The Global Perspective - Market Leading Commentary On The World Economy

Truly Diversified?

Farnoosh Torabi this week interviewed TheStreet.com's metals writer Simon Constable about the issue of whether Greenspan is to blame for the sub-prime debacle (by keeping interest rates so low for so long). Constable's answers make for poignant consideration (VIDEO HERE):

There's two things here: first of all, everyone in this episode is seemingly saying, "not me, not this, this isn't my fault, it was the other guy, it was my predecessor, it was my mother, it was my mother-in-law ... but it wasn't me." That seems to be what's happening all over the market and it goes all the way back to Enron. It's been a decade of people blaming each other. However, I talked with some economists this morning and what they're telling me is that it was probably a policy decision on his part to say that it was OK, because even though there were going to be some abuses, we'll keep the economy rolling.

Indeed, this seems to sum up neatly the attitude towards economic fundamentals over the preceding 20 years. There are two economic conditions that have made markets amenable to the sort of volatility we experience these days. The first is the focus on growth, above all else, including but not limited to fundamentals, accounting, and even value. It's for this reason the private equity market has burgeoned so much: a singular focus on driving growth as quickly as possible -- with the least amount of hassle.

Added to this, the mass democratization of capital markets, to include numerous retail speculators who now have access to unprecedented levels of margin and credit stimulates this growth like steroids in a professional athlete.

The new economic climate challenges the meaning of the "diversified portfolio." A lot of financial institutions and market commentators like to promote the concept of such diversified portfolios as a safe way to access economic growth, but in reality when the above two conditions are in full swing, diversification becomes much harder to achieve, to the extent that whatever you're invested in - be it commodities, securities, bonds or real estate - is unavoidably at some level a leveraged bet on  the growth of more speculation.   

Things Are Not What They Seem

How wrong we get it sometimes. Not so long ago, right here at The Global Perspective, I shouted off about how crude was destined for free-fall, about how U.S. markets were a straight buy and how China was a short opportunity just begging to be cashed in on.

With crude at $80 for the first time in history, U.S. markets in relative free-fall in the midst of a giant housing credit crunch, and China's markets and economy surging upwards with an unstoppable velocity, the latter scenario doesn't look so convincing -- to say the least. If I was running money I would have been laid off months ago.

Then again, I have the luxury of not running money -- and not having to make gut decisions on a day-to-day basis based on what everyone else is doing. And best of all, for me at least -- but for others who don't yet know it -- whatever the current market scenario, the fact remains, I'm right. There's more oil in the world than suppliers want you to believe, U.S. corporate fundamentals are actually in pretty good shape, and China's companies are still largely run like Taipan-geared hothouses.

In times of volatility, the first thing people tend to forget are the facts. Before you shoot off a vitriolic e-mail telling me how wrong I've got it, let me throw out here some recent examples to illustrate the point. First of all, for all we keep hearing about the shortage of oil in the world, we seem to see very few actual examples of that shortage. In fact, I can't think of one since the 1970's. Oil may be getting a little pricier on average, but it's not like anyone has been forced to stay at home or walk to the nearest mall recently. It's worth remembering that the two people sounding off about how oil is running dry are the futures and options liquid commodity speculators, and those actually involved in supplying the stuff. In reality, there seems to be so much going around that Venezuela can afford to strike bargain basement deals with the City of London. In a time of a genuine oil shortage, this would not be the case: for a start, the U.S. would be deal-making with the charismatic Venezuelan leader.  (You better believe that if London and Caracas will do a deal together, so would New York and Caracas, given the right demand scenario.)

Secondly, U.S. markets are still way up, on average. Right now, you can't pick up a copy of a newspaper without reading a story about the effects of the U.S. sub-prime chaos on equities, but in reality the two have very little to do with one another fundamentally. The reason U.S. equities plunged as credit spreads tightened is simply that in such a market, holders of credit derivatives and equities alike -- and there are many -- couldn't get rid of their mortgage backs, so logically enough, they sold their equity positions. This only had the net effect of turning up a few bargains in the market. Talk of a U.S. recession is premature, too: by definition, those who have sub-prime loans are hardly major spenders in an economy, and therefore, less significant than say, ordinary mortgage holders. The effects of sub prime defaults have been sad to see on a human level -- which is largely why they are all over the papers -- but hardly very significant on a global economic one.

And where China is concerned, the warning sign came for me the other day. "Chinese stocks are a great hedge against global equities, because while global equities have been going down, stocks in Shanghai have been soaring," I overheard someone say the other day. When people start talking of hierarchal Asian growth-stocks as a hedge against huge, stable, flat, industrial organizations with 50+ years of documented accounting behind them, you generally know you're in a bubble.

Right now you're better off not buying a newspaper, or reading a wire report, for that matter. Because the reality is, most of us have become so wrapped up in a human-interest and political argument, we've temporarily lost our economic marbles. Not for the first time, things are not what they seem.