Rational markets expect crazy economies
The financial crisis showed limits of models. Fiscal and monetary policy are even less predictable
With global asset prices embarking on another alarming rollercoaster ride this week, some investors feel it is time to throw in the towel. In London, one leading hedge fund has done just that.
The reason? Martin Taylor, Nevsky’s co-founder, thinks the world economy is subject to so much political risk that “it is more difficult than ever before for us to accurately forecast macroeconomic and corporate variables”.
One of Mr Taylor’s main concerns, according to an investor letter reprinted on the Zero Hedge website, is the fact that events in China and India are increasingly shaping the global economy.
The trouble is that it is difficult to know just how they are shaping it. “Obfuscation and distortion” make official numbers on the state of their economies unreliable.
“Never has so much of the world been governed by leaders where the logic of that peculiarly parochial yet multi-headed beast — nationalism — trumps all,” Mr Taylor writes. This, he says, is “leading to highly unpredictable and potentially dysfunctional modelling outcomes”.
Some readers will roll their eyes. After all, savvy investors often love political risk; as Nathan Mayer Rothschild is reputed to have said of the Napoleonic wars, the biggest profits are often made when “there is blood in the streets”. Hearing a fund manager wailing about “uncertainty” is thus a bit like hearing a politician or chief executive saying they are resigning to “spend more time with the family”.
Nevertheless, Nevsky’s letter is highly symbolic — particularly in a week when the oil price is tumbling, the Chinese markets have crashed and currencies are swinging wildly.
Moreover, it is not alone in drawing in its horns: several high-profile funds, including BlueCrest, Seneca, LionEye and Lucidus Capital have recently done likewise. They have all presented their decision in slightly different ways but all point to a common theme: markets are becoming so unpredictable that tried and tested strategies are breaking down.
A decade ago, it was taken for granted by most western investors that economies could be analysed with “rational” models. The financial crisis of 2008 showed the limits of this approach.
Waves of capricious government intervention that have taken place since have offered a second lesson in unpredictability.
But now a range of political shocks — such as the intensifying tensions between Saudi Arabia and Iran — are showing the folly of using economics alone to forecast where economies are headed. A century ago this point was well understood: as Niall Ferguson, the Harvard historian, has pointed out, military conflict was so endemic in the 19th and early-20th century that nobody would have dared think money and markets (or even central banks) could be separated from politics.
Of course, if you want to be optimistic, it is possible to argue that this is just a short-term phenomenon. Mr Taylor insists he still believes that, since “the laws of economics will never be repealed”, his rational, model-based approach will “eventually” become relevant once more.
Just do not count on this happening soon.
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