Not being an economist I find the present economic situation very hard to understand. My reassurance comes from the fact that seemingly well qualified economists have just as much trouble trying to explain it as I have understanding it.
A euro apparently (at least as I write) in freefall, a booming US economy, inflation at persistently low levels at the same time as employment hits record levels. With oil prices heading for record levels and strong signs of civil disobedience throughout Europe with blockades and government climbdowns at the same time as we see strong consumer confidence with record personal credit growth we have to wonder just what is going on.
If the big picture seems difficult enough to understand there cannot be much surprise that pension fund managers do not know where things are heading. Certainly being bearish has hardly paid off as managers at Phillips and Drew will undoubtedly tell you. We all know that prophets of doom are proved right every now and again but false calls do not make anyone any money, so why should any investor listen to the doomsters now.
I am certainly not going to call the market but there do appear to be more worrying signs around than usual. So maybe funds could do worse than invest some time in investigating protection strategies. Funds do need to protect their assets to meet those ever increasing liabilities, especially as actuaries appear to have underestimated the impact of improved mortality rates and members seem intent on calling for higher pensions.
Equities must seem to be most at risk and US equities most overvalued. Although the US is supposed to have the best accounting practices it still allows firms to grossly under-account for the impact on earnings of executive stock options. Ironically technology and internet stocks, the firms for whom the mis-accounting will have probably the biggest potential impact, are the ones that are apparently already grossly overvalued on any traditional basis. So we can have no comfort there.
But with many European fund managers generally far too bearish of the US for most of the past six or seven years it will be interesting to see if exposure is cut significantly. It is very illuminating to note as Andrew Hunt, global economist at Dresdner RCM, has done, that there has been a very close correlation between the S&P 500 and Japan’s Nikkei 250 if one allows for a 10-year time lag! So is the fact that the S&P 500 is now moving back to within a whisper of its all-time high just that final false reassurance?
What about bonds, well with European and American government promising strong public finances and low inflation this seems a very safe bet. However 10-year corporate spreads in both Europe and the US have widened considerably to levels not seen for quite some time. The funding gap apparently left by governments around the world (apart from Japan) is being perceived quite understandingly as a great opportunity for the issue of corporate debt. What concerns me however is the oil price ressure and more worryingly the pressure, from the electorate as a result, to lower taxes and spend more. We may find corporates and Supranationals issuing more debt as forecast just as governments forget their promises and unbalance their economies. The market will then just drive yields up and prices down.
The impact of an Oil price crisis must be the big unknown. We do not have one yet but the signs do cause concern. The world economy looks potentially more unstable than ever and this probably signals even more volatility in stock and bond markets than the record volatilty we have recently experienced. Good news for active managers and probably good news for managers with lots of cash provided they know how to use it.
I would imagine that private equity managers will be able to find many buying opportunities but sales may just dry up. If we have a really cold winter problems could magnify for everyone. We are sure to be for an interesting few months.
I shall be watching to see if pension fund asset strategies change. Most will not but we could just see a few more funds buying some option and futures contacts as a form of winter insurance.