Where she stops nobody knows

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

We have seen a confluence of events that suggests we may be reaching the terminal point of the financial markets merry-go-round – that point just before the ride stops suddenly and unexpectedly and the passengers are thrown from their seats. Having waited with increasing concern to see what might transpire from the gridlocked US political system, the market was rewarded with a few more months’ grace before the next agonising debate about raising the US debt ceiling. There was widespread relief, if not outright jubilation. Stock markets rose, in some cases to all-time highs. But let there be no misunderstanding on this point: the US administration is hopelessly bankrupt. (As are those of the UK, most of western Europe, and Japan.)

The market preferred to sit tight on the ride, for the time being. Three professors were awarded what was widely misreported as ‘the Nobel prize in economics’ for mutually contradictory research. What they actually received was the ‘Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel’, which is not quite the same thing. But then economics is not a science, and Eugene Fama’s ‘efficient market hypothesis’ is not just empirically wrong, but dangerously so. History, it would seem, is clearing the decks. Perhaps the most intriguing development of the week was the news that Neil Woodford would soon be retiring from his role managing £33 billion of other people’s money at Invesco Perpetual to start up his own business. It was widely reported that Mr. Woodford nursed growing frustration at the short-termism of the financial services industry. We will return to this theme.

One of the sadder stories in the history of investment management is that of Mr. Tony Dye. The following extract is taken from his obituary in The Independent:

Tony Dye was one of Britain’s best known fund managers, becoming a household name in the late 1990s due to his controversial opinions about the outlook for global stock markets. At a time when markets were soaring, Dye insisted they were overvalued and on the verge of a crash – a view which put him at odds with most other investors at the time and earned him the nickname “Dr Doom”.

As early as 1995, as the FTSE 100 was approaching 4,000 points, Dye began to make the case that markets were too expensive. At the time, he was the chief investment officer for Phillips & Drew, one of Britain’s biggest asset management firms, and by 1996 he had begun to move large sums of clients’ money out of equities and into cash.

In the years that followed, however, stock markets continued to soar, driven by the technology boom. But Dye stuck to his guns, avoiding the high-growth, high-risk internet stocks, maintaining large positions in cash, and consequently ensuring that Phillips & Drew’s funds significantly underperformed their rivals. By 1999, the firm was ranked 66th out of 67 for performance amongst Britain’s institutional fund managers, and was haemorrhaging clients – and in February the following year, just weeks after the FTSE had broken through 7,000 points for the first time, Dye was sacked.

Days later, his prophesy finally came true. Markets collapsed, and settled into a three year slump, which saw more than 50 per cent wiped off the value of global stock markets.

Neil Woodford’s apparent concerns are well placed. There is a grotesque mismatch between the set-up of institutional asset managers and what is in the best interests of their end clients, the individual members of the public who pay their fees. The investment fund marketplace is grotesquely oversupplied. There is far too much, to use the dismal phrase, product. The problem is exacerbated by perhaps inevitable weaknesses in psychology – both on the part of the manager, and on the part of the investor. Stress points abound throughout the chain. The investment fund world is hopelessly balkanised, and brimming over with a degree of product specialisation utterly unwarranted by investors’ real needs. The fund management industry is a perpetual production line of novelty, or rather an endless rehash of the same old ideas. The point of absurdity was reached and surpassed when there were more mutual funds listed on the New York Stock Exchange than there were common stocks with which to populate them. The industry is a monstrous hydra, busily consuming its own, and its investors’, capital. New funds are launched daily. Failing older funds are quietly tidied away, merged, or destroyed. They are ‘uninvented’.

Alison Smith and Stephen Foley covered the news of Neil Woodford’s resignation for the Financial Times. They cited the FT’s own John Kay, who carried out a review of UK equity markets last year, and who said,

The short-term horizon is basically introduced by the intermediary sector.. Pension trustees [for example] are told they should keep reviewing managers, while retail investors get constant invitations to trade from independent financial advisers [for example] and the platforms set up to enable them to do so.

As they suggest, Neil Woodford’s past success means that raising money for his new business is unlikely to be much of a struggle. “But imagine the hurdles in the way of a manager who would like to purse long-term strategies but is just starting out.” In the words of Professor Kay,

How easy would Warren Buffett find it to set up now?

We have not been immune to the demands of clients frustrated at the performance of diversified portfolios lagging the broader equity markets (although this explicit benchmarking against stocks was never a mandate to which we subscribed). We struggle, in some cases, to make sufficiently clear our concerns about broader market valuation, or just as importantly the gravity of the global financial situation (including a potential QE-driven currency crisis), which makes a wholehearted commitment to the stock market in late 2013 seem to us a risky strategy. So where, if anywhere, does the fault lie? Sometimes it is not just asset managers who should be accused of being short-termist, or of missing the big picture.

