We believe that markets are currently in the grip of at least three, discordant, factors:
A cyclical component:
A short-term factor driven by 1) anaemic economic data globally; 2) worries about present and future credit creation due to the pressure on banks; and, most importantly, 3) poor investor sentiment/confidence.
A secular component:
A long-term factor, very much in investors’ minds now (but which often recedes) that is driven by 1) high levels of developed markets (DM) debt; 2) aging populations and attendant health and pension costs; and 3) the commodity and emerging markets “super-cycle”.
A structural component:
A factor centred round institutions’ and policymakers’ abilities to address large-scale problems. This is most obvious in the eurozone and US’s difficulties in balancing the demands of debtors and creditors (across geographies in Europe, and across time in the US).
Unusually, all three factors are affecting the world simultaneously, thus creating the manic swings in markets.
The biggest issue is, in my view, the structural factor. There is evidently a need for strengthening the conflict resolution processes in our complex and imperfect democratic societies. I am confident, however, that a constructive resolution to the debt crisis will ensue in the coming months. The European project will, in all likelihood, prevail over national interests, as it has done, more or less, for many decades.
The US situation is less clear, politically, but the underlying dynamism of the economy and the resourcefulness of its people still lend confidence to a satisfactory outcome, in the medium term.
Until the complex counter-currents begin to subside, we recommend a cautious stance in the markets for most of our clients. Things could still go horribly wrong – benign outcomes are far from guaranteed. For deep-value investors with a long time horizon, however, the Q3 2011 sell-off presents an excellent entry point to buy great companies, and emerging market debt and currencies.
