Dec 06, 2013

    Wall Street's perverse 'win-win' position

    BY NOW,

    those active in the market would know that the majority of investment houses are recommending a "buy" on Western markets for next year, mainly Wall Street, and to largely ignore or underweight Asia.

    The primary reason for this is that Western economies are reportedly recovering, thanks to the extraordinary money printing undertaken by their central banks over the past five years. If so, investors are urged to buy into their markets now to position themselves for the inevitable recovery next year and beyond.

    Really? Is asset allocation tomorrow actually going to be based on economic fundamentals or is it still more likely to be dependent on simple liquidity considerations, as has been the case for the past five years?

    Traditionalists would like to say it's based on fundamentals, but this would not be entirely accurate. Since 2008, the investment game has been driven by liquidity flows and little else, and it's difficult to see any drastic change in that situation in the year ahead.

    On Oct 12, 2007, some 11 months before Lehman went bust, the Straits Times Index closed at an all-time high of 3,814.38. Today, six years after the event with a depression avoided, the index trades at just under 3,200 - about 600 points or 16 per cent below its all-time high. At best, this can be described as only a modest recovery.

    Contrast this with the United States market, where the Dow Jones Industrial Average has not only recovered all its Lehman-related losses, but has also risen non-stop into uncharted territory, setting numerous all-time highs this year, including three last week.

    Wall Street's outperformance is almost wholly thanks to the US Federal Reserve's explicit promises to keep printing money until the economy improves.

    Also, the reasoning behind the "underweight" in this part of the world is that equity gains over the past few years in Asia were propelled by "hot money" and that, if the West recovers, this money will either dry up or head back west.

    So liquidity and expectations of more liquidity have driven prices around the globe in the past five years, not fundamentals.

    Now, what of next year?

    Our guess is that markets will limp along largely on the same lines - driven by money printing more than fundamentals.

    Moreover, because investors know that the US Federal Reserve will step in to prevent a crash - even at an astronomical cost, it has said so repeatedly - it doesn't matter if the US recovery is real or not.

    As a result, Wall Street now finds itself in a unique "win-win" position. If US growth gains traction, then the original recommendation to play the turnaround theme holds true and, after an initial sell-off because of liquidity worries, prices should resume their uptrend. If growth falters, it also doesn't matter because equities should continue rising as the Fed keeps printing money.

    So, somewhat perversely, Wall Street really should be the best-performing market next year, as Fed money printing continues indefinitely and interest rates stay depressed for years to come to keep the US economy's bubbles inflated.