The point at issue

Every day, millions of pages of analysis of economic, business and financial matters spew forth from banks, brokerages, institutes and innumerable media outlets. Exposure to a quantity of this material sufficient to represent a representative sample will inevitably lead to two main conclusions:     a)  There is a fundamental argument that underlies all of these analyses, even if they are discussing seemingly quite different topics. This argument is often left unsaid and is thus implicit, but it is there nonetheless. It relates to whether the world has changed since 2007 or not. That seemingly bland statement is the point at issue referred to in the headline. If the world is basically the same as it was until 2007, then virtually all the analyses of the ‘pessimistic’ camp can be trashed, because they assume a level of disruption that is simply inconceivable in terms of the pre-crash world. Conversely, however, if the post-crash world is not the same as the pre-crash world, then virtually all the analyses emerging from the ‘optimistic’ camp can be ignored, because they are built on sand.

           b)  The composition of the two camps – i.e. who’s on which side — has a clear institutional pattern. The overwhelming majority of analysts, strategists and other employees of large financial institutions and of governmental departments, agencies etc. work on the basis that the world has not fundamentally changed. There are some exceptions to this general attitude, such as the guys at PIMCO, but that is by far the dominant approach. The much smaller group of analysts who are employed by small firms or own their own firms, tend strongly to be in the pessimist camp. To my mind, this element of independence adds considerable credence to their analyses, but it cannot by itself resolve the debate.

It is crucial to periodically revisit and re-emphasise this central issue, in order to restore a sense of perspective. The deeper one drills into business analyses, the more important this factor becomes. For example, the great bulk of corporate analysis written in 2010 reflects the assumption that, at the macro level, the global economy is in a period of ongoing gradual recovery. Assessments may differ as to the speed of this recovery and its relative strength in different countries and industries, but what is not questioned is that ‘the great recession’ of 2007-2009 was essentially the same as other post-war recessions, only worse. That’s why the label of ‘the great recession’ is so important – it says that this is a severe case of a well-known illness. Similarly, the term ‘recovery’ implies, without quite saying so, that this severe illness is behind us.

As soon as you question, let alone reject, those comfortable assumptions made about the global or national macro economy, the analyses of specific industries or firms that are based on them become useless. One result is that a ‘value’-oriented, or ‘bottom-up’ approach to investing becomes very difficult, because the assumptions underlying the apparent strength of a company and its hitherto sterling performance are of dubious relevance in the new environment. They are not ‘wrong’, they are misleading and hence potentially dangerous.

A simple example would be Ford and General Motors. If a thorough analysis points to Ford being superior to General Motors, AND if we assume that demand for autos will gradually recover from its recent very depressed levels, then clearly Ford is a better investment than GM. But if that assumption is wrong and demand will remain depressed for years to come, then the issue is no longer which is better, but whether one wants to invest in the auto sector at all. If the answer to the latter question is no, then Ford’s superiority is no longer relevant.

The ‘story’ of 2010 is the developing sovereign debt crisis. In many ways, this epitomizes the wider debate: Once the stability of a country’s sovereign debt is called into question – ie as soon as there is a measurable risk that the country may default – then  that country’s banking system is similarly in question (and possibly other countries’ banks as well). That is not business as usual, and it seems pointless and plain wrong to pretend that it is.

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