The New Year marked the end of the adrenalin rush for investors. Since the summer of 2007, investors around the globe have been hooked on the headlines. The drivers of the markets have been what happened today in the housing market or what Bernanke had to say or who launched what program to rescue who. But that era has now ended. It’s time to turn down the volume on the TV, ignore the latest tweet on the mobile device and look beyond the daily moves in the markets. I believe the financial crisis is over.
At the end of the day, the financial crisis was simply a developed market banking crisis at a gargantuan scale. And the solution, it was clear from the very beginning, was for the policy makers to come to the rescue and aid the deleveraging process for the banks across the globe in all developed markets. The problem has been that the policymakers—politicians and central bankers alike—had been reluctant to take on this imperative as there was no clear near-term upside. Rather, only in a historical context would one be vindicated (unfortunately, the vision to act in accordance with the historical context died with Winston Churchill). In my opinion, no politician or central banker cared much for doing what needed to be done until it became too painful to handle and their hand was forced. The only possible exception to this was of course Bernanke, but even he came kicking and screaming in mid-2008.
The bottom line is that beginning with the Fed in 2008 and ending with the European Central Bank in February 2012, policymakers have finally committed to aiding the deleveraging process, again on a gargantuan scale. Between them, they have printed close to $8 trillion in new money to help the deleveraging process. And they remain committed to do more. Crisis averted.
For investors, it’s now time to move beyond the headlines. This creates a challenge for even the most seasoned of investors, who recently have made a living simply capturing the big market moves. Going forward, generating excess returns will require a lot of hard work, will come in very small quanta, and will require an investor to be proficient at it over and over again. For fixed income managers, it requires a return to a focus on yield and carry, something that has been anathema for the last number of years.
The real issue is what happens next in economic terms. The natural consequence of a deleveraging process is prolonged slow growth. That is of course unless the economy’s underlying trend growth rate is so high and the policy apparatus is so vigilant that the adjustment takes a short period as they typically do in emerging markets. Alas, in developed market economies we do not have that luxury. The manufactured growth from the leveraging of the banking system (with a great assist from mobile technology-related productivity) will not be repeated. So get used to the current environment. I believe trend growth in the U.S. will be 2%, give or take a half of percent. Fears of a recession will crop up every so often to make things interesting, but other than the periodic soft patches in activity, it will be a relatively boring period. Interest rates are not going anywhere. Financial repression will see to that. Equities, as cheap as they have been to bonds in decades, will likely grind out gains—perhaps a trend appreciation rate of 5% to 6%—but probably nothing more than that. Volatility will of course rear its head from time to time.
Ultimately, a next crisis will emerge but there is nothing to suggest that one is in the offing. In my opinion, it will have all the trappings of past financial crises but will appear from a place that is currently off of investors’ radars. For now, we rejoice in the end of the last battle. In the meantime, investors positioned for the next proverbial shoe to drop in 2012 will likely be disappointed.