There is no way to know how long excessive liquidity rallies can endure before succumbing to the inevitable gravity of the next economic downturn. They always succumb eventually.
Liquidity forces are awesome and incredibly dangerous all at once. If we were day traders or speculators, we might want to just dive in and try our luck to surf the wave as long as it can last. But while wild abandon or blind bravery certainly looks like fun from time to time, we know that in the longer run, the return data for such attempts is near perfectly horrible. Just think of the overwhelming majority of hedge funds, traders and active managers who reported negative cumulative returns now for the past 12 years as at the end of 2011. They may look busy and aggressive, but their results are mostly poor and worse considering the extreme volatility they have subjected their capital to en route to nowhere.
The inescapable trouble with asset markets today is that they have been prodded, plumped, goosed and tortured by intervention and leverage to such an extent that their price discovery mechanism is basically broken. At present prices, markets are moving in a world rather all of their own.
Central bank intervention has now succeeded in reducing the expected returns for pretty much every asset class to virtually zero or even negative from present price levels. Return-free risk—how attractive! The truth about these conditions is well captured in the following quote by long-time, respected money manager Howard Marks in his book “The most important thing” (2011):
“You simply cannot create investment opportunities when they're not there. When prices are high, it's inescapable that prospective returns are low. That single sentence provides a great deal of guidance as to appropriate portfolio actions. Investment risk comes primarily from too-high prices, and too-high prices often come from excessive optimism and inadequate skepticism and risk aversion. Contributing underlying factors can include low prospective returns on safer investments, recent good performance by risky ones, strong inflows of capital, and easy availability of credit. That same pattern of taking new and bigger risks in order to perpetuate return often repeats in a cyclical pattern. The motto of those who reach for return seems to be: 'If you can't get the return you need from safe investments, pursue it via risky investments.' It takes a lot of hard work or a lot of luck to turn something bought at a too-high price into a successful investment.”
For all these reasons (and more) we find ourselves still cautious and protective of capital as we wind down another April – the third since 2009. We long to see more of a bright side. But as we carefully measure growth prospects at present price levels, we find no defensible case for blind hope.
US dollar Index 1990 to 2011: 78 now support, 88 still upside target
The US dollar continued to receive safe haven inflows for the month. $88 remains our upside target. At the same time, the Canadian dollar (below) weakened on the month as the slowdown in China and Europe attracted more attention.
Canadian dollar 2001-2012: Par proves resistance
Canadian stock market currently range bound, with overall trend bias still down
Danielle Park will talk on "After the debt-rush: understanding demand in a post-spending bubble world" on Tuesday, May 15, during the New York Hard Assets Investment Conference.