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Stewart Cowley: the extraction of wisdom

Stewart Cowley: the extraction of wisdom

In the past couple of weeks I have had my wisdom teeth out and, due to damage to my lingual nerve in the process, how I perceive the world has changed.

For instance, the bloggers and trolls who follow around anyone who ventures into the public domain can, quite legally and without fear of redress, now write that 'Stewart Cowley has no taste'. Because I don’t - every meal has become a whole new set of adventures in texture and the degree to which I can detect salt, which is the dominant taste sensation that I am now left with.

Interestingly, this personal perception shift had coincided with a change in my investment perceptions again because of a small change in how to look at the world.

Draghi gets it

What has brought this about isn’t a slightly careless maxillofacial surgeon but something worse - European Central Bank chief, Mario Draghi and his carefully crafted press conference last week, showing that they had finally 'got it'.

The incredible shrinking financial system that is Europe is going to need some form of support process. Otherwise, the deflation that is all too obvious in the real economy is going to take hold.

What is clear from Draghi’s comments is that they are going to find their own version of quantitative easing – not for them the Americanised money printing that has seen the Federal Reserve’s balance sheet quadruple without major consequence for the real economy.

The US financial economy has become inflated – stocks, government and corporate bonds all have been twisted by the process but then again that was the purpose of it – but the real economy hasn’t experienced the inflationary burst you might have expected.

No, it looks like the Europeans are going to go for something more administrative: something that will see the ECB take onto its books the tangle of bad loans that is stopping the quantity of money from expanding.

It will also serve to counteract the self-inflicted wounds of Basel III and the Asset Quality Review which makes bankers cautious and, in aggregate, constrains money expansion at a time when the system needs it most.

Draghi may have learned his lesson from the previous March press conference when the mere suggestion that Europe would not support the system with QE sent the euro spiralling upwards, something that is now becoming of concern.

Unfathomable currency movements

Because, at that moment, the game that we all knew was going on, was given away. Unfathomable currency movements can be rationalised like this;

• If you indulge in QE your currency will be punished

• If you indulge in QE all financial assets will rise, almost indiscriminately

Using these rules you can understand why the US dollar and yen have fallen, the euro has risen (despite all the problems within Europe) and why sterling began to appreciate the moment Mark Carney turned up at the Bank of England last summer and ended the process of QE for the UK.

Changes in market dynamics

What is also interesting is the timing of a European-style QE process – it will happen (for surely it will) precisely at the moment when the US is ending theirs. This could give rise to some very interesting changes in market perceptions and dynamics;

• The euro could fall against a basket of currencies (especially the US dollar and sterling)

• European financial assets will rise sending stock markets higher, government bond yields lower and corporate bond spreads tighter almost indiscriminately

• The European and US financial cycles decouple for the first time in many years

• Previously unloved emerging market currencies become the beneficiaries of money flows out of the Eurozone

Arguably, some of these new trends are already in place - you only have to look at corporate bond yield spread declines in Europe - whilst some emerging market currencies are beginning to appreciate again.

But this should be seen as part of the process of 'early movers' acting on the markets rather than the emergence of wholesale money flows – that could be yet to come. 

Unfortunately, we now work in a market system that – despite our best efforts to finesse it – behaves in a coarse and uncouth way, indiscriminately sending prices higher or lower to an extent that you feel like a helpless passenger commentating on a car crash rather than a careful driver steering a considered course.

And it doesn’t take much of a shift in perceptions to set off a new and powerful trend.

You could say that whilst I have had my wisdom extracted, Mr Draghi may have just implanted a new wisdom into the markets that will dictate our investment taste sensations in 2014.

Citywire + rated Cowley runs the Old Mutual Global Strategic Bond fund, which has returned 5.6% in the three years to the end of March versus 1.78% rise in the benchmark.

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