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Monday, 23 October 2017

The day that everything changed

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Anthony Peters, Swiss Invest Strategist

Anthony Peters, Swiss Invest Strategist

EVERYTHING WE READ, listen to or watch is or will be full of reminders that the 10th anniversary of the attacks on the twin towers in New York and the Pentagon in Washington DC is upon us. Ingrained in history as 9/11, the attacks changed the political world we live in forever – and the economic and market environment beyond recognition.

I recall sitting at my desk on the London trading floor of Banc of America Securities. A message from a friend on the New York T-Bill desk reported a plane had hit the WTC. We watched the TV with awe. Then came the second strike. I can’t remember many moments in my life when even I was rendered speechless: this was one of them.

I’ve no memory of how long it took until the London CEO, William Fall, asked us to clear the building – we were, after all, BofA and could have been a target. We went to a pub where we watched as the towers collapsed. I was standing next to the then head of government bond sales, Andrew Bernard, as he turned and simply said: “We’re watching history in the making.” Were we ever. I’m tempted to believe that many have never considered how deeply the markets were affected by what happened on that morning 10 years ago.

Second-quarter US GDP had been reported at 2.8% quarter-on-quarter but Q3 was expected to show a much weaker reading. In fact, it was to report as having fallen to 1.3% QoQ. This was clearly the beginning of the natural and normal cyclical downturn that had been forecast.

Since November 2000, when Fed Fund rates had been at 6%, the FOMC had shifted its rhetoric away from inflation risk towards predicted economic weakness and at the August 21 meeting rates were cut for the sixth successive time to 2-1/2%. We have been brought up to believe economic cycles last seven years – give or take – and the sole concern was that Alan Greenspan and his merry men could engineer something of a soft landing. Then 9/11 happened.

Many have never considered how deeply the markets were affected by what happened on that morning 10 years ago

THOSE WHO DIDN’T live through it will never be able to understand how all forms of rational thinking were suspended in the aftermath of the attacks – how every certainty in our lives was blown away in a few hours.

Greenspan was faced with huge economic uncertainty and with a nation that could deal with an economic downturn and with the horrors of the attacks – but not both simultaneously. He could do nothing to make 9/11 go away, but he could postpone the recession. And that’s what he did.

The Fed immediately eased rates by 50bp and at both of the subsequent FOMC meetings they were cut by 50bp. By the December meeting they were down to 1-3/4%. Within a few months, the economy had regained composure, although the political and military world hadn’t. With the shocks of the 2000 dotcom bust, the general equity market collapse and 9/11 in mind, Joe Sixpack took the cheap money on offer and bought into the only asset class that looked unshakable: residential real estate. The rest is history.

AIDED BY THE boom in house prices and concomitant wealth effect, the US went shopping. Consumer goods were sucked in from cheap production platforms in Asia and the virtuous cycle of disinflationary imports was set in motion. The more they consumed, the more inflation went down; the more inflation went down, the more rates fell – by June 2003 Fed Funds were at 1% and Greenspan was the most popular man in the US. Then it all went wrong.

Insurers and pension funds couldn’t live with the persistently low rates and needed to find ways of generating more respectable yields. With the benefit of falling default rates on mortgages, structured products were being put together that purported to offer near risk-free returns far and away above what made rational sense. But needs must and investors leapt on anything banks could produce.

Leverage was cheap and hedge funds, credit conduits and SIVs were popping up, as were CLO and CDO managers. The virtuous rate cycle began to spawn the vicious product cycle. Sooner or later, the delay of the 2001 recession was going to going to haunt us all and … here we are.

Had Greenspan followed the advice of his predecessor, William McChesney Martin, and taken away the punch bowl before the party got going, we would probably be in a happy trend growth period, living in smaller houses with smaller cars, older TVs and cash in the bank. But we’re not.

Of course, all the while governments believed the growth in consumption of the middle years of the decade would go on forever, with all the juicy sales and value added taxes coming in ad infinitum and social welfare strategies duly expanded to meet the booming revenues. Sound familiar?

To suggest that the 9/11 terrorists won in the end would be wrong, but it could be argued that their vicious actions 10 years ago indirectly contributed to many of the problems facing us today. We all lost friends or had friends who lost friends on 9/11. On the day, I will be thinking of them. For the rest of the time I will, along with everyone else in the markets, be dealing with the fall-out.

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