By JAMES SPENCE
Asymmetry & asynchronicity, repression & compression.
Four words borrowed from the other worlds that are being used currently in financial markets and have bearing on the direction of those markets. We attempt to explain what they mean when people in markets use them.
Asymmetry is a joyous word in the hands of financial analysts and traders. It is used to connote opportunities where the likely benefits outweigh the likely risks. Analysts and managers like to speak of them to bulwark their rationale for positions held. Often they speak with more certainty than a cooler appraisal would permit.
More recently, though, it has been adopted by the world’s pre-eminent financial authority, the Federal Reserve. When their various chairpersons use it they are attempting to describe a policy setting on liquidity and interest rates whereby more tolerance is being applied to the inflation rate than would normally be the case. The word asymmetry is being used to convey the sense that the Fed will be relaxed when the inflation rate passes through the official target of 2% and even so if its remains above that target level for some time. In this respect, the Fed remains very much in the grip of its own work on Japan and the lost decades that followed the bubble peak that took place there in the late 1980s. The Fed’s considered view of this is that the Japanese authorities and its own central bank, the Bank of Japan, was too quick to withdraw exceptional monetary policy measures as Japan chugged slowly out its own post-boom demise.
For critics of US policy settings, asymmetry is a false concept and pregnant with danger. How on earth could the world’s leading authority continue to push to stimulate inflation when so many prices indices are moving up strongly and the pinch points are so many and so obvious?
Furthermore, it has been pointed out that, with the Fed’s strategy of responding to real-time data and conditions – as opposed to forecast – when a change in policy settings comes (as hawks suggest it will) they will shed credibility in the process. The credibility of the Fed has implications even if you do not invest in US assets.
Asynchronicity has become a recent favourite term of large corporate managements and is being used to describe demand patterns throughout the world as we emerge from the pandemic.
In Coca Cola’s 19th April results call, Chairman and CEO James Quincey stated “In markets at the forefront of the recovery, we’ve seen early signs that our actions taken during the pandemic are helping us outpace recovery. It’s important to note that the path to a full recovery remains asynchronous around the world. Many markets haven’t yet turned the corner and are still managing through the restrictions.”
In simpler terms, some parts of the world are doing better than others. Whilst this could be conceived as a drawback, it also bodes well for the positive progression in corporate earnings through this year and beyond as the world becomes more synchronised.
The author remembers repression as being a reliable term in cod-psychology from 20 years ago. As in: “he/she is so repressed”. This term has been somewhat eclipsed by extended borrowing from clinical therapy, often used to make to critical or disparaging remarks about other people. The expatriated members of the British royal family appear to have a good handle on this stuff.
Repression, when used in a financial market context, refers to periods of time when interest rates are deliberately held below the prevailing inflation rate. Repression supports economic activity and is generally good for financial assets. Russell Napier, who sits on our investment advisory committee, is somewhat of a professor of repression, though his own personal demeanour is anything but. Russell looks back to prior periods of repression in financial history to study their causes and effects, the most notable being the 10 years following the cessation of hostilities following WW2.
One big difference between then and now is that the economies of many advanced nations could now not cope with significantly higher interest rates. That being the case, the theoretical distinction between appointed technocrats and the governments that appoint them look to be weak and in Russell’s brusque expression “governments are in markets and will remain so”. This makes him positive on the near to medium term outlook on equity markets and more doubtful in the long term as he believes we are heading inexorably toward government sequestration of institutionalised savings. Not for nothing does he keep a chest of doubloons in his northern manse.
The final term of the quartet is compression. Compression takes place when valuations of assets fall. In our recent webinar on the subject of global equities, we pointed out that in the 37 years between 1983 and 2020, 40% of the after inflation return from US equities was derived from valuation expansion. Last year, it was over 50%. So whilst 2020 was a remarkable year in many respects, it was a conventional one in equity markets in respect of the preceding years. It would, though, be unwise to bet on this continuing as our view is that long term interest rates have bottomed. Whether expansion turns to compression (falling valuations) depends to a great extent on whether natural market forces push interest rates higher and to what extend they are repressed.
Nobody has the definitive answer to this big question and anything that looks like an answer is really an opinion and most of these opinions are guesses. The question then becomes, how to navigate this uncertainty in financial assets, especially as holding cash looks so unattractive?
We will offer some ideas in a forthcoming webinar. Please join us for an Investor Update on Wednesday June 23rd in which the investment team will explain how our portfolios are aligned.
Registration can be made via this link.