The ghost of John Maynard Keynes and
Some comments on the present market and economic conditions
William R. Thomson
Oct 23, 2008
1) What is your view of how long the financial system crisis will continue and how much deeper it will it get?
One can only hazard a guess by looking at other experiences with banking crises. Japan took about 5 years from the time it started to recapitalize its banks. Sweden and Thailand took a little less time but none were V shaped recoveries. There is a far greater urgency to efforts now in the US and Europe after a year of dithering and denial but these are still early days and the scale being global is larger and we have the unprecedented scale of the derivative problem. It could still spiral out of control requiring the whole banking sector to be taken into public ownership, but more likely we will have an extended period of recession and subnormal growth covering much of the Obama presidency - assuming he wins. He will inherit the most poisoned chalice but with a substantial, probably enhanced majority in Congress, will have an opportunity to do well or, more likely, to screw up. In the face of these uncertainties, the markets could be even more volatile since change causes both many winners and many losers.
2) How deeply do you expect the crisis to effect into the "real" economy and how long the overall downturn (slump/crash/Depression) will last?
In my opinion we could well be at one of those transition points in economic history. The past 30 years of market liberation and deregulation are going to be challenged and called into question in a way unimaginable 2 or 3 years ago. It is quite possible that Obama will be presented with problems akin in magnitude to those facing Roosevelt in 1933, forcing a major rethink in the way the economy is managed. Old industries, such as automobiles, are on their last legs and looking for government handouts. Millions are facing foreclosure of their homes and the middle classes are in retreat. The healthcare and pensions crises require addressing and come at the worst possible time when the financial sector is in meltdown. The situation in Afghanistan and Pakistan is worsening by the day. The whole concept of globalisation, on which prosperity has been based, could face substantial challenges if the US economy, in particular, deteriorates significantly. A Democratic lock on Congress and the White House could even see the rebirth of the trade unions.
3) Has the crash in stock and other financial markets created buying opportunities in general yet, or is the "heat of battle" still so intense as to obscure any coherent strategy? If it is still too dangerous to move back into markets, what signs and signals should investors look for to tell them when it is time to move?
The crash has been precipitated in no small measure by indiscriminate hedge fund liquidation of good assets as their loans are called by their banks and prime brokers. This means that many good assets now have real value even if the markets have not reached their ultimate bear market lows. A sure sign of value is companies with unimpeachable dividend records yielding 50 to 100 percent more than 10 year Treasury bonds. Look at BP and Royal Dutch Shell, for instance. These sorts of opportunities do not arise every day.
Studies show that a significant part of the long term returns from stocks are from dividends. Well covered dividends that can grow are a vital protection against long term inflation that could well be the results of the explosion of liquidity the central banks are pouring into the markets once fear dissipates and animal spirits resume more normal service.
4) If there are buying opportunities, where and what are they. - E.g. in equity, bond or other markets? Advanced versus emerging markets?
Outside the government bond markets prices in most asset classes are very much more attractive than they have been except for the bottom of the markets in 2003 and 1974. That's not to say we have seen the ultimate lows. I do not believe we have, but I can foresee a decent recovery rally after the extreme drop into the early days of the Obama presidency - as I expect it to be. That could easily run out of steam as the magnitude of the challenges and the size of the mountain to climb become apparent again. But where there is great value it is a time to buy as Warren Buffett has shown. It's not a crime to lock in a profit later.
Emerging markets have been savaged, especially the BRIC favourites. China alone is off 65 percent from its peak and valuations are accordingly more reasonable. China's growth will slow in 2009 but is likely to exceed 7 percent whilst OECD members show zero economic growth. Value is obviously there.
At the same time, those emerging markets, especially in Eastern Europe, such as the Baltics, Hungary and the Ukraine, that ran large current account deficits are in very real trouble and will be seeking assistance from the IMF. They have been decimated but do not have the resiliency of Asia.
I have previously suggested that emerging markets in general be invested in through hedge funds or ETFs, which can be long or short. That advice remains valid although a more selective long bias is more justified now. There are special situations galore right now. It is even possible to get double digit dividend returns in selected blue chip companies in emerging markets. As Ronald Reagan said: if not now, when?
5) What is the outlook for gold and other precious metals?
It can hardly come as a surprise that given the macroeconomic background I believe a position in gold absolutely must be retained, in fact, enhanced if at all possible. The sell off since August reflects the giant margin call that hedge funds have faced as banks are trying to reduce their loan books. There is a huge disconnect between the paper market in precious metals as represented by futures and the physical market as represented by coins and bullion. The latter has been on fire and physical is selling at a premium to the paper form.
The US Government is up to its usual games making gold ownership more expensive by suspending the production of gold coins whilst, at the same time, debasing the dollar like never before. It is not beyond the realms of possibility that they will try and make ownership of gold by Americans illegal again in any future crisis. Would you rather own gold or the paper of a hugely indebted government whose budget deficit next year as a percent of GDP could get close to double digits?
Silver and platinum are even more depressed but both metals have some industrial uses which are less in demand under present circumstances. But they are cheap on both a relative and an absolute basis.
6) Are there any other points that are not addressed in the above questions?
Commodities, in general, have been hammered and in some cases, such as oil, are at a level close to the cost of finding and bringing new production on stream. They also have much better value than earlier this year as many of the leveraged speculators have been forced out.
Property in those countries that experienced the biggest booms: the US, UK, Ireland and Spain still has a way to go to reach the bottom. That may not happen till 2010 or even later. Whilst that situation endures the consumer will be under pressure to rebuild his balance sheet. The pressure will have to be taken up by government investment in areas such as infrastructure and alternative energy as well as domestic demand in Asia, whose currencies should strengthen against their Western competitors.
Much as we may regret it, the era of big Government is back. As a life long supporter of Adam Smith I fear the ghost of Lord Keynes hovering over us and Milton Friedman, who I was a fan of long before he became popular and died last year, must be weeping in his grave. The so-called followers of Smith and Friedman corrupted their thoughts and allowed unfettered greed to take over and alas we will all pay the price for a generation.
Oct 19, 2008
William R. Thomson
email: wrthomson@btconnect.com
William Thomson is Chairman of Private Capital Ltd. in Hong Kong and an adviser to Axiom Funds and Finavestment Ltd. in London.
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