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Central Bank strategy: “The beatings will continue until morale improves…”

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[Editor’s note: This letter was written by Tim Price, London-based wealth manager and editor of Price Value International.]

In Tobe Hooper’s 1982 horror film ‘Poltergeist’, strange things start happening in the Freeling household.

Unbeknownst to its occupants, the house is built on ancient Indian burial ground. The TV set comes to life; glasses of milk break all by themselves; furniture starts moving of its own accord.

Having spent the day watching the mounting weirdness with just her small daughter for company, Diane Freeling (played by JoBeth Williams) happily greets her husband Steven (played by Craig T. Nelson) as he returns home from work.

As she sits him down and tries to explain the freak occurrences, she prefaces the story with this:

“Reach back into our past when you used to have an open mind. Remember that? Now try to use that for the next couple of minutes.”

With that advice at hand, we’ll try and keep an open mind for the next couple of minutes as we recap recent events.

Kobe Steel, one of Japan’s largest makers of construction equipment, saw its shares fall by 12% at the end of last month after the company issued a profits warning.

Adobe stock fell by nearly 10% earlier this month after the software company issued a profits warning.

Rare stamps dealer Stanley Gibbons saw its share price fall by 29% earlier this month after the company issued a profits warning.

WalMart stock fell by 10% on 14th October after the world’s largest retailer issued a profits warning.
Shares in the educational and erstwhile FT publishers Pearson fell by 15% last Wednesday after the company issued a profits warning.

Shares in Home Retail Group – owner of the UK’s Argos retail chain – also fell by 15% on Wednesday after the company issued a profits warning.

Shares in insulation specialist SIG fell by 21% on Thursday after the company issued a profits warning.
Motion-and-control technology company Parker-Hannifin on Thursday issued a profits warning. The company supplies parts to companies including Caterpillar, which itself issued a profits warning on Thursday.

UK bookmakers William Hill on Friday issued a profits warning.

The owner of the world’s biggest shipping line, AP Moeller-Maersk also saw its shares fall by 8% on Friday after the company issued a profits warning.

David McCreadie of Panmure Gordon tells it how it really is:

“The list of earnings casualties continues to grow. What is ominous is that the list is geographically agnostic and it includes well-run companies with respected management.

“Such is the growing momentum of misses, disappointments, warnings and downgrades the market won’t be able to hold the dam indefinitely.

“Reality is setting in and it’s not coming from equity strategists, it’s coming from companies.

“Phrases like ‘challenging market conditions,’ ‘lower than anticipated demand’ and ‘margin erosion,’ are now common currency. Given the technical backdrop it would be difficult to conjure up a more favourable bearish market scenario.”

For ‘challenging market conditions’, ‘lower than anticipated demand’ and ‘margin erosion’, read just one word. Deflation.

Happily, Mario Draghi has our back. From the Financial Times, October 23rd edition:

“Eurozone government bond yields have dropped to record lows after the European Central Bank came close to promising more action to deflect the risk of deflation.

“Yields on two-year debt now stand below zero for almost every member of the euro zone, which means investors effectively pay to own it. For Italy, yields dipped into negative territory for the first time on Thursday, while German yields for that maturity are now at a record low of -0.327 per cent.”

Simply telling savers and all on fixed incomes that the beatings will continue until morale improves is not the way to run a functional banking system.

Quite the opposite, in fact. Driving deposit interest rates definitively below zero is the perfect way to manufacture a bank run.

The world economy is clearly slowing. Confidence in central bankers is rapidly eroding. Stock markets, in the main, have largely decoupled from economic reality – perma-QE means that liquidity now trumps profitability as a driver of market returns.

Adam Smith in ‘Supermoney’ expressed the sentiment perfectly:

“We are all at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know, by the rules, that at some moment the Black Horsemen will come shattering through the great terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no-one wants to leave while there is still time, so that everyone keeps asking, “What time is it? What time is it?” But none of the clocks have any hands.”

If you elect to own equities, hold defensive, geographically unconstrained value.

Hold cash.

Hold uncorrelated assets.

Hold gold.

And let’s hope that one day we can hold unelected central bankers accountable for the growing chaos they are inflicting on the financial world before the global currency system collapses.

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