On the money / World gone mad, according to N.
Get used to a scary new world with no returns or profits, says this market animal who's been all too right before; and by the way, economic forecasting is categorically impossible.
Four years ago, in January 2008, TheMarker published a forecast by N., a highly original market animal who declined to be identified by name. N., who spoke with TheMarker along with another market guru, was the more pessimistic of the two, darkly predicting a crash. He had it right, as we know now. The markets crashed, benefiting mainly investors who had the foresight to flee in time.
We have since spoken with N. three times. He was always downbeat on the global economy's direction. Yet in his second forecast, delivered in November 2008 - at the height of the global crisis - he recommended that investors buy shares. Investors had overreacted and the downturn had overshot, he explained. Again he proved right: People who bought shares at the time did well.
His third forecast, in August 2009, missed the target somewhat. He said the market would stop in its tracks, that the gains were not fueled by concrete change. The markets didn't listen this time and climbed another 30%. But N. had been right in his diagnosis - the world economy was sick.
In his fourth forecast, in October 2010, N. called on the public to get out of the market. The gains had been fueled by rock-bottom interest rates (rendering safer investments such as bank deposits profitless ), not by positive economic developments. He was on the money: Markets have since lost about 12% of their value.
What does N. say today? He says the markets could gain a little more or drop a lot, and that in general there's no correlation between the (terrible ) state of affairs and short-term market performance, or even medium-term market performance. On the contrary. Sometimes the markets seem positively perverse. But in any case, the general direction is negative, N. says, and it's going to stay that way for a long time.
Investors need to protect the value of their money, he says, and only then think about profits. And finally: Cash is still king.
We shall briefly revisit his first four forecasts and then bring you his fifth.
1 January 1, 2008: A year of manic depression, N. predicted. It would be a bad year, N. predicted, marked by bankruptcies. The United States was trying to artificially pump up consumption, but it wouldn't work. The crash would start after the holidays, he predicted.
N. was right. The TA-25 index lost 48%.
2 November 19, 2009: A year of defaults, N. predicted. The world would descend into deep recession, N. predicted. Things would get worse, but not horribly worse. Stocks reflected more reward than risk - a lot were trading too low. Stock exchanges would correct upward but it would be impossible to say when, he added. People outside the market would miss an opportunity to make a killing, but make no mistake: Some companies would collapse.
Again he had it right. The TA-25 index gained 47%.
3 August 12, 2009: The morning after would be a grim one, N. predicted. Share prices overshot on the upside and would be bound to fall. Low interest rates couldn't sustain their effect forever, he predicted. The real economy, beyond the world of finance, wasn't showing true signs of recovering from recession. Corporate profits would prove more modest than expected. The momentum on the markets wasn't based on economic fundamentals.
Not quite. The gains continued. Tel Aviv's benchmark TA-25 index climbed 29%.
4 October 25, 2010. The low interest rates were stupefying. There was a whiff of crash in the air, N. said.
N. admits to misreading the power of the low interest rates. "I thought it was like taking aspirin, but it was more like taking Valium," he said. "It doesn't cure, but it soothes. Everybody bought stocks and bonds because interest rates were so low there were no alternatives. There's no reason for the gains. At some point the realization will filter through that the world isn't going anywhere. Then an adjustment in share prices will come."
It's very much in the interest of the world's leaders to pretend that it's business as usual. But it isn't, N. said.5. The world is a goner. Anything is possible
And now? N. is still pessimistic about the state of the global economy, but this time he has no forecast for share prices in the short run. Stocks could rise. They might not. There's no telling.
What's for sure is that the world is lost, economically speaking, N. says. "At best it will stagnate. There will be no growth at the global level. I've been saying that for two years, but now it's the consensus."
Meaning, stocks will fall?
"Once an investment manager told me, 'Tell me if unemployment will be worsening or what interest rates will be, and I'll tell you where share prices will go.' A century of stock market history is based on the thesis that macroeconomics dictates change in share prices.
"Forecasting is never easy. But this time, the correlation between macroeconomic processes and share price has pretty much disconnected. The sheer intensity of the problems, and their complexity, destroy any ability to predict their influence. In other words, we can identify the process but can't predict its results, or share prices.
"For example, there's a consensus that Japan is bankrupt. Everybody agrees about that. Their debt was 200% of gross domestic product before the tsunami disaster. They're in a state of total loss. But nobody can explain the appreciation of the yen.
"It turns out there's no direct correlation between processes that can be anticipated and their effect on prices, mainly because of the enormous number of parameters," N. says.
Economic systems are like biological ones: Cause and effect can be hard to predict because of the practically infinite parameters. Ambient temperature can change biochemical processes but so can a thousand other things, and the same applies to economic systems. Possibly, N. says, true forecasting in economics is impossible. That's why the world's investment gurus may guess right at the process but miscall its effect on the market.
What does that insight mean for investment management?
"That investment management is much less important. The world has turned into one giant stock exchange that is being threatened by a planetwide earthquake. It's very hard to generate returns at low risk. A veteran American investment manager recently said that not only didn't he know anybody who'd beaten the market over time, he didn't know anybody who knew anybody who'd beaten the market over time. Because of the complexity, any scenario goes. It could even be that the worse the crisis gets, the more stocks rise."
Against all logic?
"Against all logic is the heart of the matter. There could be gains in the short run, I think about 15% if the euro zone injects trillions more into the system. After that we'll be back to stagnation, because there's no solution to the long-term problems.
"Imagine this. The concerned family of a dying man waits outside his room. The doctors come out and say his situation has improved; they've halted the tumor's growth. What happens in that second? The optimism meter rises. The family feels relieved and maybe even goes out to celebrate that evening.