Blain’s Morning Porridge – June 24 2022: Has Covid Changed the Capital Markets for the Better?
“The best laid plans of mice and men aft gang awry.”
This morning – Post-pandemic markets are challenging! We’re juggling multiple crises from inflation shocks, market wobbles and policy normalisation. Markets today are adjusting to the last 14 years of extraordinary monetary policy which have distorted the basis of markets and economic behaviours. Addressing them will be a long-term market challenge.
Earlier this week I found myself at the Euromoney Global Borrowers Conference in London. I was part of a debate: Post pandemic reflections: has Covid changed capital markets for good? If post-pandemic change means an elevated probability of global conflict, raging inflation on the back of broken supply chains, food and energy shocks, and markets looking set to crash in line with the rising likelihood of global recession… then its difficult to work out what’s Good about this new extraordinarily chaotic post Covid economy.
I loved the topic. It was a fascinating debate. I was delighted the organisers gave us the opportunity to go freeform. There was no well-prepared speech I prepared for the debate, but this is what I broadly remember discussing:
Capital markets deal with the allocation of capital within the economy. When they function effectively, they allocate capital efficiently at the right cost based on risk. When they don’t work – because of crisis, shocks, or deliberate distortions – there will inevitably be consequences.
Clearly, capital markets have changed – but, not perhaps in the way you think.
My long-term thesis is: the chaotic market mayhem we are seeing today is largely due to the last 14 years of extraordinary monetary experimentation. Since the Global Financial Crisis of 2008, and then the Pandemic, we’ve seen Central Banks set artificially low interest rates, distorting the basics of the market economy and relative price of all financial assets, hasty regulation has changed the functioning of markets, while QE has disguised fundamental liquidity gaps.
Extraordinary times have spawned extraordinary consequences – which lie behind much of the market’s moves today. We are living with a cascading series of consequences from the decisions taken since 2008. Not all of them are yet apparent.
The big issue is simple – when central banks and governments start messing with the basis of capital markets and the efficient allocation of capital, things were likely to go awry. They have. Its Adam Smith 101: if you mess with the invisible hand, trouble is inevitable. It has arrived.
That’s not to say monetary authorities did the wrong thing. Extraordinary times required extraordinary measures.
Stepping into the save the global financial system in 2008, and using ultra-low rates to defibribulate the global economy’s heartbeat back into activity was positive – avoiding a devasting deep global depression. Reopening the financial spigots in 2020 to fight the economic sepsis Covid threatened to trigger was equally positive in avoiding economic collapse when businesses were forced to close. (Full marks to government for furlough programmes, also.)
Problem is… once you step in and save the market once, participants expect you to do it again, and again…
One of the first points that emerged in the debate is that roughly 60% of people working today in financial markets have joined post 2008. They have never experienced normal markets. Even fewer “pale, stake and male” old blokes like me who remember 18% mortgage rates and double digit Treasury yields didn’t experience a true deep stagflationary market. The post GFC financial generation are not stupid – far from it – but they lack the experience of “normal” markets, having learnt their trade in distorted post GFC markets.
14 years of absurdly low interest rates has changed economic behaviours. As stocks soared and bond yields crashed – everyone managing money looked a bona-fide genius. They were not. I’ve written many times about how making capital absurdly cheap had multiple consequences. Like triggering wild speculat1ion by mispricing risk, and non-optimal investment strategies – like raising debt to buy-back stock (to push up the stock price, benefiting the stock options of managers) rather than building new plant and machinery to improve productivity to create long term gains.
There is an optimal price for money – the interest rate – at which economic participants are encouraged to invest for growth. If rates are too low they invest in financial assets which produce returns which increase in line with the amounts being invested in them. When rates are too high it discourages investment in financial assets, while inflation can be positive as real assets (like factories) tend to be inflation proof. At some point there is the sweet-spot, the optimal level when the best returns are garnered from building new plant, new jobs and new businesses – without inflation or deflation. That has not been the case for years.
During the post GFC, everything was focused on financial assets, and as they got more and more expensive, people looked for other ways to 1) get rich quick, 2) with the least effort. 14 years of stupidly cheap money spawned crypto, NFTs, SPACs, and crazy beliefs like growing market share was better than profits, and fooling the market corporates have nothing to worry about in terms of leverage. Because money and fees were easy, folk had time for focus on other things, like market repution. Which may explain the new backlash against ESG as markets get tougher.
The monetary authorities have done a great job ensuring the Global Financial Crisis will not happen again. They swiftly, perhaps hastily, introduced new capital regulations that severely impacted the risk-taking appetite of banks. The effect was to shift capital markets risk taking away from the banking sector – which was seen as a great success, because it was the near collapse of banks worldwide in 2008 that near triggered global economic meltdown.
But risk in the economy is like matter – it can’t be undone, only transformed. Now market risk lie with investment managers, meaning pension savers are vulnerable to the next crisis. It’s a truism Generals are always prepared to fight the last war. The next financial crisis will be very different from the GFC, and its likely to involve more social strife over savings. And, because banks no longer make markets, who will now Central Banks have stopped being bond buyers of first and last resort?
Now it’s the wake up and smell the coffee moment. It was the last 14 years that was the extraordinary time. Not today.
Today we are normalising. Central banks are crying crocodile tears about the difficulties between choosing to maintain jobs while raising interest to combat inflation rates, Governments talk about the need for tax hikes and austerity spending to repay debt, while workers – having seen their bosses get richer and richer while their pay packets barely rose on the back of low interest rates – demand higher wages…
Some of us remember the 1970s. It was grey, it rained a lot, the telly was black and white and so were our lives. The good news was they were followed by the 1980s which was a blast of colour, some dross music, and life was an absolute riot – what little I remember of it…
The good times always return.
We just have to get through the 2020s first. We face… issues ranging from the Micro-level decision of workers whether to strike for fair wages and maintaining standards of living as Central Banks chose to let inflation run. They go right up to nations struggling at the Macro level to maintain their Virtuous Sovereign Trinity of a steady currency, a stable bond market, and confidence in its political leadership.
Ouch.. across the leading G7 western nations, there are severe and escalating doubts about the quality of political leadership, and even if it works. US democracy is impossibly polarised, the UK’s beleaguered prime minister thinks he’s a president, the French president has discovered he’s just a prime minister, while Germany is shaping up for battle with Italy over debt. Ouch and double ouch.
In short, it’s the markets of the last 14 years that have led us to this situation. They turned the rules of finance on their head, they have demonstrated the importance of experience and pragmatism, the primacy of knowledge, and the need to be adaptable. We shall manage. We always do… don’t we?
No time for five things this morning, but have a great weekend.
I will racing in the world-famous Round The Island Yacht Race on behalf of Walking With The Wounded. Batfish 5 is my yacht, and we race around The Isle of Wight in Southern England in the company of some 1200 other boats. It should be great fun, the aim is to put a couple of thousand pounds in the pocket of the charity to support wounded members of the UK’s Armed Forces.
Please visit: https://www.justgiving.com/fundraising/Bill-Blain1 if you care to support this deserving charity by making a donation.
Strategist – Shard Capital