Despite that, for me, a consolation of 2008 was that it seemed western society had finally realised the danger of borrowing the proceeds of future economic activity to spend today. At best, the long term consequence of speculative borrowing is a new economic equilibrium with the same level of growth but more debt. At worst, the pyramid scheme collapses, when people realise the prices of assets today are only underpinned by a general belief that some greater fool will pay more for them tomorrow. Governments around the world, and their central banks, intervened to ensure order, giving economic participants time to adjust their expectations to the new regime, to minimise dislocation in the real economy and attendant misery.
Hardcore free-marketeers argued that investors instead be left to suffer their losses and learn the lessons of their misbehaviour. Increasingly, it seems they may have been right. The return of gazumping to the London property market; the continuation of excess in the football transfer market and the doubling of the China A-share market from its low are not evidence of a prudent new investment paradigm. Nor are they merely a reaction to oversold markets in the first quarter of the year.
However, even to the extent the recent rally has been liquidity driven, the mere fact that markets have recovered has improved the fundamental prospects of many corporates. In the past, many bears have met their end, drowned by the tide of rising liquidity that has flooded a post-crisis market, only to see their fundamental views proven right in the long term. This period may be no different.
There are only a limited number of ways out of the current malaise. We can earn our way and pay down the debt, resigning ourselves to a period of stagnation. We can inflate it away; whilst governments may like that independent central bankers will not. We can increase our labour supply, for example, by retiring later. Or we can develop new technologies that increase our productivity. The last is perhaps the most appealing and we should not lose sight of the ability of humanity to overcome its difficulties through technological progress.
We expect the USA to do better than many other countries over the long term. With excess demand for US citizenship, it will have no problem importing young, talented, hard working people to boost its economic potential. It has the space to accommodate them. It also has a robust system of law and a culture that holds entrepreneurialism in high regard.
In contrast, the market is looking more to China for its salvation, on the basis that the Chinese government can direct the country out of recession. This is a mistake. If the twentieth century taught us anything, it was the inferiority of the command-economy model. Directing banks to lend to corporates to make product no-one wants to buy is not generating genuine economic growth. That needs a balance between supply and demand and it is the absence of the latter that creates recession. It is difficult to foresee an increase in western demand with the consumer and business retrenching and government ability to finance further borrowing becoming increasingly constrained.
So, whilst we attempt to hold onto the coat-tails of the rally by our fingertips, we remain conscious of a bleak fundamental backdrop and retain an element of flexibility in our portfolios. We have also increased our allocation to funds managed by those stock-pickers we feel can generate good returns in spite of a weak economic outlook, particularly from those developed markets which remain under-appreciated by the wider investment community.