Ongoing financial repression has created immoral hazard

I used to think of financial bubbles as rare and precious things. It is now clear that they are more like London buses: miss one, and another will be along before you know it.

Having lived through the first dotcom mania – the one that burst so spectacularly back in 2000 – I never expected to see versions 2.0 and 3.0 within a mere decade or so.

The third iteration of technology stock insanity, masquerading as ‘social media’, now seems to be imploding, with the likes of LinkedIn and Twitter having shed more than a third of their stock market value since their autumn 2013 highs.

Evidently, Sir Isaac Newton was right when, having lost his shirt on South Sea Company stock, he remarked that even the best scientist could calculate the motion of heavenly bodies, but not the madness of people.

The insanity is not restricted to the stock market, even if it seems to be focused there. The fact that beleaguered Caa3-rated Greece was last week able to launch a five-year Eurobond at a yield of less than 5%– and which was seven times oversubscribed – would seem to suggest that messianic delusions of relevance are alive and well in the credit markets, too.

The size of that overstuffed order book for the Greek deal should be taken with a pinch of salt: any trendy deal is always healthily padded out with subscriptions from greedy investors who realise their allocations will be scaled back by the underwriters.

Yet, one is forced to conclude that the average time it takes for a bond fund manager to forget reality is now down to just two years. That’s how long ago it was that Greece defaulted.

The credit specialists at Stratton Street Capital point out that the only way for private investors to justify continuing to throw money at Greece is if they believe that the €222bn the EU has lent to the country “is entirely fictional, and will effectively be converted to 0% perpetual debt, or will be written off, or Greece will default on official debt while leaving private creditors untouched”.

However you view the future economic development of Greece, which I suspect will continue to be something more like the Bataan Death March, this deal is a travesty.

Cursory analysis of the order book reveals the guilty parties: asset managers (49%), hedge fund managers (33%), private banks (14%) and ‘real money’ investors – ie, pension funds and insurers – comprising just 4% of the purchasers.

Regardless of its composition, any and every entity involved in this deal should be personally and professionally ashamed.

While it is easy to point to conspicuous overvaluation in both equity and bond markets, it is also surprisingly easy to answer why this should be the case.

The culprit, as always, is central banks. It is transparently clear that if you drive interest rates down to zero and print trillions of dollars, pounds and yen out of thin air, you will drive desperate savers and investors into anything offering a yield more meaningful than zero.

In this stampede for yield, risk is largely overlooked. Last week’s more pronounced market volatility will serve a useful purpose if it reminds investors that you cannot have reward without risk.

This ongoing financial repression is, of course, immoral, but our monetary leaders have never let morality stand in the way of supporting an unsustainable banking and financial system. Call it immoral hazard, if you will.

The asset bubble problem is compounded by the participation of so many economic agents and intermediaries – all those asset managers, hedge fund managers, and so on.

Individual investors should be free to make their own mistakes and lose their own money – this is how free markets are supposed to function – but the so-called professionals are indulging in their own peer group-driven mistakes without being ultimately accountable. They have no skin in the game. This is a tragedy in the making for the rest of us.

All of which leads me to some classic Benjamin Graham-style conclusions. Don’t buy junk. Don’t overpay for what you perceive to have value. Ignore the indices – they have no relevance to the private investor whatsoever. If in doubt, simply don’t invest; keep some dry powder in your wallet.

Cash may offer a derisory yield and a negative real return, but it gives you options: time and the freedom to invest at a later date when some semblance of sanity has returned to the markets.

These are testing times for value investors. If you don’t understand the rules of the game, sometimes the smartest move is not to play.

Tim Price is director of investment at PFP Wealth Management. He also writes The Price Report newsletter.

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