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Where to from here? Tips to dodge the noise Spatium Capital June 2022 Over the years, Spatium Capital has written about and been interviewed on many topics - the Russian invasion of Ukraine, the Omicron strain, the Delta strain, lockdowns, the rise of ESG investing, Donald Trump, the yield curve inversion…the list goes on. Whilst the famous saying goes, 'there's only two certainties in life; death & taxes', we would argue there's a third overlooked certainty; perpetual worry in the financial markets. Whilst empirical evidence has highlighted time and time again that markets do rise over the long term, and that short-term dislocations are often (not always, however) the best time to invest or start a business within a given market, the ever-present knot exists within each of us - "what if we are wrong, and everything goes to ruin?" Central Banks have played a considerable role in wrapping economies in 'cotton wool' since the Global Financial Crisis (GFC) and more recently throughout the COVID pandemic - perhaps they've even appeased many knots in stomachs. As we once commented, central bank policy has evolved considerably over the last few decades to develop and implement new monetary policies that are reflective of the shifts in modern society. Evidently, the support for these policies can be seen in the outcomes. The most recent monetary responses have led to, as an economist might say, minimising 'deadweight-loss'. That being, when supply and demand are unbalanced, a deadweight loss is a cost to society. Prime examples of this were the central bank interventions during the GFC which protected many of the world's largest interconnected investment and retail banks (and their balance sheets) from triggering a domino effect of collapses and subsequent job losses. The recent COVID-19 era also saw both fiscal and monetary policy pump trillions of dollars into the system with the view to protect businesses and people's livelihoods from collapsing under the financial strain of being forced to stay home. Arguably, both of these central bank responses minimised the amount of deadweight loss in the system, despite 'true' capitalists asserting that by intervening in the natural flow of capitalism, central banks had only deferred these problems to a yet-unlived future. A problem which we appear to now be living through.
S&P 500 annual returns since 2000 - an annual return of 7.1% over the 21 years. Is it then fair to criticise central bankers for fuelling the current monetary environment, given that when they were tasked with deciding how to respond to COVID-19 (which at the time was an unknown-unknown) their most recent precedent was the GFC? Despite the material differences between both the GFC and COVID-19, both had the potential to collapse the financial system on which we all so heavily rely. So, perhaps the response was warranted. However, the current discourse seems to be arguing that central bankers have allowed 'loose' monetary policy to continue long past its due date, thus leaving society with the threat of persistent inflation, continual demand exceeding supply, and interest rate rise that may cripple those who overexposed themselves to a cheap-debt market. With the above being said, defending or recusing central bankers is not our focus nor within the bounds of where we believe we add value. Rather, we have found that as the months have become years, the one guarantee we are almost prepared to give is that when new "unknown unknowns" enter the macro news cycle, you can almost always expect an overreaction. At its inception, the unknown-unknown nature of the pandemic was so unpredictable that it was unlikely to be solved using logic or predictive algorithms. If we consider a less destructive situation, logic or predictive algorithms have a great deal of difficulty trying to predict how many meals a restaurant may serve on any given night, or what time patrons will arrive. This is because the number of variables and potential decision-tree options associated with this task is so diverse that it is almost impossible to be correct. Bringing this logic back to finance, consider how an algorithm might forecast retail, wholesale, and institutional investors' response to a black swan event such as the pandemic. If we thought dinner choices had a lot of variables, investor decision-making might just break the algorithm. Taking it a step further, now introduce the most recent geopolitical challenge, and add an Australian federal election. Central bankers may be forgiven for leaning towards the accommodative stance taken. The beauty about unknown-unknowns is that they personify disruption and despite best efforts or claims made by 'experts', none will see them coming. So, if the third certainty in life is that there will always be a perpetual worry in the financial markets, (you just need to pick the topic you want to read/worry about - as we've shown with our take on Central Banks) we have learned and encourage our readers to consider some general principles to reduce said worry:
Author: Nicholas Quinn |
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