08.09.17

Snapshots is watching live updates of Hurricane Irma and hoping for the best outcome for people and their livelihoods in her ferocious path

Written records show hurricane impacts in the Caribbean going back to 1600s.   They are unfortunately a part of human history.  They used to savage trading ships, fishing vessels, homes, plantations and cause many deaths.  The good news is that people and economies always bounced back.  Current damage assessments show the economic impact of Irma for the reinsurance industry and GDP to be manageable.

Main Street versus Wall Street

We have been attending a number of economic outlooks recently.  Economists point out that global growth is at a 6 year high and earnings momentum is strong after the earnings recession of 2015/16.  Everything points to a very healthy economic expansion on Main Street, which we do not dispute.  It is the simple extrapolation of this trend to asset prices which are already at historically expensive levels that we question. It reminds us of a quote by Laurence J Peter (who also coined the infamous Peter Principle):

“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today”.

We continue to think that pricing in parts of the liquid credit markets does not compensate investors for the risk they are taking.  Deutsche Bank’s CEO, John Cryan, was the latest to warn this week that he is seeing “growing signs of bubbles in areas of capital markets”.

The Gig economy and R*

There has been a broad-based government bond rally with many developed market bond yields hitting lows for the year.  This is in sharp contrast to the economic data highlighted above.  The Phillips curve suggests wage inflation should be picking up in economies reaching full employment but we are instead seeing signs of disinflation.  Could the nature of jobs in the new gig economy explain some of this?  Perhaps it changes the point at which inflation kicks in on the Phillips curve?  We are of course cognisant that debt and demographics have moved R* (the equilibrium rate of interest) in the developed world to lower levels.

October Blues

Summer is over and as the season is changing so is central bank policy on quantitative easing.  After 9 years of QE the Fed is starting to shrink its balances sheet.  The pace will be gradual and we do not think it will impact Main Street.  It is Wall Street that we are worried about.  Government bond buying has caused some indiscriminate private sector buying of risky assets on a replacement basis.  This has happened at the same time that we have had a structural shift from active investing to passive investing.  We think that QE withdrawal will shine a light on the misallocations of capital that have been made over this credit cycle as a result of these two factors and are adopting a cautious stance to liquid assets we think may be impacted.

By Asif Godall
Deputy CIO