We start the morning with the following “anecdote” From Eric Peters, CIO of One River Management:
“There’s no way out, they need to stimulate through it,” said the CIO. In 1965 the government spent 3.25% of GDP on research and development, today its 1.25%. That missing 2% of America’s $18trln economy equals $360bln of annual R&D investment. Gone baby gone.
In 2000, NYC spent 8% of its budget on healthcare and pensions, today that’s 29% and rising. “Taking these factors into account, developed economies have the tightest fiscal policies since the great depression by multiple standard deviations.” Tight fiscal policy requires loose monetary policy. So today’s interest rates flat-line either side of zero. Everywhere. But as interest rates decline, so do investment returns.
And as these grind inexorably lower, unfunded pension liabilities soar. Imposing more belt-tightening. A nine-year 80% increase in Illinois property taxes didn’t fill their sink hole. “By stimulating the economy with lower rates, monetarists reflexively turn these fiscal screws ever tighter, creating the opposite outcome to the one they expect.”
And the multiplier is highly negative now. For every one dollar of rate cut stimulus, the fiscal screws tighten four. “This explains the growing disconnect between financial markets and the real economy.”
Asset prices are many things, but mostly they’re the net present value of their expected income stream discounted by an interest rate.
“As the reflexive relationship between loose monetary and tight fiscal policy slowly asphyxiates the economy, expectations for perpetually low interest rates become widespread.”
Valuing a cash flow using a 10% discount rate yields a narrow range of possible prices, but discounting it using 1% generates a vast range of potential outcomes.
Almost anything becomes possible. “People are nervous about the S&P 500 here because they can’t enunciate what I’ve just described. But there’s no longer a right price for the S&P, just an extremely wide range of possibilities. 2,000 isn’t crazy, nor is 3,000, or 4,000. Almost nothing is crazy.”
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