Mar­kets work be­cause of their in­her­ent risk. With­out it, what game are we play­ing, and, more im­por­tantly, at what cost?

Financial Mail - Investors Monthly - - Contents - RON DERBY

Ron Derby col­umn

What does one say about the in­ter­ven­tion of the Chi­nese gov­ern­ment in its stock mar­ket over the past month? It may have, for now at least, averted a cri­sis — per­haps on a scale of 2008 if not big­ger — for emerg­ing mar­kets such as SA, which I have no doubt would have mor­phed into another cri­sis for the rest of the globe.

Be­cause of that, per­haps, the Chi­nese gov­ern­ment is de­serv­ing of some ap­plause for pump­ing bil­lions into its stock mar­ket, block­ing trade in over a thou­sand stocks to stem what was fast be­com­ing a sell­off on a scale we’ve never seen. China’s do­mes­tic mar­ket fea­tures no strong in­sti­tu­tional in­vestor base, but has an in­di­vid­ual re­tail in­vestor bias, leav­ing it to the mercy of any tale of woe, whether it is true or false.

But here’s the prob­lem with China’s res­cu­ing act: it may have re­moved “risk” in its mar­kets, which is what keeps in­vestors dis­ci­plined. It’s the risk of tak­ing an un­in­formed punt on a stock that en­sures the in­vestors will ex­er­cise some sense. There’s no con­se­quence if, as a wily in­vestor, you know the state sim­ply won’t en­ter­tain mar­ket panic that may, or may not, lead to a col­lapse. So you keep your money in the mar­kets, no mat­ter the val­u­a­tion or the price:earn­ings ra­tio, be­cause po­lit­i­cal head­quar­ters in Bei­jing will in­ter­vene to safe­guard your in­vest­ment.

This is what Washington and for­mer US Fed chief Ben Ber­nanke has taught the world: just pump money into fi­nan­cial mar­kets and all will end well.

It may have worked in not re­play­ing the Great De­pres­sion of the early 20th cen­tury, but what has it done for the nuts and bolts of the real econ­omy in the US and, in turn, in the rest of the global econ­omy?

It has served to keep the world of fi­nan­cial mar­kets more at­trac­tive than the real econ­omy. Why would any­one with R100m in­vest in a risky start-up that will de­liver only low sin­gle-digit growth, when that money could in­crease by much higher mul­ti­ples in fi­nan­cial mar­kets? And if you con­sider the Chi­nese res­cue of its stock mar­ket and the quan­ti­ta­tive eas­ing res­cue by the US Fed, it will be an in­vest­ment that will be safe­guarded by ei­ther tax re­ceipts or the print­ing of more cur­rency by cen­tral banks.

Mar­kets work be­cause of their in­her­ent risk. With­out it, what game are we play­ing, and, more im­por­tantly, at what cost?

The cost is a lack of in­vest­ment. And do you blame any­one with R1m from in­vest­ing in Naspers rather than buy­ing a house or in­vest­ing in a start-up that may just be the next Ap­ple — as far-fetched as that may sound to you right now? That sort of in­vest­ment in the Cape Town-based media firm would have grown your in­vest­ment 15% over just the past six months.

We have to be con­cerned about the bub­ble that the world’s lead­ing economies with their mas­sive bal­ance sheets are fuelling. Lit­tle old SA and even big­ger emerg­ing pow­ers such as Brazil end up at the mercy of their res­cue mis­sions.

Let’s take the value of the rand, which has de­pre­ci­ated against the US dol­lar by 17,4% over the past 12 months. It’s among the weak­est-per­form­ing emerg­ing mar­ket cur­ren­cies, but how much of it is ac­tu­ally about trade? Our own goals aside, the plum­met­ing rand is the re­sult of a de­ci­sion made in that fi­nan­cial mar­ket, that bal­loon whose elas­tic­ity keeps be­ing in­creased. The swing, more vi­o­lent each time, from risk on to risk off, is mak­ing it al­most im­pos­si­ble for one to see the true value of the rand, let alone ev­ery­thing else.

So, in analysing whether China’s res­cue mis­sion is healthy for mar­kets, I am go­ing to go into the camp that says it isn’t.

And by ex­ten­sion, I have to be as crit­i­cal of the US, Ja­panese and Euro­pean in­ter­ven­tion in mar­kets as well. They’ll keep it up un­til they feel mar­kets have a strong enough crutch, and step in once more if that crutch comes un­der pres­sure. They’ll be hop­ing that when the global econ­omy next faces a “black swan” event their cen­tral banks have enough am­mu­ni­tion in the form of high in­ter­est rates to fire away. Right now, of the ma­jor pow­ers, only China has am­mu­ni­tion.

And it’s fir­ing away.

We have to be con­cerned about the bub­ble that the lead­ing economies with their mas­sive bal­ance sheets are fuelling

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