Tiger by the Tail

Ben Hunt of Salient Partners recently wrote:

I spent the past week in Switzerland, meeting with old friends and making some new ones, and just like my recent travels in the US there was one overwhelming sentiment. No one doubts the omnipotence of central banks. No one doubts that market outcomes are fully determined by central bank policy. No one doubts that central banks are large and in charge. No one doubts that central banks can and will inflate financial asset prices. And everyone hates it.

Among those investors and allocators with the freedom to flee public markets, the interest in private market opportunities has never been greater. Among those investors and allocators trapped by mandate diktat in the Alice in Wonderland world of public markets, the resigned desperation has never been worse. It’s a quiet desperation in Zurich – a Teutonic stare at the floor and a wrinkling of the mouth – more obvious in Geneva with a Gallic shrug and a full-faced grimace. But’s it’s all the same emotional response to the Bizarro markets in this, the Golden Age of the Central Banker.

At this point in time, the dominant investment belief of our time is that central bankers are omnipotent and no one wants to fight them. The direction of markets is up, as ridiculous as this seems to every sentient being. Portfolio managers may not be happy about all of this as Mr. Hunt points out, but they will not fight it.  They will play the game and be fully invested.

I am quite sure that fund managers don’t understand the true implications of the omnipotent central banker meme, both for society and for themselves.

As far as society is concerned, central bankers have been able to pin interest rates at ridiculously low levels causing a collapse in the savings rate. Below, we can see that net savings in the U.S. has collapsed over the decades following the end of the Bretton-Woods monetary system and a move to pure fiat that central banks can create from thin air:

As we can see, net savings has averaged about 1% of gross national income for a decade. This is a negative savings rate in real terms. There is no way for a society to grow and become wealthier without savings and investment.
This lack of savings is certainly impacting capital spending. We can see from the following graph of industrial and construction capital spending from Goldman Sachs (via Zerohedge) that capital spending is going nowhere fast and is certainly declining in real terms in the U.S., Europe and 
Japan:



   
In short, corporate capital allocators have given up trying to grow their businesses. They are now starting to liquidate their firms because interest rates near zero limit their returns on investment to zero as well. Better to return the capital to shareholders and be done with it. Corporate America is now returning about 4% of the current equity market capitalization to shareholders in the form of share buybacks and dividends each year, and borrowing very heavily to do so.

If I were a professional fund manager I might look at this situation and assume that this is very bad for my profession. It is, after all, tough to be a professional capital allocator if the corporate world is giving up on capital allocation and returning the money to shareholders so that it can be consumed.

Nevertheless, I see some pretty stupid commentary from professional fund managers extolling the wonderful opportunity that we have to buy shares at these levels.  Morgan Stanley strategist Adam Parker even posits that the S&P 5oo could rally another 50% by 2020. All that this requires is a 6% year growth rate in earnings and a 17x P/E multiple in that year to make it so. Well, these companies are telling you that they are going to shrink in real terms if their capital spending plans are any indication. Additionally, if they continue to grow earnings it will be below the operating line and solely a function of financial arbitrage. No one should be dumb enough to pay 17x earnings for shrinking companies in liquidation mode. I wish Mr. Posen’s clients luck in their share buying endeavor. They will certainly need it.

Yes, the primary investment meme of our day is one of central bank omnipotence and that nothing can stop the march of rising asset prices. The cynicism drips heavily from my keyboard now as I am convinced that not only are the world’s central bankers not omnipotent, but they are nothing but a bumbling group of fools who have a tiger by the tail.

Central bank interest rate decisions of the past 15 years have created a situation where societal capital is liquidating itself while asset prices have been forced to levels that predict growth as far as they eye can see. They have created an environment ripe for a disaster.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.