Bank to the future

This is the penultimate column I shall be writing in 2013 and in holding with tradition, this is the one in which I reflect on the past year. I thought a good place to start would be by reading what I wrote in the last one last year which is, equally traditionally, the one in which I try to crystallise my forecast for the coming year.

Had I opted to be lazy, I could have reprinted the entire piece as it firstly makes fun reading and secondly is still largely valid a year on. In the introduction, I referred to a meeting I had had on the street in Zurich with a chum from Citigroup and of which I noted: “We exchanged the usual seasonal niceties, marvelled at how this year has been so much better than all of us had feared and then laughed at the equally seasonal: “Next year is going to be really tough….” I’m not sure it’s going to be such a joke.”

From a market perspective, this year has been much easier than it had looked it was going to be. The central banks have not yet begun to either withdraw stimulus or to tighten (not the same thing) although by this time tomorrow and after the FOMC meeting this statement might already no longer be true. Inevitably, financial assets have well supported and the lack of underlying yield has disproportionately benefited risk assets.

Onerous regulations

However, the regulatory environment is becoming significantly more onerous, the cost of doing business is increasing and the rewards for both shareholders and employees are looking progressively less compelling.

I went on to write “So, 2013 might be the year when the role of central banks and, more importantly, their recent trend towards total transparency might begin to shift. Perhaps being predictable isn’t all it’s cracked up to be – I remind that the Bundesbank of old had a cult of secrecy to its thinking – and markets might be a healthier place if they didn’t know quite what to expect next.

“Oh!”, I can hear the cry of horror… “How is industry supposed to invest if it doesn’t know what the monetary authorities are thinking…?”

Well, I don’t recall the rise of Germany having been hindered by that or was it? …..Proper growth is created by entrepreneurs and their employees producing goods and services better or cheaper (or both) than the competition, not by 10 or 12 people on a rate setting panel and certainly not by 26 prime ministers, presidents and one chancellor.”

In this context, that great invention of the recent years, forward guidance, looks to me to be a cooked goose. Much has been made of it, especially by the new Governor of the Bank of England, Mark “the Magician” Carney, but the speed at which the economy is recovering in this country, whether healthily or not is a moot point, might yet cause him to trip up over his assertions on future rate policy.

He will no doubt be wondering, to dig out one of my own old chestnuts, whether the patient is breathing easily because of or despite being linked to the life support system of near zero rates. Surely he will wish to leave it to Fed Chairwoman elect, Janet Yellen, to test those waters.

The withdrawal of stimulus should, in my humble opinion, have begun a long time ago but the FOMC didn’t seem to feel the need to canvass my views and I’ll happily let bygones be bygones.

Credit addicts

What the postponement does show is the uncertainty as to what the real underlying state of the economy is and whether even the tiniest reduction in the oxygen flow will suffocate the recipient. I don’t think it does but one of the lessons of the economic crisis is that both the production and consumption side of the equation are packed full of credit addicts which cannot stand on their own two feet without monetary and/or fiscal support. Whether this is good or bad is not up for debate – it is the way it is and we simply have to live with it.

2013 has seen some aggressive deleveraging by banks as reg cap rules tighten and structured reg cap trades become more difficult to either construct of justify and this is good in terms of risk concentration. However, household leverage which all the regulation in the world cannot prevent is rising again and I hear some scary numbers with respect to open interest in equity markets.

The prime trigger for Fed tightening, the 6.5% unemployment level, is closer than it was this time last year – surprise, surprise – but the decline in the jobless rate has been more linear than exponential and unless something changes it will be reached in October next year. The FOMC has been remarkably timid this year and anything can, going forward, be blamed on the soon to be ex-chairman.

Markets love to believe that the central banks don’t have the guts to turn off the taps and 2013 has proved them right in this assumption. Equities have performed accordingly. Exiting the year, I have still not been able to work out whether they are priced off near nothing discount rates or hopes for future earnings growth. But they’ve been going up and hence nobody really cares. The poor return on bonds has helped them enormously which is hard to argue against and equally hard to see coming to an end for a while to come.

I wrote last December: “In 1994 markets manifestly failed to price the imminent tightening by the Fed and I fear that the same fate might befall us again as portfolio managers prefer to get wiped out in the bunch than risk exiting the market on their own early, only then to have to watch on while the others’ performance races ahead….”

Well it certainly didn’t apply to 2013 which is good as I am, for my own account, more or less limit long equities although with no leverage – I might be a bit mad but I’m not totally crazy

So, 2013 was a good year to be invested in risk assets of which none of us had enough but one never does own enough when markets are going up. For the while I’m happy to stay that way – long but not too long.