Investment Management Blog - Montague Capital

It’s one of those rare days when one feels just the teeniest bit sorry for HMG.  It is being criticised by a group of 16 know-it-all “economists” for its plans to accelerate public works programmes in order to try to spend the UK’s way out of recession.  Admittedly there is a germ of theoretical truth in the accusation.  In a static economy a big increase in central government spending can “crowd out” private sector investment as it sucks in a disproportionate amount of resources and cash.  It gets worse if a government tries to pay for this spending by raising taxes.  However, HMG has been vilified, and rightly so, for suggestions that it might sit back and do nothing at all.  But for these “economists” to centre their criticism on the assertion that HMG will not pick the right sectors to support utterly misses the point.  They should be embarrassed for trying to call themselves “economists”.  Not only does any spending have to be better than nothing, history shows us that it decidedly is.  Just look at the US’s New Deal after the last global credit crunch and collapse in equity markets. 

These “economists” would make far better use of their time if, rather than sniping at anything the government tries to do, they offered some help where it is most needed.  This does not have to be a static economy.  There is no reason why the private sector would not play too, if only the banks would release some of the billions of pounds they have been given in the form of fresh, affordable loans.  The banks’ gross selfishness is a far more corrosive force for bad.  They are doing precisely what Hoover and his Treasury Secretary Mellon did in 1929.  Look where that got the world.  (But who employs most of these “economists”?  Why, the banks of course.)  Besides, given the antique condition of much of the UK’s lamentable infrastructure, the benefits of any major government spending programme will be felt far beyond the navigation of the current recession.

But a really far-sighted government would be looking beyond just keeping the capital’s brickies and sparks in jobs by boosting work on Crossrail or the Olympic Village.  It should be addressing one critical issue which has made the current recession worse than it would otherwise have needed to be.  Greater energy independence would have left the UK far less exposed to the inflationary effects of a soaring oil price.  And that would have given the Monetary Policy Committee far greater latitude to pursue a more accommodative monetary policy.  With some of the best sites for alternative energy sources such as wave and wind power in the world, it is a scandal that the private sector has not stepped up to the plate.  To misquote John F Kennedy, we should choose to do these things not because they are easy, but because they are hard.  We need them if a re-run of the current mess in a few years’ time.

It’s rarely a good idea to stand in front of a stampeding herd of elephants with an upturned hand.  But it is utterly astonishing that the media, and apparently the markets too, have been quite so slow to understand that a recession was inevitable.  In the UK the Monetary Policy Committee has been telling us for months, if not years, that the fight to contain inflation would demand slower growth.  And what is going to happen to that outlook when the domestic and global banking system then looks poised to do a Chernobyl?  Anyone with an ounce of brain (not necessarily a required qualification in Canary Wharf admittedly) could see for a long time what was likely to happen.  Of course, the media loves this.  In the absence of a nice new juicy war or major natural disaster, there is lots of material to talk about when we’re heading into recession.  Plenty of “human interest” stories for the mawkish, sadistic audiences of today who think that Big Brother is quality television.

To attribute another 6%-ish fall in the Nikkei today to “blind panic” is not quite as lightweight as it sounds.  Share prices are still being moved to a large extent by the unthinking “join the dots” black boxes of “sophisticated” fund managers.  Substitute data mining for hard, rational, independent thought and this is what you get when you feed rubbish in at one end.  One of the most serious failings of these black boxes is their reliance on consensus forecasts for company earnings, or worse, a simple extrapolation of what has gone before.  This is completely hopeless when the machine has gone straight from sixth gear into reverse.  While companies may be clinging to the vain hope that their earnings won’t suffer as recession bites, market strategists are looking, quite sensibly, far further down the road.  The consequence is that, in Europe, a consensus forecast for a 10% rise in FY09 earnings is on its way to being revised down to a 40% fall, and with only a snail-like recovery after that.

Don’t dwell for too long on what OPEC’s attempts to keep the oil price up by cutting production, or the need to compensate for the disastrous fall in the value of defined-contribution pension schemes, or alarming new evidence that inflationary wage expectations aren’t dead after all, might do for this trend.  It is a fact of life that valuations contract once it has become clear that earnings are on a downward trend.  Valuations don’t expand again until there are convincing reasons for believing that earnings are about to resume an upward trend.  Sadly, we’re simply not there yet.  This is not to say that all possible investments deserve to be tarred with the same brush.  But sensible selectivity is required here.  There’s nothing to be gained (rather, a lot to be lost) by being exposed to companies most likely to suffer in a major economic downturn of the sort for which we are headed.  When the black boxes update their data and capture that fact, what has been picked out today from the wreckage will do nicely tomorrow.

Japanese investors will have an interesting take on whether Western markets have reached the bottom.  Having seen their financial system start to implode about sixteen years before ours, the Nikkei is now roughly 82% below its all-time high, and that’s about eight years after its banking crisis was “solved” and its economy returned to “growth”.