Risk of Addiction to O.P.M.-Other People’s Money

This article was last updated on May 19, 2022

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As cyclical indicators worldwide indicate bottoming out and amidst crucial meetings from Jackson Hole for central banks last week to later this week the London G-20 finance ministers’ meeting, we believe markets should be wary of large deficits raising risks of near term lumpy activity and a longer term addiction to O.P.M.-Other People’s Money as stimulus to activity. With our expectation of earnings bottoming out currently but more normality returning only from 2011 to the earnings cycle, the market discrepancy between stronger growth Asia and cyclical expectation Europe/North America needs to be ironed out. We expect it to be in some consolidation/correction now. Longer term, quality of execution and bifurcation could be crucial especially if less than perfect execution were the realistic result of central bank policy change.
 
Back at September 18, 2008, our weekly note was titled September to Remember, to underscore then that “… the current credit crisis is no exception that during economic duress, the pressures on financials include failures or mergers. Rapidity of response seems of the essence… ”. Now at the cusp of a late 2009 business and earnings recovery cycle, we believe the credit crisis is still unfolding in myriad ways. The duration and amplitude of revenue recovery for countries and for companies is likely to be a key, well beyond current cost cutting and government largesse. September is the traditional, albeit volatile, start of a new investment season. Much has been made about the availability of large pools of cash (for instance, $ 3 trillion in cash and near cash in U.S. mutual funds). Instead, we stress that of three potential recovery outcomes, active cash management becomes unattractive under only rapid resumption of easy credit financed global growth. Such yearning is understandable as the prior cycle was of rapid, easy credit financed growth and since March, performance tilted to low quality, cyclically driven capital market activity. However, an era of large deficits, central bank largesse and massive government subsidies could result (despite good intentions in crisis) in two other potential outcomes, namely of rising inflation as built up in the 1970s or of prolonged deflation due to liquidity traps as reared up in Japan of the 1990s. Either fat tail outcome would support for investors (and corporations), active risk management using cash (12% of our benchmark) as well as gold as the preferred alternate asset ( 2%) over more economy sensitive areas like oil and industrial commodities. Unlike reductions in the last cycle, now in an era of large deficits in all major investible currency zones, we expect central banks to add to gold reserves.

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