By far my favourite comedy film is Spinal Tap. For those unfamiliar, this is a spoof ‘Rockumentary’ about an ageing British heavy metal band trying to defy the years and milk more from a music career that should have ended long before. One of the most iconic scenes involves the lead guitarist (Nigel Tufnel) describing how his guitar amp is louder because the dial goes “all the way to eleven” (see here).
Western policymakers are not dissimilar to Nigel Tufnel and the rest of Spinal Tap. Firstly, they have not displayed an ability to move with the times and are seemingly wed to a discredited economic model that offers real choice between growth and austerity. Surely, this is a false predilection and the reality is that difficult decisions need to be made for the long term.
The move of Moody’s, the credit rating agency, to strip the UK of its coveted triple A status is seen as a verdict on the coalition government’s strict adherence to austerity as a way to reduce, and eventually eliminate, the country’s budget deficit. Readers may remember it was not too long ago that Moody’s and other ratings agencies urged the UK not to diverge from its austerity path or risk losing the status anyway. Sometimes you just cannot win.
Thankfully we have France as the poster-boy for another approach entirely – namely keeping spending high and allowing taxation (particularly on the ‘rich’) to take the strain. Most economists (themselves not covered in glory over recent years) argue that low and stable taxes, both incentives for corporate investment and entrepreneurism, provide the basis for economic success. While we wait to find out whether François Hollande has actually found the recipe for success, the wealthy and talented of France continue to vote with their feet.
Perhaps turning the dial to eleven should actually be compared to central bankers’ propensity to utilise unconventional measures such as quantitative easing to paper over underlying economic cracks, prevent debilitating deflation (exacerbating the debt trap) and give their exporters a competitive advantage through currency depreciation. Ironically, one may view the UK as the current ‘winner’ in this respect following the recent slide of sterling against other major currencies. Nevertheless, this ‘race to the bottom’ in currency terms could well result in the market equivalent of an exploding amp, which may mean the populations of these countries having to busk for many years to come.
Recent events remind us of the need for investors to think globally as they seek opportunities to generate returns and protect against specific risks. We also need to remember that markets can be highly emotional, which often leads to more extreme price moves than are justified. Keeping a focus on valuation therefore allows us to exploit dislocations on behalf of our clients.