Return figures for the first half of 2010 did not make for inspiring reading. Government bonds performed rather well and some high yield and emerging market credits much better still. The main story however was one of renewed volatility and flatlining or declines by most asset classes. July has so far been a different story however, with several key markets and risk assets turning sharply back up.
This patchy narrative is, frankly, not much of a surprise, given the nature of the economic conditions through which we are living. Volatile markets moving sideways amidst continuing uncertainty about economic trajectories is very much what the “new normal” is meant to be about. It has not made managing money any easier however. Of more than 2700 UK funds monitored by Trustnet, for example, the median return year to date is just 2%.
According to the latest quarterly survey by Asset Risk Consultants, the average manager of sterling or dollar based private client assets gave back all or more of the gains that were eked out in the first quarter. For many hedge funds, the year has been a virtual washout, despite the fact that on paper volatile markets are meant to be the ones in which they should be thriving. Those dumb, derided retail investors who poured their money into bond funds for the moment look smarter than the pros.
Standing back from the fray, is it possible to see what is going on? While equity markets were clearly due a pause after their powerful recovery last year, investors remain mired in the fog of a seemingly unending struggle between powerful ongoing global deflationary forces and concerted Government and central bank attempts to head off the consequences through monetary expansion and (whisper it not too loudly) competitive currency debasement.
The inflation/deflation argument seems to ebb and flow from month to month, mainly in response to news flow and shifts in investor sentiment, with little regard to fundamentals. One paradox is that while sovereign debt has been the outstanding news theme of the year to date, it has so far failed to make much of a dent in the performance of government bonds outside the most obviously indebted crisis areas.
By the same token the argument whether or not the US economy is heading into a double dip recession may have become more shrill, but it is hardly nearer resolution. The evidence on either side, as far as I can see, is so far too inconclusive to award a victory to either side. Leading indicators are pointing down, but that is consistent with a slowdown as well as a new recession. The one certainty seems to be that the Federal Reserve will continue to err on the side of monetary laxity, with a second bout of QE on its way at the first sign of any market panic at deteriorating economic data.
In his latest investment bulletin, the fund manager Jonathan Ruffer likens the current economic environment to a dangerous downhill road. At the wheel sit the drivers of economic policy, desperately lurching from one side of the road to another in a furious attempt to keep their economies out of the ditch. Deflation is the ditch on the left, inflation the ditch on the right. Unfortunately, the faster and more furiously they yank the steering wheel from one side to the other, the more dangerous and erratic the descent becomes.
Mr Ruffer’s view, like mine, is that the final destination of this bumpy ride can only be the ditch of inflation. At present there is “an overwhelming dynamic”, he writes, away from “do-nothing deflation towards the soothingly-delayed consequences of monetary compromise”. Although we are trapped in a period when “the fundamentals of economic forces are willed into quiescence by politicians and bankers”, the only good news is that it cannot last indefinitely.
But if quality real assets are the ones which investors need to own to prosper from the eventual inflationary outcome, the choice is not so simple for those who either lack that clear-cut conviction or feel professionally constrained to outperform over shorter horizons. How soon we reach the final inflationary destination is impossible to predict with precision. (Mr Ruffer, whose funds set out to make positive returns in all conditions, still owns lots of bonds for that very reason).
All we know is that the journey ahead will be full of heart-stopping moments when one or other ditch looks like claiming a new victim. For hazards in today’s financial markets, read spikes in volatility and bonds whose capital value must, as a matter of mathematical inevitability when yields in general are so low, leap around in extravagant response to every minor twist and turn in the ongoing inflation-deflation debate. Markets that are hooked on monetary stimulants will tend to be bipolar in nature.
It is only small comfort to argue that the one sure way to make money in these difficult market conditions is to play currencies, the instruments through which the global game of competing monetary disorder is being played out. Having no intrinsic value and defying fundamental analysis, currencies are the ultimate zero sum game. Seeking to elevate them into an asset class is a sign of how hard conditions for managing money have become while the current “monetary disorder”, as Mr Ruffer calls it, persists.