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Thursday, 19 October 2017

The day that everything changed

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Anthony Peters, Swiss Invest Strategist

Anthony Peters, Swiss Invest Strategist

I have decided to take an unusual route for my Friday comment and am going to relate the piece, though unabridged, which I wrote for the IFR’s weekly print copy which was published last Friday. I should like to dedicate it to the memory of Mike Taddonio and all the many, many others who never came home.

Everything we read, listen to or watch either is or will be full of reminders that the tenth anniversary of the attacks on the twin towers of the World Trade Center in New York and the Pentagon in Washington DC is upon us. Ingrained in history as 9/11, the attacks changed the political and security world we live in forever – and the economic and market environment beyond recognition.

I can quite clearly recall sitting at my desk that lunchtime on the London trading floor of Banc of America Securities, waiting for the morning meeting with the US to begin. Then came a message from a friend on the New York T-Bill desk reporting that a plane had hit the WTC. I thought it must have been a Piper or a Cessna until CNBC cut to pictures of the smoking tower – I sat right under the TV screen. We watched on with awe and then came the second strike.

I can’t remember too many moments in my life when even I was rendered speechless but this was most certainly one of them. I’ve no clear memory of how long it took until the London CEO, William Fall, pitched up on the floor and asked us to clear the building as quickly as we could – we were after all  the Bank of America and could well be a prime target, should whatever was happening in New York begin to happen elsewhere. We repaired to a nearby pub where we watched, on a huge screen, as the towers collapsed, one after the other. I was standing next to the head of government bond sales, Andrew Bernard, now with Tradeweb as he turned and simply said: “We’re watching history in the making”. My word, were we ever.

I am tempted to believe that many have never considered how deeply the markets were affected by what happened on that morning 10 years ago. Q2 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 which 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 had all been brought up believing that economic cycles lasted give or take seven years 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, how any and every certainty in our lives was blown away in a few hours. Greenspan was faced with huge economic uncertainty. He was also faced with a nation which could deal with an economic downturn and which could deal with the horrors of the attacks but it was not a nation that could face both simultaneously. He could do nothing to make 9/11 go away but, if he had to, 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 rates were cut by 50bp; by the December meeting they were down at 1-3/4%.

Within a few months the economy had regained composure although the political and military world hadn’t but with the dual shocks of the 2000 dot.com bust and general equity market collapse and 9/11 in mind, Joe Sixpack took the cheap money on offer and bought into the only asset class which looked unshakable: residential real estate. The rest is history.

The ripple effect

Aided by the boom in house prices and concomitant wealth effect, America went shopping. Consumer goods were sucked in from cheap production platforms in Asia and the virtuous cycle of disinflationary imports which suppressed consumer inflation despite burgeoning demand 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 Alan Greenspan was the most popular man in the US, baseball and football stars included. 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 – money cost next to nothing in historical terms – structured products were being put together which purported to offer near risk free return prospects far and away above what made rational sense. But needs must and investors leapt on anything the banks could produce. Leverage was cheap and before, long hedge funds, credit conduits and SIVs were popping up like mushrooms as were CLO and CDO managers. The virtuous rate cycle began to spawn the vicious product cycle. Sooner or later the postponement of the 2001 recession was going to haunt us all and… here we are.

Had the great Greenspan followed the advice of his predecessor, William McChesney Martin, and taken away the punch bowl before the party began, then we would today most likely be in a period of happy trend growth, living in smaller houses with smaller cars, older TVs and with cash in the bank. But we’re not. We have big houses, big cars, flat screen tellies and a mountain of debt.

“Sooner or later the postponement of the 2001 recession was going to haunt us all and… here we are”

All the while, governments believed that the growth of consumption in 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 terrorist won in the end would be quite wrong but it could clearly be argued their vicious actions 10 years ago indirectly contributed to many of the problems which are now taxing us day in, day out. 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, still be dealing with the fall-out.

Please permit me to wish you and yours a very happy and peaceful weekend and may you, if only for a brief moment, join me in reflecting on just how very fortunate and privileged we all are.                               

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