A lot of people are getting confused by economic news that is maybe not particularly promising, and yet they keep seeing all these risk-asset prices getting higher and higher since they bottomed out at the low point in December. Since then, we have seen a really strong rebound in risk-asset prices. You have to look at this in terms of a longer-term picture. If you look all the way back to 2008, when we had the Global Financial Crisis, since the period following the recession, the so-called great recession, we have not really seen any kind of economic activity recover the way we normally would after previous recessions.
Unemployment is still a real problem out there. I know in the States they are now saying it has come down from 9% to 8.5%, but it’s reducing very slowly. If you look at the aftermath of previous recessions, unemployment has always recovered much more quickly than it is recovering this time. Now, there are a lot of people who would challenge those figures and say that the 8.5% figure is misleading and unrealistic because there are different ways of calculating unemployment; if you have been unemployed for a year in the States then they do not count you any more; if you are no longer looking for work, they do not count you. As I have said in the past, lies, damned lies and statistics.
Perhaps an even more important metric is that average wages in the US are still falling quite dramatically as well. Even if the above figures are true and actually have gone from 9% to 8.5% unemployed, the total quantum of what people earn actually is not getting any larger; consumer earnings are not getting any bigger either because salaries per person are actually getting lower. There is a real problem there in that if unemployment is getting better, it is only improving very slowly. Also, it is not really following through into the total amount of consumer earnings and, therefore, the amount of money consumers have to spend because wages are falling.
There are also other measures; if you look at GDP, American GDP for 2011 was only 2.8%. We have had something like twelve quarters now of positive GDP since the official end of the recession, but it has been very slow GDP growth.
Again, following a period of recession when economic activity is muted and people stop spending, you would normally have a catch up effect because neither people nor businesses were spending and so that really sends GDP increasing quite sharply. We have not seen that either, so we have this disconnect where real economic activity is very slow, very muted, and people can see that in the streets.
If you go to America, you get the sense of unemployment and of people worrying about their jobs, and of businesses that are really struggling to operate and to borrow money, and yet asset prices, on the other hand, have gone up really sharply since the end of the recession in 2008, probably much sharper than would normally happen following a recession or a depression.
A lot of people would say that the current asset prices are a sign of optimism, but the real problem is the disconnect between the price of assets, and the answer to that is something that we have been talking about for quite some time, and that is that risk-asset prices are really being driven by liquidity. When new capital comes into the markets, capital automatically finds its way to the best opportunities. It will go wherever the highest return is. If you have got capital yourself, you will go and place it where you think you can get the best return. All capital basically behaves in that way.
What we were concerned about in the third quarter of last year was that liquidity really seemed to be drying up. This happened, despite all the efforts of the Central Banks, despite Quantitative Easing and all the other things that bankers have done to try and force more money into a system that was not generating extra money through its own economic activity. Despite all that, we saw a couple of really alarming indicators in Quarter three of 2011.
We were watching the TED Spread and the LOIS, everyday. The TED spread is basically the difference between the interest rate that gets paid on the Treasury-Bill and the interest that gets paid on the EuroDollar, which is basically the cost of borrowing Dollars outside of the United States, and that gap was getting wider and wider all the time. Once that spread gets wider than about 50 points, that is usually a flashing red light and a sign that we might be heading into some kind of liquidity crisis.
The flashing red light went back to amber following the intervention of global central banks, most evidently manifested in the ECB’s LTRO #1 and #2 programmes which have pumped one trillion Euros into Europe’s weakest banks and economies - but it is a small step from there back to the danger zone. Be afraid, be very afraid... and be opportunistic too - there is a real opportunity to profit from expected dislocations - non-US investors should take a holding of Greenbacks to profit from any short term USD strength.
Above all, stay liquid. If you know where to look then there are still good gains to be had but do not get tied up into anything which will inflict severe penalties if you want a quick exit. Remember, if it sounds too good to be true then it usually is.