Why the money flood can't last forever
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The world is awash in a giant ‘wave of liquidity’, sending asset prices everywhere afloat to record levels. Will 2007 be the year it begins to dry up? Maybe…
Humility is our only virtue. And even where that’s concerned, we’re insincere. We believe our modesty gives us an advantage, merely because we recognise how foolish we can be. Others, less aware of their own infirmities, tend to bet too heavily on things they know nothing about.
But modesty often pays off. As the mass of self-confident gamblers pile onto one end of the see-saw, so we are lifted up on the other end by the weight of their numbers. So, instead of making predictions, let’s look back at 2006 – just to see what the cocksure are betting on.
2006 was a record-breaking year in the markets
So many records were broken in 2006, we could barely keep up with them. “Mergers and acquisition activity at record $4trn in 2006,” notes the Associated Press. “US high grade, junk issuance break records,” adds Reuters. Private equity was on a roll by year-end, with twice as many deals as the year before – financed, of course, by record lending from lenders with a record amount of loose change in their pockets. US corporate profits reached unprecedented levels. Real-estate deals in New York City hit noteworthy highs.
The Dow ended the year at a record high. Money shufflers in the City and Manhattan got record pay. And the worldwide value of the derivatives market reached about seven times the value of world GDP.
In many parts of the world, stocks rose to new highs, with the Chinese leading the way. The Shanghai index doubled in the last year – hitting, naturally, a new record. So did many commodities. Tin reached a 17-year high by year-end. Corn is at a ten-year high. And uranium has never been more expensive; it is twice as high as it was a year ago.
There were records set in politics, too. It was the first time ever that we can recall that a vice-president of the US mistook a middle-aged hunter for a duck and blasted him with buckshot. The Bush administration must have broken all records for spending money, as well as for its overseas military misadventures. But who keeps track?
Why high levels of liquidity are to blame
We were not surprised by these records, merely shocked. They are the inevitable consequence of what the FT calls a “wave of liquidity” and what the Wall Street Journal calls “rapids” of cash. The world has not seen a wash like this since The Flood. And at the close of 2006, it was still pushing up asset prices and setting new records just about everywhere. And most investors, commentators and analysts expect it to continue. “Another year of riding the liquidity wave,” predicts the prestigious Bank Credit Analyst of Montreal.
But it is not given to man to know his fate. At least, it is not given to us. To the big question – is this the year when this ‘wave of liquidity’ finally begins to ebb? – we have no answer. But our guess is that too many people are betting too heavily on it. Some have even come to the conclusion that it is not temporary, but permanent; that we are living in a
‘New Era’ of permanently high levels of available cash and credit.
If there were records set in prices last year, so were there records in investors’ levels of hope, faith and recklessness. People pay record high prices when they suspect that nothing bad can happen. Almost all the records we have seen in 2006 reflect a level of complacency bordering on coma.
Why investors should be cautious in 2007
We don’t know what’s ahead for 2007, but we warn readers that for every high, there’s a low. And for every fool, there’s a wiseguy waiting to take advantage.
The records we find most intriguing were set in the art world. Overall, the Mei Moses art index rose a record 22% last year. A Gustav Klimt painting sold for a record $135m. No one had ever paid that much for a painting. And then, a few months later, along came someone with $140m for a Jackson Pollock.
And here, we have to sit down and compose ourselves. $140m would produce about $7m income a year, invested at 5%. Who could get $7m worth of pleasure from looking at a Jackson Pollock each year? Obviously, the owner has a lot more money than we do. But if he is so rich, how come he’s not smart? Or are we the stupid ones? That is the problem with humility; it always leaves you in doubt. But unless the owner can get a return of $7m, he must be counting on something other than yield. He must be counting on capital gains – an even higher price, an even greater record. He’s probably betting there is an even richer fool waiting to buy the thing.
He may be right. But humble readers might want to get on the other side of that see-saw, just in case.
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