Our thesis has been consistent for five years now. We believe we are at the tail end of a 40-years’ and counting experiment in money and the constant expansion of credit. This experiment is not ending well. Because government money, unbacked and unchecked as it now is by anything of tangible value, can be created at will, it has been. What is extraordinary is that despite trillions of dollars / pounds / yen of stimulus, there are few visible signs of what we would call inflation, in anything other than the prices of financial assets themselves.

We are living through a historic period of global currency debasement. The neo-Keynesian money-printers who dominate the world’s central banks have ‘won’ the debate, but are now scratching their heads, looking in vain for the economic recovery that they were expecting all those trillions to have bought. They will continue to look in vain, because money creation and true wealth creation are polar opposites. As portfolio manager Tony Deden has asked,

If cheaper currency is the source of wealth, where has Bangladesh gone wrong? If cheaper money means economic prosperity, why not just print as much as we can and give it out to everyone? We have become fools. The customers know nothing and the advisers know even less. And then we have the idiot economists – the neo-classical Keynesian variety with solutions to problems they did not even anticipate; solutions that have, in fact, been long discredited. And so we lurch from crisis to crisis, eating our meagre capital in the hopes of becoming rich in money. It is a pity.

Those words were written four years ago. The printing presses have been run to exhaustion ever since. So far they have bought us an inflationary rally in the prices of financial assets, and not much else. It has been a lousy time for anyone focused on the disciplined and genuinely diversified pursuit of capital preservation in real terms (more recently, for anyone seeking to escape the inflationary insanity via the honest money that is gold). We have not, to any significant extent, participated in the ‘phony rally’. But then we are playing a longer game than most of our peers. Round and round and round she goes; where she stops, nobody knows. Fund manager Sebastian Lyon recently quoted another celebrated fund manager, Jean-Marie Eveillard:

I would rather lose half of my shareholders than half of my shareholders’ money.

This article was previously published at The price of everything.

5 Comments

  • chuck martel says:

    So the rise in markets isn’t due to the recognition of increasing corporate value by individual investors but is instead caused by churning on the part of funds that must purchase equities in order to be “doing something”.

  • Paul Marks says:

    They are not “neo Keynesian” – they are ULTRA Keynesian.

    The monetary and fiscal polices now being followed in most of the Western world (for example in the United Kingdom) are more extreme than most of the “General Theory…..” of 1936.

  • stuart says:

    I would like ‘Keynes’ to not be constantly misrepresented, he was a very successful investor and his policy to expand the monetary supply was to use government funds from a good period to smooth out the bad period then to contract the excess when things stabilised. This is apparently a discipline beyond the government politicians to exercise.

  • MrVeryAngry says:

    Tim, you and me both (I am one of those maligned ‘financial advisers’ – and like you struggling to explain this to people).

    But you are wrong about platforms being set up to enable us to trade [investments]. Platforms if used properly are an administrative godsend to the IFA sector – at least to those who are vaguely economically literate.

  • Paul Marks says:

    stuart – read (if you have not already done so) Henry Hazlitt’s “The Failure of the New Economics” and the book of essays (by various writers) he edited “The Critics of Keynes”. If you insist on reading only modern works – then read “Where Keynes Went Wrong” by Hunter Lewis.

    In 1936 (when the “General Theory….” was published) there was no “deflation” in Britain (or in the United States) – even if by “deflation” you are talking about a failing bank CREDIT BUBBLE (rather than an actual reduction in the real money supply – by people going round destroying currency for some reason). So your “smoothing out” (whatever) does not fit the facts on the ground in Britain in 1936 – an expansion in the money supply in 1936 would have been monetary inflation (period).

    The early 1930s (not 1936) did indeed see a collapse in a banking credit bubble – but the correct policy would have been for the Central Banks (such as Benjamin Strong of the New York Fed) not to encourage the credit expansion of the late 1920s in the first place. Not for people in 1929 to try and save the Credit Bubble – after all the Credit Bubble collapse of 1921 had NOT led to a Great Depression because WAGES AND PRICES were allowed to adjust to the credit bubble collapse of 1921 – thus meaning the economy started to recover after a severe six month contraction.

    Herbert “The Forgotten Progressive” Hoover did everything he could to PREVENT wages and prices adjusting to the collapse of the Credit Bubble in 1929 – thus turning the crash into the Great Depression (President Hoover was in the grip of the “demand fallacy” – oddly similar to Keynes himself).

    Keynes was not a good economist (to put the matter mildly). And as for him being a “good investor” (a radically different thing from a good economist) it would have been hard for him to be anything else – given all the inside information he was given by his friends in government over the years.

    To give a modern example. Was Warren Buffett a “good investor” for investing in Goldman Sachs when any rational examination pointed to Goldman hitting hard times (due to the collapse of AIG – of which it was a major creditor)?

    No Mr B. was not some genius investor – he had just been privately told that the government was going to bailout AIG (and thus save Goldman Sachs). This is one of the many occasions where the political contacts of Mr B. have been helpful to him.

    The case of Lord Keynes is rather similar.

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