Hindsight is a wonderful thing. If only humans could do a better job of using it to make money! When economic and investment trends are in the process of unfolding, it is hard to figure out why some things are happening that just don’t make a lot of sense based on the information we have at the moment. But, after enough time has passed, the pieces of the puzzle can be connected as to why things went the way they did. Kind of like financial crime scene investigation.
It is now becoming obvious is that the use of credit, both consumer and financial institution leverage, helped the economy grow at above average rates for much of the last couple decades, and investment returns were above normal in various asset classes, each in turn as the financial leverage rolled through different investment categories. All of this has culminated in the antithesis of an asset bubble – the speculative bubble of fear that exists today.
If you didn’t think you could invest in fear, just look around. Ninety-one-day U.S. government T-bills are yielding barely above 0 percent interest. Something like eight trillion dollars is sitting in risk-free cash equivalents here in the U.S alone. Even 10 year government bonds are yielding under 3.5 percent (the average of the last 80 years or so has been about 5.4 percent). Investments in fear don’t typically pay very much, but they tend to provide safety of principal. When investors are scared, the return of your money is more important than return on your money.
In the late 1990s the bubble of capital rolled through the stock market providing returns almost double the long-term average. When the bubble in stocks burst, the capital flows shifted to real estate, and for the first five years of the new century, real estate returns were way above normal.
The bursting of the real estate bubble saw investors shift their attention to commodities and emerging markets, buying into the theory that China’s endless growth would use all of the world’s oil. Gee, I guess that theory worked about as well as the one in 2000 that said Internet companies didn’t have to have any sales or profits to be worth $100 per share!
What most, including myself, did not see coming was the impact of the unwinding of the huge mountain of leveraged investment debt, which was tied up mostly in derivative investments related to mortgages, and how the selling avalanche to get out of any vehicles you could get out of would impact the share prices of even high quality corporations and high quality corporate bonds.
The resulting aversion to risk has created speculation in fear, as investors seek safety above all else. Like all bubbles, the fear bubble will pop. I don’t know when, but when confidence is regained in the system and investors poke their heads out of the caves to seek higher returns than zero, we will see the fear bubble deflate and assets which carry a risk premium will do well again.
This has been a very stressful time for investors, and it may not be over yet. I believe however, that like all speculative bubbles, this one too shall one day be a thing of the past and we can look forward to investing based on fundamentals and a chance to earn reasonable returns on our capital without the fear of leverage undoing the structure of the system. Of course, that’s until the next credit bubble begins, hopefully a good ways off after this latest experience.
Tom Breiter is President of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.