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Assessing the post-crisis investment landscape

The policy cures that have been adopted to deal with the recession are made of the same poison that caused the crisis. The post-crisis world demands policy solutions that extend beyond short-term expediency, writes Adrian Saville.

Measured by economic and financial criteria, the global economic meltdown of the past two years is unprecedented.

In 2009, the world economy went into recession for the first time since the end of World War 2; commodity prices collapsed, with oil prices falling by more than $100 a barrel in the space of 12 months; and international trade declined by 10% between the start of the crisis and the middle of this year.

Further, the crisis has seen a raft of firms disappear, including former icons such as Bear Stearns and Lehman Brothers.

For many of the survivors, business as usual has been replaced by substantial adjustment. Firms such as Merrill Lynch, General Motors and AIG stand out on this score.

Equity markets captured this impact on firms by shedding $35 trillion in capitalisation over the 15 months to the end of March 2009.

As an aside, it is staggering that this figure is equal to eight times the world’s store of gold at the start of the crisis.

Policy-makers in leading economies responded to the meltdown by embracing three tools. First, aggressive easing of monetary policy was undertaken to help thaw financial markets. In places, including Japan and the United States, this hard-line easing has seen so-called zero interest rate policies augmented with quantitative easing, allowing banks to borrow as much as they want at close to zero percent.

Second, policy-makers attempted to restore business sentiment by providing rescue packages for failing or sick firms.

Third, to repair consumer sentiment and bolster real economic activity, governments put in place generous fiscal packages, such as the $800-billion spending programme in the US.

It is evident from recently released economic data that these policies have had some impact. For instance, data indicates that, in all likelihood, the Western European and US economies have troughed. Further, economies in other parts of the world, including Brazil, China and India, have taken solace from the forceful policy action, managing to grow quickly this year despite the global recession.

Capital and commodity markets

In turn, capital and commodity markets have been spurred on by the policy cocktail. The MSCI World Equity Index, for example, has gained 50% since the first quarter of 2009, representing a recovery in equity values of some $20 trillion. Similarly, the prices of commodities, including oil, copper, gold, platinum and sugar, have risen materially.

Read together, the recent economic data and the market price responses suggest that the world has seen off the worst of the global financial crisis. This view, though, seems short-sighted for the simple reason that policy-makers have embraced greater spending, easier credit policies and government sponsorship to solve a problem that has its roots in reckless lending, unbridled risk taking, financial decadence, and regulatory failure by governments.

Given this, for investors who are trying to make sense of the ebullient responses of the markets following the depressive mood of early 2009, it may serve them to recognise that the policy cures that have been adopted are made of the same poison that caused the crisis.

For investors, then, the question becomes: what lies beyond the short-term policy and market reactions?

In part, the answer to this question resides in accepting that the financial crisis has caused debt mountains to grow instead of shrink. This is particularly true in the case of advanced economies. By way of example, in Japan, the national debt now stands at more than 200% of gross domestic product. In Western Europe, Italy faces a similar figure.

US deficit

The headline grabber, though, has been the US economy, whose fiscal deficit has resulted in a debt-to-GDP figure in excess of 100%.

If the US government’s off-balance sheet debt is added to the equation, national debt balloons to more than 500% of GDP.

If we accept that a national debt-to-GDP figure of around 75% is considered to be a red line, and that the advanced economies such as the US have shrinking workforces, it follows that some of the world’s advanced economies are in debt traps.

To boot, during the last two years, debt has been monetised in many of these economies.

For the US, this printing of money has resulted in money supply more than doubling between 2008 and 2009.

Moreover, from history we know that excess debt and consumption is always followed by currency debasement. This poses a major risk to the stability of the US dollar, which has served as the world’s reserve currency since World War 2.

In any event, it is evident that this cocktail is poisonous. If the principles of economics hold, there is a reasonable chance that the next crisis faced by investors will involve navigating the threat of sovereign debt default in some advanced economies while coping with the spectre of high consumer price inflation.

Assets to withstand tough times

Experience shows us that some asset classes are reasonably well placed to deal with this tough environment. In particular, portfolios that hold physical and productive assets – which include commodities, and particularly gold, real estate investments and equities – are far better equipped to deal with the debt, deficits and default than the so-called safe haven asset classes of cash and government bonds.

Drawing these arguments together, investors equip themselves to navigate the post-crisis environment by recognising the risks and opportunities that are likely to flow from the policy actions that have been taken to address the crisis. In the same breath, the environment demands more than investment solutions.

To be sure, the post-crisis world demands policy solutions that extend beyond short-term expediency. More of the same simply will not suffice to cure the world and its leading economies of the credit binge.

Adrian Saville is founder and chief investment officer of Cannon Asset Managers

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