In today's Exponential Investor...- The new game described
- Inflation is not the only likely outcome
- Something is always going up
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VARNA, BULGARIA Southbank Investment Research's editors are, without exception, very interested in financial history.
If you were to ask each of them to identify just one big budget movie that deals with financial markets – and financial excess – the chances are that they would give you the same reply:
Wall Street.
Starring Michael Douglas as Gordon Gekko and Charlie Sheen as Bud Fox (with lots of reasonably well-known actors in supporting roles), this classic depiction of the
zeitgeist of the 1980s was released at about the same time as the global stock market crash of October 1987.
Now, if you were to ask each of the editors to consider what has happened in global financial markets since
Wall Street was released and to identify just one feature that makes the markets of today really stand out, you would get a variety of answers.
However, you can be certain that at least one of them would mention soaring government deficits.
Earlier this month, in a podcast for subscribers to
Exponential Investor Premium, my colleague Eoin Treacy highlighted how the combined fiscal deficits (i.e. excess of spending over revenues) of the world's governments had soared to $2.22 trillion.
On its own, that figure may not mean much.
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The new game described
However, as Eoin points out, it indicates that a new game is afoot in the world's financial markets.
Twenty years ago, the world's governments were, collectively, spending about as much as they were receiving in tax revenues.
In the first years of the new century, there were deficits, but they were generally trended downwards.
The global financial crisis of 2008/09 (a vastly bigger event than the sell-off in stock markets which coincided with the release of
Wall Street back in 1987) was the catalyst for a major change in trend.
By the end of 2009, the governments' combined deficits had jumped to about $1.5 trillion, as the governments spent money to counter the effects of the crisis.
For the next decade, the combined deficits trended downwards.
In the United States, there was a long debate about fiscal spending.
Fiscal austerity was a major theme in the UK and in much of continental Europe.
Then, the deficits soared again as the governments sought to counter the public health and economic impacts of the Covid-19 pandemic.
When governments spend more than they earn, they must make up the difference by issuing bonds.
That exercise assumes, of course, that (institutional) investors are prepared to buy the bonds.
In the latest episode, the buyers of the bonds have been predominantly major central banks such as the US Federal Reserve, the European Central Bank (ECB) and the Bank of England.
This means that these central banks have started to play a major role as financiers of (excess) government spending.
This represents a major change: traditionally (and in some cases explicitly) the central banks' missions have seen price stability as the main objective.
Previously, the central banks were fighters of inflation; now they are fighters of the economic chaos that might result if governments become unable to spend as much as they want.
This is an enormous change – there is a new game afoot.
Readers of almost all of Southbank Investment Research's publications will know that, without exception, our editors are expecting inflation to return.
Already, there are signs that this is happening.
In the United States, for instance, consumer prices rose by 0.6% in the month of May and were up by 5.4% year-on-year.
Inflation is not the only likely outcome
In a recent edition of
Capital & Conflict, I explained how John Butler, one of our contributing editors, sees problems ahead for the euro.
A part of the problem is government debt.
The International Monetary Fund (IMF) reckons that, as percentage of GDP, Italy's general government debt has risen from 119% of GDP to 144% from 2013 to 2021.
In Spain, the debt/GDP ratio has risen from 81% to 105%: the figures are similar to this in France.
However, another part of the problem are the various current account (im)balances
within the euro area itself.
These balances are reflected in the balances that each of the various national central banks within the euro area hold with the ECB.
There has been huge capital flight from various countries with structural economic challenges to Germany and Luxembourg.
From the end of 2013 to 30 April this year, the balance of Germany's Bundesbank rose from +€510.2bn to +€1,024.7bn: for the Banque centrale du Luxembourg, the corresponding figures were +€103.7bn and +€299.7bn.
At the other extreme, the balance of the Banca d'Italia went from -€229.1bn to -€480.7bn, while that of the Banco de España moved from -€213.7bn to -€498.7bn.
As John points out, this situation can persist without a crisis in the euro area as long as:
- The ECB is willing remain the buyer of first and last resort for government bonds; and
- The German government is prepared to allow a continuing rise in the Bundesbank's claims on other central banks.
If one or both of these conditions cease to hold, then there is a real risk of a crisis in the euro area.
Such a crisis would involve a country that currently uses the euro abandoning that currency and trying to replace it with its old currency (or a new one).
Outside the euro area, such a country would have the opportunity to resolve economic problems by devaluing its currency.
The crisis would undoubtedly give rise to some wild swings and dramatic headlines – however, there would also be huge opportunities for astute investors.
That is what the new game is all about.
Something is always going up
Needless to say, Southbank Investment Research's publications are conceived for the new game.
Many of them seek to identify opportunities where businesses, markets or companies are growing and changing very rapidly – with shareholders being the likely beneficiaries.
Many of them highlight the benefits of diversification: by holding your investment eggs in just a few metaphorical baskets, you are likely to achieve a (much) better overall outcome overall.
Not all gold stocks are alike.
Not all green energy stocks are alike.
Not all frontier technology stocks (including drug stocks) are alike.
Factors which make one perform very well will not necessarily have any impact on another company that is apparently in (broadly) the same industry or sector.
Just as this edition of
Exponential Investor began with a 1980s movie based mainly in the Financial District of New York City, it should finish with another.
That other movie is 1988's
Working Girl, starring Harrison Ford, Sigourney Weaver and Melanie Griffith.
In the movie, Melanie Griffith's character misses out on attending a lecture on the emerging markets.
The emerging markets were interesting then as they are interesting now – not least because they often perform in diverse ways.
However, a discussion of their relevance in a world where a new game is afoot will be the focus of another edition of
Exponential Investor. Until next time,
Andrew Hutchings
Managing Editor, Southbank Investment Research
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