I recently gave a ‘Levelling’ related talk in Paris, where one of the points I made related to the way in which markets and finance have dominated our lives. I am often sensitive to the way markets are discussed in France. In contrast to the USA, where markets are seen as a source of wealth and to a degree, a part of American culture, in France, the opposite is the case.
This, in my view has something to do with France having a much longer economic history (August Landier and David Thesmar’s book ‘Le Grand Méchant Marché is worth a read on this point), and therefore more financial crises, than the US. Indeed, when John law was blowing up the French economy, the US was a ‘frontier market’ and colony of King George I.
One perspective on markets that I think interesting is they way they act as laboratories, signalling the impact of real-world events and economic policies. Markets can be brutally honest in this regard, pricing the effect of tragedies, wars and economic blight in an unsentimental way.
Some recent market behaviour has been revealing. For instance, the price of soya beans fell once the US and China signed their ‘trade’ deal. The drop in soya bean prices likely reflects a very sceptical view on the quality and enforceability (specifically that China would buy large amounts of US agricultural produce). In my view, this scanty deal only serves to provide the President with some politically helpful headlines, eases the stress on the Chinese economy and, profoundly underlines the fracturing in the relationship between the two countries.
In contrast to weakness in agricultural commodities, there are other market price moves that tell us little about the real economy, but a lot about how the plumbing of markets works. The recent, rapid rise in the price of Tesla stock is a case in point (the value of the company has doubled in the past six months and its equity value is worth more than the likes of Volkswagen, who produce far, far more electric cars). The rise in the value of Tesla tells us little about the health of the car market (modest in the US, weaker in Germany and China), but a lot about investor behaviour and the state of banking.
First, in terms of investor behaviour, by October of last year there was a sizeable community of investors sceptical that Tesla would ever become a profitable business. This set of investors had established large ‘short’ positions in Tesla stock. However, as markets rose, they were forced to cover or buy back these short positions, pushing the price ever higher. Anyone who thinks the sharply rising price is an indicator of Tesla’s future is mistaken, it is simply a function of investor positioning.
Another reason for the hubristic move in Tesla stock is that the federal Reserve has been infusing markets with more liquidity. There was a time when earnings, corporate strategy and good governance were determinants of stock performance. Today, in the USA at least, it seems that liquidity is the pre-dominant driver. In the aftermath of the global financial crisis, the banking system has changed in that the nature or species of participants in lending markets has become more diverse.
Hedge funds, private investors and asset managers now participate in lending marketplaces that were once the preserve of banks. The other change is that regulation has pushed banks to have smaller balance sheets, so to that end they are less sizeable players in many corners of financial markets.
At the same time, the amount of debt in the world has ballooned. The effect of this debt load, the changed composition of the banking marketplace and the refinancing pressures it puts on the marketplace is that the Fed now needs to lubricate the wheels of capital markets more often.
As it does so, it adds fuel to speculative fire, which in recent weeks has taken many measures of risk taking to extremes (Tesla’s rise is one example). Regular readers will know that I hold central banks guilty as charged for encouraging people to take on, rather than calibrate risks.
One upshot of this is that strength of the stock market is being used as a self-marketing tool by President Trump (in a recent note I commented that the number of his stock market specific tweets had increased sharply since November). Trump also loudly eggs Fed Chairman Powell on to be more accommodative. As such the Fed is now losing credibility, in a way not seen since the mid 1970’s, and it is entangling itself in asset prices in a way that will compromise it and the US economy.
As for President Trump, the potential near-term peak in equities might mean we have seen peak Trump, especially given the commencement of the impeachment hearings next week. His approach is that of a classically short-term property speculator – take on debt, pump up the value of an asset and then try to sell it. As he does so he is mortgaging the pensions of future generations, and potentially, his next four years in the White House. The stock market is due a correction, and so is Trump.
Perhaps someone, even in Paris no less, will write a book called ‘Le Grand Méchant Président’.
Have a great week ahead,
Mike
The Levelling 