John Mauldin-  Challenging the Consensus

One of the most universal consensus calls in the markets today is that interest rates are destined to rise. Thirteen out of 13 major investment banks all think that interest rates for global fixed-income will rise this year. I get nervous when everybody is on the same side of the boat. And so does my good friend and business partner Niels Jensen of Absolute Return Partners in London. This week’s Outside the Box is another of his thoughtful essays, giving us five reasons why interest rates may in fact go down this year. That is not to say that we don’t both agree that rates have to go back up eventually, but to us the timing is not so obvious as it is to the major investment banks. Rather than tip his thunder, I’ll let Niels advocate for his position. (And you can see more of his consistently excellent work

It’s been a busy week here in Dallas, but then aren’t they all lately? But it’s good to be busy at home for the next few weeks. Lots of material to be written and edited, plans to be made, and trips to be scheduled, of course. My current sedentary lifestyle will soon revert to its normal peripatetic frenzy, but it’s good to give the body a bit of rest. Enjoy your week.

Your getting ready for some left-over Super Bowl chili analyst,
John Mauldin, Editor
Outside the Box
[email protected]

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Challenging the Consensus

“The noble title of ‘dissident’ must be earned rather than claimed; it connotes sacrifice and risk rather than mere disagreement.”

Christopher Hitchens, Polemicist

Herd mentality is one of the strongest and most powerful human instincts. Humans take great comfort from walking the same path as others have walked before them, and nowhere is this more evident than in the field of investments. Most investors are simply incapable of disregarding the consensus when making investment decisions, if for no other reason than because ‘being out there on your own’ is associated with considerable career risk (I wrote about this back in October 2012 – see here).

I consider myself a contrarian investor. Not a contrarian for the sake of being a contrarian but a contrarian nevertheless. My inclination to go against the prevailing view is based on one very simple piece of knowledge acquired through 30 years of trial and error. When an investor states that he is bullish, he is more often than not close to being fully invested, hence he has used most, if not all, of his dry powder. Obviously, the more people who find themselves in this situation, the less purchasing power there is on an aggregate basis. At this point the market is at or near its peak. Precisely the opposite is the case when most investors are bearish. They have sold most if not all of their holdings, at which point the market is more likely to go up than down.

This way of thinking is frequently challenged by people (often academics) who argue that it cannot be that way, because investing is a zero sum game. We cannot all sell out at the same time, as someone has to own those bonds, or so the argument goes. Whilst theoretically correct, this view fails to take into account the distinction between core and marginal investors. Whilst marginal investors (e.g. private investors, hedge funds) can, and do, move freely between asset classes, core investors (e.g. pension funds, sovereign wealth funds) are at least partially restricted in their movements. Such limitations ensure that, in practice, investing is not a zero sum game.

Now, when I look at financial markets going into 2014, I cannot recall ever having come across a more one-sided view than the one which prevails. The consensus view on bonds is overwhelmingly bearish while pretty much everyone is bullish on equities – or at least they were until EM equities began to fall out of bed. Barry Ritholtz (The Big Picture blog) has done a great job of assembling, and presenting, the sell-side view in a simple to understand format (chart 1).


Some may argue that the sell-side is always bullish on equities, and while that is not a million miles away from the truth, this year is still uniquely one-sided. And it is certainly not the case that the sell-side is always uniformly negative on the outlook for interest rates. As far as the bond market is concerned, the 2014 consensus is a major outlier, and that is precisely what has piqued my interest. It is much more difficult to obtain reliable information on the buy-side consensus. Suffice to say that none of the information I have at hand has given me any reason to speculate that the buy-side view differs materially from that of the sell-side. See, for example, the recently updated policy portfolio for the Harvard University Endowment here.

Five reasons you may want to change your bearish view

In the December 2013 Absolute Return Letter (‘Squeaky Bum Time’) I discussed our 2014 expectations for equities – see here. This month I will focus on the outlook for interest rates and challenge the prevailing wisdom – i.e. that rates are destined to rise as 2014 progresses. I am not suggesting that the consensus view will definitely prove wrong in 2014; however, I can think of at least five plausible reasons why many may end up with a little bit of egg on their faces as interest rates fall before they rise.

I agree with the view shared by many that, in the long term, as economic conditions normalise, interest rates will almost certainly rise. I cannot possibly disagree with that. The words to pay attention to, though, are ‘long term’. In the meantime, 2014 may contain one or two surprises, effectively delaying the bond bear market.

Now to those reasons, and in no particular order:

  1. The emerging market crisis escalates further;
  2. The Eurozone crisis re-ignites;
  3. The disinflationary trend intensifies and potentially turns into deflation;
  4. The economic recovery currently underway proves unsustainable; and/or
  5. Flow of funds provides more support for bonds than anticipated.

The emerging market crisis escalates further

Quite a serious crisis has been brewing in some EM countries since talks of Fed tapering first began in May of last year. I first referred to it in the September 2013 Absolute Return Letter (‘A Case of Broken BRICS?’ which you can find here). More recently the ‘Fragile Five’ have become the ‘Fragile Eight’, suggesting that the crisis is spreading (see for example Gavyn Davies’ excellent analysis here).

At the heart of this crisis is a realisation that many EM economies depend on foreign capital to fund their external deficits. That foreign capital is more often than not U.S. dollars. I am not the first to have noted that the ‘Fragile Five’ all run substantial current account deficits (chart 2).

Source: Barclays Research, Haver Analytics

The United States provides liquidity to the rest of the world through two channels, one of

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