Christine St Anne: I just attended a media briefing with the team at Advance Asset Management spoke about some of the big themes that will affect the way people manage their money.
Today, Felix Stephen, talks about some of these themes.
Felix Stephen: Quantitative easing gives with one hand and the other hand takes it back through regulation and uncertainty and so on. That's the liquidity trap. And to come out of the liquidity trap is very difficult, because it means that you have to dismantle some of the headwinds that are preventing the traction of growth coming through. And most of the developed world is, in fact, suffering from this liquidity trap due to financial repression, also called quantitative easing.
And there is clear thinking amongst the central bank fraternity that quantitative easing has gone too far. As they said at the G-20 conference in Washington, they have always stepped the mark or they're in unchartered territory and is now left, having all the heavy lifting done by central banks, now for elected politicians to do the rest. So, that's the fallacy or the negative side of quantitative easing or what I could call the liquidity trap.
The economic cycle or the business cycle is so distinctly different from the financial market cycle. Now, if you look at the financial market cycle, the financial market cycle is driven by investors discounting news into the future. In other words, anecdotal information about how GDP or CPI or unemployment or employment is growing is of very little significance. It’s what the investors believe is the future is going to be. So, they're discounting into the future.
In the past, before the advent of digital technology and the information technology being so good, the gap between, for instance, the financial market peaking and the business cycle or the economic cycle peaking was roughly about 1 to 1.5 half years or maybe in some cases even 2 years. But there are a whole heap of things that have happened in the meantime to, in fact, reduced that quite significantly and most analysts and strategists believe that the gap between the financial market peaking and the business cycle or the economic cycle peaking could be as short as 6 to 9 months.
Now the important thing here for managers like us is to understand the dynamics between these two cycles because we are here to manage money of the – we are, in fact, custodians as I keep saying you the faith and trust of our investors. So, we should pay less and less attention to the economic cycle and more attention to the financial market cycle, because if you hang your hat on the economic cycle, you're going to get caned because the financial market cycle would start moving faster.
So, we believe that the financial market cycle will give you the best signal to take risk on or off. So, as we approach to a peak of the financial market cycle, we're taking risk off the table and going more defensive and then as it bottoms and the financial markets cycle shows signs of bottoming and beginning to turn, you accumulate risk.
Now, retail investors, who don't understand the dynamism of these two cycles, are always looking at anecdotal information. They look at what the news that was produced. So, they're always chasing the tail when the financial market cycle is driven by institutional investors, the professionals, who have ordered a discount at this news.
So I have, over the years, in fact, at Advance, we constantly keep advising people to understand the difference between the two cycles. So that's the only way they can understand it.
The middle income trap is basically driven by the emerging world where what happens is – doesn't matter for what reasons they are, it could be coming after devastation of a war or natural disasters, doesn't matter what it is, those economies grow from an extremely low base and when they're conducive in a forces that play in the global economy, they accelerated at a fantastic pace. You know, growth of 8 per cent, 9 per cent, 10 per cent, 15 per cent is no accident. It happens.
But what happens in that case, either they grow so fast that over-investment takes place, productivity starts falling, the lack of governance, the lack of transparency, the lack of legal systems, the institutions that, in fact, ensure and protect private capital, nepotism, cronyism, all that becomes so rife followed by inflation. And so they get caught in this middle income trap.
They are a few countries that are already suffering from this problem, because the system did not recognize and the political system wasn’t conducive, or they didn't have the foresight to manage the growth profile that they were blessed with in order to avoid this trap.
In fact, historically there is only one country that has avoided the middle income trap and that's South Korea. All the others have got caught in this trap that is coming from very low base and then massive accelerated growth and then caught in that.
There are signs. In fact, if you think about that the Chinese authorities are fully aware of this, and some of the changes that they are making in the economic model, is to avoid this trap. And if they handle it well, I am sure this would be the second country in the history of the world that's avoided that trap.