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Novelty policy initiatives will drive “Value Bounce”

Posted by: Brian Dennehy
Membership level: Free
 
Cutting interest rates is now pointless. Even the central banks now accept this. So what are the alternatives to revive flagging economies? And what is the impact in terms of investment risks (and opportunities) for you?
 
I don’t like stepping outside our strict investment brief. Politics in particular is dangerous ground, and economics is like voodoo – it’s very old magic and no one really has a clue what is going on. Yet before the Lehman’s bust in 2008 we highlighted growing political risks, and first wrote about “helicopter money” back in August 2016. The former is now accepted (though we received some barbs at the time), and the latter is increasingly coming into focus.
 
Two key reasons for our airing “helicopter money” and Modern Money Theory were:
  1. cutting interest rates no longer work as a tool to cure an ailing economy
  2. current debt levels are already at dangerous levels, so there are severe limits on what can be (conventionally) borrowed to buoy an economy in recession.
 
Something else needs to be done. Proclamations on the alternatives (you can’t call them “conversations”, as there is no exchange of views), tend to be polarised and angry, and insults flow both ways.
 
There are few people or institutions I would listen to in such an environment, but Eric Lonergan at M&G is one of them. Here are extracts from a note he and M&G published on 5th August, with my additions in square brackets [sorry Eric!]:
 
“The next phase [next recession] will require great political skill and intellectual bravery.
 
When interest rates are already this low, further reductions are ineffective.
 
Last week, Mario Draghi, president of the European Central Bank, suggested as much, stating that it was “unquestionable” that fiscal measures [government spending] would be required if the eurozone economy deteriorates further. Olaf Scholz, the German finance minister, promptly poured cold water on his suggestion. [as Germany is averse to debt, and spending more means more debt]
 
If interest rates are a spent force, and finance ministries unreliable partners, who will save the day?
 
Three novel proposals are gaining support, all of which involve giving people money. [yay!]
 
The first literally involves central banks posting cheques to households. The Australian government sent households money during the financial crisis and Australia avoided recession.
 
One problem with this common sense idea is its simplicity, which rarely appeals to economists charged with taking important decisions. [because if you are so so clever, and the solution is so so simple, it wrankles – same in the investment industry re Momentum strategy]
 
Another policy, already being practised by the Bank of Japan, is that central banks consider giving money to the owners of the stock market by buying equities. Unsurprisingly, many balk at the idea that shareholders are the most deserving beneficiaries of central bank largesse. [yup]
 
The most intriguing and practically viable idea of all is emerging from the least likely of sources, the ECB: so-called targeted long-term refinancing operations. [stick with this…]
 
One of the problems with reducing interest rates, and with negative interest rates in particular, is that households suffer a decline in interest income on savings. [in particular it is a bummer for those in retirement, and/or for those who are simply risk-averse]
 
So what if the central bank decides to reduce the interest rate that borrowers have to pay on loans and raises the interest rate households receive on their savings?
 
The evidence from economic history, and simple logic, suggests that if you boost household income in this way economies will recover.”
 
Interesting stuff from Eric. Also note that in June the Federal Reserve chairman highlighted that further interest rate cuts will make little difference in the next downturn, and how they should respond in that downturn is “the pre-eminent… challenge of our time”. Somewhere in Eric’s ideas, and amongst those which fly under the flag of helicopter money/Modern Monetary Theory/People’s QE, is the solution.
 
First steps will be controversial and tentative. More widespread action will probably only follow a severe economic downturn.
 
The first point that is clear is that policy initiatives will be designed to have an impact in the real economy – unlike quantitative easing post-2008, in which case the primary beneficiaries were financial markets and those who could exploit their gyrations. 
 
The timing of these initiatives is unclear. The second point that is clear is that when they do occur, the obvious beneficiary is domestic economies, and those companies which typically come within the “Value” categorisation, an area which is currently badly beaten up, and pregnant with potential. To this you should also add smaller companies.
 
Right now it is a good time to build your “Value” fund shopping list. We will work on this over the next week or so.
 
Topic: Market commentary


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