As the S&P500 rocketed into the close this morning on yet another European bailout rumour, it occurred to me just how broken the equity market is right now. We are trapped in bear market dynamics of grinding sell-offs punctuated by explosive short-covering rallies with no end in sight.
The obvious conclusion to draw is that we are witnessing a great stuggle between bulls and bears. That the outcome of this struggle will determine the economic cycle and our own job security. And today was a great win for the bulls, snatching victory from the jaws of the bears. That’s the way the media will portray it.
Rather, I would argue, what we are seeing is the death of the entire paradigm that defines “bulls versus bears”. Let me explain.
For thirty-odd years, Western stock markets have enjoyed one of the greatest booms in history. The reasons why are easy enough to see in retropect:
- an historic boom in credit and leverage
- a period of expanding liberalism, trade and globalisation
- the triumph of the Western consumption model
- little conflict between Great Powers
- technological advancement giving common folk direct access to equities
- governments committed to ownership societies through tax breaks
It’s no wonder that throughout the period, equity markets enjoyed stellar returns. The list is pretty much “the end of history bull market”. That phrase coined by Francis Fukuyama to decribe the period of American triumphalism following the end of the Cold War, when liberal democracy and capitalism seemed destined to end the political economy struggles that has determined human progress for millennia.
But the “end of history” was always an illusion. What was really happening, was that the US liberal empire had reached its apogee and, like all empires before it, lost sight of what got it there when no peer was left to define it.
In its military and political dealings, the US became arrogant. It spurned traditional alliances and the institutions of strategic management that it had itself established to serve its own ends. It abandoned the strategic ideals of realism and liberalism in favour of a more perfect, and hence flawed, goal of forcing others into its own mould. And it did it alone, through voluntary wars in far flung provinces.
In its economic dealings, the US rightly insisted all other countries follow its lead. But when other countries did so, and began to hollow out America’s own strength, it turned not to redoubled efforts to compete but to easy answers like credit inflation. This is as true for the markets and businesses that embodied US liberalsim as it is the empire itself. The manufacturing power, caution and surpluses that had defined US economic leadership through much of twentieth century was replaced by post-modern games of financial inflation, never ending deficits and a complete abrogation of risk.
The outcome was, of course, the opposite of that planned. And so, the world is now reaquainting itself with something that it forgot during the 30 year party that was the “end of history”: structural risk. Let’s revisit our list of structures underpinning the bull market of yesteryear:
- a historic credit boom and leverage has turned to a series of burst bubbles and deleveraging
- exapanding liberalism, trade and globalisation has tipped into a period of intense currency wars, leading inexorably to trade wars
- the triumph of the Western consumption model is over. In its place we now have a mad scramble for economic surpluses
- little conflict between Great Powers is, sadly, passing, though, if we are fortunate, hostilities will be confined to economies
- technological advancement giving common folk direct access to equities is still intact but is now fighting a tide of skepticism powered by volatility
- governments remain committed to ownership societies, but how committed can they be when they themselves are so close to bankruptcies and must raise taxes?
So what does this have to do with today’s short covering rally? Everything. Days like today are not some romantic struggle between bulls and bears, they are a reminder that in periods of structural risk that volatility reigns. Anyone that tells you otherwise is a fool or trying to sell you something.
To me, the nomenclature of bull versus bear now makes no sense whatsoever. In a world chock full of structural risk, the only sensible approach to your money is to look for modest returns that incorporate risk. You must be bull and bear.
The alternative is that you’re a gambler and, sooner or later, broke.