Blame Game

The search for a scapegoat is the easiest of all hunting expeditions.

Dwight D . Eisenhower

After the two weeks we have just had in global markets the hunt for a scapegoat and someone to blame for the plunging of equity markets around the world has been a fertile area. Most have pointed the finger in China’s direction. The usual suspects have pointed the finger at the FED and of course the second plunge in oil has raised a lot of questions also.

Ideally when things go wrong we like to appoint blame to someone else to shift the weight of guilt or blame off our shoulders, it much easier and comforting to believe that someone else has inflicted this on you instead of analyzing your own role to play in the situation.

Equity markets didn’t just collapse circa 10-15% because of one factor, rather it is the accumulation of many factors built up over time that has led to a viscous snap back in prices. Investors around the globe needed a shake up. For five years we have complained and complained ad naseum about the role of centralized planning and QE induced rally. At times it has felt like a zombie market as it just continued to grind higher as everyone repeated the mantra “Dont fight the FED, Dont fight the FED, Dont fight the FED.”

Well the FED stopped buying assets some time ago – nearly a year now, they have kept interest rates low throughout this period. So if it was a FED induced rally then yes you would expect when the punch gets removed for everyone to start coming off the buzz and start to feel the hangover effects. THIS IS A GOOD THING.

Markets are hopefully getting back to a normal footing whereby prices rise and fall based on normal supply and demand conditions from informed investors. We are not there yet, it takes a while to ween the patient off this mentality. For five years now the FED has made most investors lives very easy, very simply they have pushed you into riskier assets in the hope to stir animal spirits and create inflation and growth.

You can argue over the effectiveness of their strategy all you like, but at the heart of it underlies the assumption that the FED manipulated the market higher. If this is the case as it was the same argument five years ago then who is to blame? The FED or the investors. The FED set out its agenda, it was then up to you what you wanted to do with this information.

If your decision was to shift into historically risky assets to align yourself with the FED’s policy then that is your decision to do so. But to do so blindly and ignoring the inherent risk in doing so is almost certainly your fault. The argument that ” a bigger boy made me do it rarely washes in the schoolyard let alone financial markets. You made that choice and you acted on that choice, now that you are experiencing pain it is not the FED’s fault, it is your fault.

All through this period of equity markets rallying across the globe has been through a period of soft data – the only real growth consistent winner in terms of data has been US employment rate which has got down to a lot more healthier 5.3% although the participation rate certainly calls these figures into question. GDP growth has been muted to declining in most parts of the world, inflation has fallen in most things (ex-real estate).

Investors around the world have abandoned previous risk parameters in the hunt for a safe yield. The same investors that were so spoilt with a robust bond market rally for the last thirty years have become so accustomed to simply investing money and picking up a safe guaranteed return that the rise of alternative investments is no coincidence. Starved of the traditional return from government bonds these investors have scoured the globe causing mini bubbles in assets in their wake as they feel can replicate the returns of a bond.

This is where we go full circle in the blame game, these people can only do this as they are cash rich and can borrow money for ALOT less than the likes of you and I. This is of course enabled by guess who ….the FED. The cash reserves built up at the FED from the major US investment and retail banks as I referred to in a previous post underlies that it is not the banks causing this asset price inflation directly.

excess reserves

The FED ZIRP policy allows big balance sheet investors who are often cash rich already to borrow for very little and invest in assets that provide a yield. As long as those assets are yielding at least on paper in excess of say 5% then its a no brainer in this current environment.

Now when you take this concept and apply it to equity markets who can provide either a yield, capital gain or in an ideal world both its an obvious place for these funds to look to boost returns. I cant stake the validity of the chart below but look at the growth of Hedge fund AUM since ’08. A roughly 85% growth in AUM over a 7 year time period is reflective of investments activity leaving the banking industry and just converting to the Asset management industry.

hedgefundAUM

*source http://www.barclayhedge.com/

This industry’s purpose is to create a return, some will be successful and some will not but that is an awful lot of growth in an industry whereby your job is to invest and put capital to work, especially if you are often constrained in where you can put that money to work.

This leads to an inevitable overcrowding into positions. the famous ” buy the dip” or BTFD mentality has not come from the FED, it has come from the titanic amount of money that needs to “go to work” in this industry. When you get overcrowding in positions it is only a matter of time when you are eventually going to get a snap back or reaction like we have had recently. Investment funds spend a varying amount of time deciding on how to get INTO  a position depending on their mandate and style, however it almost always looks something like this when they decide to get OUT of said position.

exitstrategy.jpg

We are in an era of cheap money, and even if the FED raise interest rates to 1-2% over the next year or two we are still in an era of historically cheap money. What investors and people choose to do with that is their decision but if and when it goes wrong dont go pointing the finger but rather give yourself the same criticism on the way down as praise on the way up.

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