Highlights from Bermuda’s GIC conference
The Chartered Financial Analyst Society of Bermuda recently hosted the Global Interdependence Conference in Bermuda on October 10 and 11. It was a fantastic forum with some world-class speakers. What follows are a few key takeaways.
1) Sometimes we don't know
One of my favourite sessions was one in which Herb Taylor and Michael Bryan, both senior staff members of Federal Reserve Banks, discussed quantitative easing and inflation. What really hit home for me was Mr Bryan's stark admission that forecasting is not only difficult but fraught with huge errors.
More specifically, he graphically displayed how forecasting large macroeconomic aspects such as gross domestic product are nearly impossible with any semblance of accuracy. History has proven time and time again that professionals who forecast all aspects of the economy or market have questionable and inconsistent track records. The future performance of the stock market or the economy will always be an open question. There is a huge risk for many professionals to get “model myopia” and “quantitative blindness” when they immerse themselves deep into complex models with unwavering faith in the math. Reality of systems that are impacted by human emotion and large exogenous shocks cannot, in my opinion, be modelled with pinpoint accuracy.
They can be “guessed” but one needs to ensure that common sense and acknowledgment of reality is used as a constant check. To be honest, most investors would be better served worrying about aspects they can control like their asset allocation, tax planning, and how much they are actually saving. The sexy allure of big picture and macro focus has unfortunately created an environment that focuses too much on what we will never be able to know for certain and what we surely cannot control anyway.
2) Fear and liquidity traps
Paul McCulley, former Managing Director at PIMCO, gave an intense speech, full of analogies. Two such analogies stood out for me. The first involved explaining what a liquidity trap is. The analogy he used is one of a bartender serving beer. At first the beer is $2 a glass. Then customers stop coming to the bar, so the bartender lowers the price of beer to $1. Unfortunately there is little change in the volume of clientele. So the bartender throws up his hands and offers beer for $0.
Typically you would see a stream of people pile into the bar to get free beer. But this time you don't. Nobody wants beer anymore — he cannot even give it away. The problem is the bar is located in the basement of the Alcoholic Anonymous building. The analogy refers to borrowers and the cost of money. Even though the Federal Reserve has dropped rates to essentially zero, borrowers are not flocking to borrow and lever up again.
They have chosen to ignore this almost free money and instead focus on repaying what debt they have. Why? Mostly it's fear or at least a sense of apprehension.
This brings us to his second analogy. Let's assume you are driving and get pulled over for speeding. After being written up with a ticket and the prospects of a steep fine what are you likely to do right after you pull back into the road and commence driving? You are likely to keep staring at the speedometer every couple of minutes to make sure you're not speeding again. The chance of you getting another speeding ticket in the next hour is virtually zero but still you will constantly fret and check the speedometer to make sure you are within the legal range. In fact, for the next few weeks and maybe months you are likely to be very conscious of your speed and far more cautious. But maybe after a few months you will forget about the ticket and put the incident behind you. Then of course, you are likely to go on driving a bit faster like you used to do before.
This is a simple analogy for some of the behavioural aspects in investing. Once we have a huge financial crisis we are emotionally scarred. The 2008 financial crisis left investors in a fragile state where they constantly expected another “speeding ticket”.
Almost every problem since has been thought of as a calamity even though most are simple problems. Investors have suffered “Armageddon hypochondria” — irrational fears of imminent economic and financial collapse. This has hampered confidence and the recovery so far. Volatility and price swings have been witnessed on mere indication of another potential adverse event. Examples include the mention of: a double-dip in the housing market, a massive series of municipal bond defaults, a loss of the AAA bond rating for the US, the break-up of the Eurozone, a hard landing in China, and more recently a dysfunctional government.
As a result the market's animal spirits have been slow to return as post-traumatic stress disorder has hampered confidence. Imagine what could happen if businesses and investors felt a sense of clarity and exuberance? Time heals and helps confidence return. It offers “financial amnesia” of sorts and slowly brings back risk taking behaviour. When we get to this point, however, you probably should slow down before you get a speeding ticket again.