Last week the US Government had to ‘shutter’ some of its ‘non-essential’ operations because the Senate, the Representatives and the President, all of whom need to agree, could not reach consensus on spending plans. In most countries this would be somewhere between humiliating and unthinkable – although it should be noted that US ‘non-essential’ does not do anything to rid us of intolerable politicians, they’re still operating [I use the term loosely] as normal [I use the term ironically] even though they should be the first people not to get paid.
But in American politics this is quite normal – admittedly it has not happened since 1995 but this is something like the 18th time since 1982 so it is not exactly uncharted territory. In fact it is actually one of the system’s checks and balances. When I tried to explain this recently, I was asked. “But why do the checks and balances have to be so stupid?”
I couldn’t answer.
But maybe the answer is that they are not stupid; it is just the politicians that are. We already found that out (if we had any lingering doubts) earlier in the year when we went over the fiscal cliff. The sequester was a programme of budget cuts that were designed to be too stupid to actually pass but existed merely as a threat to both sides that if they could not agree something sensible then ‘silly’ season would prevail. Guess what, they couldn’t agree something sensible.
But the sequester/cliff was no big deal – except for the failed attempt by the government to make some kind of point by messing up flight arrivals and departures, which ‘they the people’ quickly revolted against and Congress suddenly found a miracle cure for.
Similarly, the shutdown is no great deal per se – not in global economics terms at any rate. I am acutely aware that some 800,000 people will go salary-less until this is resolved but the economic cost seems to have been determined at just 0.1% of Q4 GDP for each week of shutdown.
It is not, by itself, likely to cause any lasting damage unless…the politicians do something really, really stupid.
We have to see this as a prelude to the debt-ceiling debate – if the shutdown drags on until then and if positions have become so intransigent that the debt ceiling increase cannot be agreed then we are starting to get into more worrying territory. Long tail risks, such as downgrades (remember that the US downgrade previously came as a direct result of debt-ceiling political intransigence), and maybe even ‘default’ start to creep in. Schroder’s Greg Taljard recently made the point at the Singapore Expert Investor Forum that by mid-October Apple Inc. is projected to have 5 times as much cash in its bank account as USG will have. I think that Greg was talking up AAPL’s corporate bonds in that statement but I would have used the point to talk down USG.
That said, T-Bills continue to rally from their oversold levels which maybe highlights the madness of the politico-economic outlook right now. One interesting aside right now being that Australian developer, Deal Corp, is converting a Melbourne lunatic asylum into an up-market residential development – if ever we needed a metaphor for Australia’s property market, the Deal Corp guys have gift wrapped that one for us!
The tail risks to the US and global economy of downgrade or even default are starting to make headlines everywhere but most commentators are missing the point – if the underlying US recovery was healthy then this would just be a short term piece of news froth – a buying opportunity for good quality assets temporarily mispriced by a storm in a congressional coffee cup. All would quickly get back on track.
If the underlying economy, as remains my thesis, is not recovering, then the process will aid price discovery – the retreating tide will help us to see to what extent the US and global economies have been swimming naked.
Either outcome would be a form of resolution although the latter will be the more painful, although we would argue ultimately necessary, transition. After four years of capital market recovery but real economy stagnation, it would be healthy for valuations to retrace back to levels more connected with fundamental factors (some 90% of that capital market performance can be traced directly to stimulus and we would argue that the remainder can be traced there indirectly). As long as you are not swimming naked (too high exposure to US equity markets) you may get badly buffeted but the coming transition could be the greatest investment opportunity for decades.
Either way, the key for all investors is to have the right risk focus going into this. Therefore, if it is possible, people should embrace the volatility as an opportunity – a difficult challenge that, if planned properly, can be overcome.
In fact our earnest hope is that if the underlying economy is in as bad a shape as we believe, then the shutdown àceilingàFOMC meeting will bring on the reset that policies have prevented. Unfortunately though, the reality is that we may get dragged through a lot more policy-making before that.
A great many adjustments, although they may hurt the unprepared in the short term, are badly needed but require a trigger to make them happen. Policymakers want to avoid that as long as possible, even though the future consequences would be more and more dire each day they fail to address the underlying issues, because they want to get re-elected.
It is still most likely that the current issues will get resolved and the can gets kicked further down the road and the present problems are just another chapter in this ongoing saga. If this is the case then we will have spent a lot of time fretting over nothing. But there is a chance that all the intransigence leads to loss of control which leads to a forced re-set, with a huge global crisis preceding a genuine recovery.
People can only watch the political posturing in full readiness and respond accordingly. If you can, get liquid as soon as possible so you can get out or get in dependent on what your own particular strategy requires. As many people know, the Chinese word for crisis is the same as it is for opportunity.
|The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]|