: “America’s corporate titans fight back”. With just a cursory look at the layout of the page, one could be forgiven for thinking that “America’s corporate titans” were somehow fighting against a common foe. But on closer reading it transpired that JP Morgan’s Jamie Dimon had merely succeeded in defending his own interests – as chairman and CEO of America’s most iconic bank – versus those of the people who notionally own his company, i.e. JP Morgan’s shareholders. Apple’s CEO, Tim Cook, on the other hand, was defending his company against the predations of some of America’s biggest crooks, a.k.a. the US government. “We pay all the taxes we owe,” said Mr Cook; “every single dollar. We not only comply with the laws but we comply with the spirit of the laws.” In sympathy with Mr Cook, the Republican senator Rand Paul added,

I’m offended by the spectacle of dragging in executives from an American company for doing nothing illegal. If anyone should be on trial here it should be Congress.

There was a similar atmosphere of populist corporate tax avoidance witch-hunt mania here in the UK, as Google’s executive chairman Eric Schmidt suggested that it was not for companies to decide what tax policies should be, but rather for duly elected governments. This prompted the FT’s political columnist Janan Ganesh to tweet, somewhat archly:

Eric Schmidt is sparing the time to teach C-list MPs who have never created or run anything the difference between law and morality. Impressed.

The ‘debate’ over corporate tax is really no such thing. Rather, it is a classic piece of misdirection by cynical governments whose own fiscal affairs are out of control. “As times change,” writes Erwin Grandinger in his devastating critique of Germany’s own stability as a sound sovereign entity, ‘Beyond Repair’, “so do the methods of sanction”:

In today’s Germany nobody has to fear for his life or fear ending up in a.. concentration camp. As is evident, a media-led or tax-based execution is quite sufficient. That is the subtle art of execution. The need to be seen to be acting and the creativity of the state when it comes to tax revenue issues lead to attempts to channel mass perception and to make the scandal personal. [This may be why the UK authorities started their tax avoidance pogrom against high profile entertainers before attacking equally high profile corporations.] The strategy of the system is always to employ a secondary theatre of war as a replacement for the central action in order to avoid the firing line.

Lord Clyde gave the last word on tax avoidance, and it applies equally to corporations as it does to individuals. Indeed, for-profit corporations and the entrepreneurs who build them are the true wealth creators; all government can do is shuffle other people’s wealth around. Said Clyde:

No man [he could have added: or company] in the country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or property as to enable the Inland Revenue to put the largest possible shovel in his stores. The Inland Revenue is not slow, and quite rightly, to take every advantage which is open to it under the Taxing Statutes for the purposes of depleting the taxpayer’s pocket. And the taxpayer is in like manner entitled to be astute to prevent, as far as he honestly can, the depletion of his means by the Inland Revenue.

And it’s not even an equal fight. Which makes the hysterical posturing by politicians that much more absurd. If politicians don’t like the tax regime that they themselves have conjured into being through regulatory fiat, they have it in their power to change the laws they make. That they are too stupid or lazy to understand this basic principle suggests that the quality of our political class, and their respect for the electorate, stands at an all-time low.

But tax itself is just a sideshow. The real black comedy lies in the manipulation of market prices that is now endemic throughout the global financial system. As Japan is now showing, even with the unrestrained commitment of a central bank and its magical powers to create money out of nothing, there are practical limits to market rigging activity. Last week’s price action within the Japanese government bond market and stock market suggests that both of these markets are in the early stages of shaking themselves to pieces. The fallout of unintended (counter-intended?) consequences from massive market manipulation will be awesome.

And this is invariably what happens when government – which in the opinion of this observer shouldn’t be entrusted to play with a ball of string – is allowed to control money. Call it the anti- Midas effect. Everything that government touches, whatever its initial value or worth, ultimately turns to ashes. Investors are now reduced to all sorts of linguistic contortions and analysis in order to try and parse the meaning from Fed chairman Bernanke’s latest pronouncements about quantitative easing, and whether the magic money tree will continue to shower its seemingly effortless largesse over the financial markets of the US. From our perspective, if we cannot understand the dynamics of a market (or if we have scant respect for the pronouncements of the central banker pulling the strings of that market), then we would prefer not to participate in that same market. This is by no means sour grapes. On a cyclically adjusted price / earnings basis, the US equity market trading at around 23 times is expensive even without the imponderable (and impossible to price in) inflationary aspect of QE. There are compelling valuations elsewhere, in markets like Russia (with large cap, single stock p/e’s down at 4 or 5) or more broadly across Asia, where domestic consumer-focused businesses are still available in single digit p/e’s and at price / book levels of one or less.

Brent Johnson of Santiago Capital wrote a while back that the greatest trick central bankers ever pulled was convincing the world they work for the public and not for the banks. Now that asset bubbles are alive and well across stock markets, bond markets and credit markets, it takes a brave – and probably foolish – investor to accept market risk at face value, rather than adopting a
perspective of extreme selectivity and aloofness – unless you’re indifferent to the prospect of permanent loss of capital, and we aren’t. We are content to allow the trend-following managers with whom we invest to ride the momentum of markets, and in both directions, up and down. But for the much larger percentage of client portfolios that are under our own discretionary control, we feel more concerned than we ever have as we watch markets like Japan’s writhing and roiling with extraordinary volatility, as investors, traders and speculators alike tie themselves up in knots trying to assess what the end-game of a money printing bubble means for their own bottom line. Playing a game of chicken with one central bank – or siding with it, for that matter – is bad, and difficult, enough. Playing a game of chicken with all of them seems tantamount, to this asset manager at least, to career suicide. So this is a game we elect not to play. We disregard the conventional indices and benchmarks (someone else’s rules altogether), and we make more nuanced investments across only those assets and asset classes that we think, in a hopelessly distorted world of disparately inflated prices, have genuine value. In other words we play our own game, by our own rules.

This article was previously published at The price of everything.

1 Comment

  • George Thompson says:

    Just a word of warning. When I clicked on the above embedded link to “The price of everything”, my anti-virus program trapped an intruder.

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