This month is the tenth anniversary of the beginning of the “financial crisis” that precipitated the great recession of 2008-09. In June of 2007, two hedged funds managed by Bear Stearns that speculated in credit derivatives backed by subprime mortgages collapsed. That started a chain reaction that over the next eighteen months led to the forced merger of Bear Stearns into JP Morgan Chase, credit markets virtually shutting down, and by September of 2008, the bankruptcy of Lehman Brothers. At the time, even money market funds were in question as safe repositories of assets.
Global central bankers, led by the Federal Reserve, acted decisively to provide liquidity to global markets. Confidence was sufficiently restored. Markets began to work again. Although many would argue that central banks have been too long at the rescue. They have used “tools” never before used in modern monetary policy like negative interest rates, and so-called quantitative easing (buying bonds with created money). The Bank of Japan is even buying Japanese stocks! Of course, all this easy money has led to inflation in paper asset prices, even as the central bankers claim to be ever mindful of concerns about inflation in consumer prices.
The Federal Reserve has started to “normalize” monetary policy after the economy has achieved a “normal” rate of full employment. They have even spelled out their plans to reduce the balance sheet of the FED (slowly selling the bonds they have purchased over recent years). In spite of this, longer term interest rates have recently declined, bringing the difference between short term and long term interest rates to the lowest spread in many years. Either the bond market is expecting a slowdown in the economy, or, there is much money in the global financial system being created by the other central banks that is finding its way into our bond market. I am guessing it is the latter. In this globalized, digital world, money created anywhere eventually finds its way to the more attractive assets. US Treasury Bonds at 2% don’t seem great to me, but compared to German bunds at 0.3%, the yields seem enormous. Someday the music may stop, but it doesn’t appear to be any time soon.
Meanwhile it is interesting to think of what real changes have occurred in the last ten years. A list of some follows. It is neither comprehensive, nor is it in order of importance. Most of these things are causing changes of their own.
The Arab Spring which was hailed as a democratic revolution in much of the Muslim world proved to result in power vacuums filled by terror groups, or dictators.
ISIS, which has led to increased terrorism, immigration backlash, and even Brexit ( the UK leaving the European Union).
Plummeting Oil prices caused by the efficiency of “fracking” in US shale oil fields. The US shale oil players are now the swing producers in OPEC. They answer to no particular government policy, but to market forces and bankers. A side effect is much reduced CO2 emissions in the US because natural gas is being found in abundance, driving down the price and driving coal out of the electricity market.
Mobile computing has transformed social media like Facebook and YouTube from cute pass times to central players in the economy. And it is still early!
The internet of things means that all kinds of businesses have been, or will be, digitized leading to stunning growth in “the cloud” (warehouses full of computer servers). Through this, Amazon is transforming the retail business.
Banks and financial service companies in the US are being overregulated in reaction to the long passed financial crisis. Can’t get a mortgage or loan from a bank? You are not alone. Bank capital ratios are 4-5 times greater than before the crisis. The CFPB is trying to “protect” consumers. All of this results in rationing credit away from borrowers who need it. The good news is that our economy is resilient. Private credit partnerships and new public companies called business development companies have been created to fill the void left by the regulators. Of course, it comes at higher costs to consumers.
US markets have fundamentally changed as more than $2 trillion have moved from actively managed mutual funds to passively managed index ETFs. This has reduced market volatility and the appetite for initial public offerings. In addition, algorithmic short term trading (microseconds) now makes up 90% of the daily volume in US equity markets.
Please notice that I did not list any changes in politics, or politicians. It seems like business as usual to me.
A very economically sophisticated friend recently told me that these are not “normal” times. He is concerned that when the central banks get really worried about inflation and they unwind the money they have created, the asset bubble will collapse and create a great buying opportunity. Maybe. But, you could have been saying that for most of the last eight years and missed a lot. I do not pretend to know when the bell will ring.
I do know that the things I listed above are important and real. I also know that people here and abroad work constantly to prosper in a changing world. Opportunities are created from difficulties. The “financial crisis” didn’t end prosperity. Presidents Bush, Obama, and Trump did not, and do not, create prosperity. Free people, in reasonably free markets, create their own prosperity over time.
Robert C Davis, CFA
A note from WSC and WAMI . . .
Robert C Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Caney Creek, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.