Mind on Money: Time to listen to the markets | CPT PPP Coverage

After the smirk this line always garners from me, first reminding me of a particularly silly night in the Cayman Islands, but silliness aside, it’s important to understand the meaning of this cryptic wisdom and why the concept is particularly timely right now.

During days of plenty, which we will define for this conversation as easy credit or low interest rates, rising stock prices, a growing economy, stable inflation and low unemployment, even the sloppy can thrive. Sloppy business models get funded, the stocks of sloppy companies rise, sloppy investors make money, sloppy banks make profits on sloppy loans and sloppy politicians and governments convince their governed to entrust them with more money and control.

These conditions encourage the mismanagement of risk of all sorts. Irresponsible corporate managers burn through capital, irresponsible investors leverage their portfolios with margin borrowing and speculative options, irresponsible governments create unsustainable programs using deficit spending, and the environment of abundance allows everyone to pull it off. Until it doesn’t, and the tide of plenty recedes. And it always eventually recedes.

Try as we might, our modern economic system has not eliminated what in college economics we called the “business cycle.” The business cycle is the ebb and flow of supply and demand based upon a complex composite of demographic, technological, financial and monetary factors that are difficult to envisage and yet present as fundamental as the passing of the seasons.

This all-important cycle is not quite as predictable as cooling temperatures in October and snow in January, but nonetheless, the cycle occurs so consistently through modern economic history it appears almost constructed of natural order, and much of the smart money is telling us winter is coming, the tide is going out. Which is where the naked part comes in.

Swimming naked may be fun for a while, but it always seems to end poorly. Injury, embarrassment or arrest are three likely outcomes I can think of (not to mention the beginning of “Jaws”). When it comes to the financial world poor outcomes for those who haven’t covered up prudently often equates to insolvency, bankruptcy and in the worst cases collapse. The rub (or should I say chafe) is, as Warren quotes, it’s hard to know who the skinny dippers are until the cycle turns, which in a way puts us all in a bit of a dilemma. A currently on-going dilemma.

To address inflation, the word’s central banks are using their policy tools to slow demand attempting to cool prices off. The process seems likely to work, and stock and bond markets have already adjusted in response to this expectation. The problem is, except for the brief but violent COVID lockdown disruption the economic cycle we continue to experience has been very long, reaching all the way back to March of 2009. In historical context, this is a very long period of expansion, which was built and facilitated in part by Fed policies of very low interest rates and nearly continual expansion injections of liquidity into financial markets through now common quantitative easing. These policies contributed to the inflation problem the Fed is trying to fix and have come to an end. It would be prudent to anticipate economic slowdown as a result, or said simply, while its not here yet, it could be time for a recession.

Unfortunately, the 13-year period of very accommodative interest rates and monetary policy has probably enabled a lot of naked swimming. Some of the swimmers will be minor players, catching only their own investors in the “poor ending,” but some may be major players presenting risk that could endanger entire financial systems, economies or even nations. And we just don’t know where and when the tide will really recede and who will get caught.

There are hints, however. I would have bet there was a lot skinny dipping going on in the crypto currency markets, and the tide is already receding there. This week financial behemoth Credit Suisse wasn’t looking good, which was probably roiling markets during September, and the British government and British pound might be swimming in deeper water, but I’m not entirely sure they’re covered up. There will be others.

So, when markets get turbulent in the absence of overt news over the next few months, investors will want to pay attention. The bond market will likely sound the tidal warning first, and the stock market will follow. It’s time to learn how to listen.