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Saturday, 19th September 2020
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The World in the Year 2000 Back  
Over the last seven years, I have done my utmost to keep readers ahead of the game when it comes to financial market developments. This has been a tough challenge, particularly given the inevitable pressure of deadlines for publication. For this reason, I have striven to restrict myself to the "big picture", focusing on events likely to play out over a one/three month horizon and providing tools to equip readers with all likely eventualities. This month, I face my toughest challenge. As this is my last column for some time, I'll try and paint a road map into 2000 and beyond.

Before setting out, I should probably state that this may be an exercise in vain. For instance, had I predicted in 1998 that the overhang of bond inventory, the collapse of emerging markets and hedge fund leverage would cause a global banking collapse allied with the greatest bear market since 1973/74, I would have looked good in October 1998. However, by June 1999 I'd look very foolish following the skillful reflation strategy conducted by the Fed. My analysis would have been correct were it not for the Fed's actions but I would have ignored one small detail which would have profoundly reversed the outcome. This caveat in place, I'll give it a go!

I'd like to focus on three main areas: the overall macro-economic cycle position, the likely outlook for a number of key markets and the Irish political and economic position.

The Macro Economic Cycle Position

I'll start with something completely unfashionable - the Kondratiev Cycle. What, you may ask, is the Kondratiev Cycle? This theory arose from the ashes of the thirties depression and suggested that with approximately a sixty year periodicity, a cycle of economic expansion and implosion would be seen. In essence, out of the depths of a depression, a broad expansion would follow. Its peak approximately thirty years later would be marked by high inflation and high interest rates and it would be followed by a broad decline. When I was at university in the mid eighties, this theory was still popular, though I'm sure it's not taught today.

The reason for this is that during the eighties, many academics suggested that a depression in the nineties would follow the stagnation of a number of economic crises during the eighties. This depression needless to say never happened.

However, the fact that the world economy has continued upward, does not mean that the Kondratiev Cycle is a flawed theory. If one had bought bonds or sold commodities in the early eighties expecting lower interest rates and commodity prices (per Kondratiev) you would have been more than happy with the theory. Considered as a measure of monetary and inflationary expansion and collapse, it has performed masterfully. In the early eighties, Irish interest rates were in the twenties, gold had rallied 3000% in a decade, oil had rallied 1000%. Look where we are today, Irish interest rates at 2.5% and a two - decade history of commodity deflation.

If you accept (I guess few of you will) that there are swings in global human psychology that occur not even each generation (but every second) which in turn trigger inflation panics and deflationary implosion. Where do we go from here?

My view is that deflation has some time to go. I first mentioned deflation in 1995 a couple of years before it had come into vogue. Today, I believe that we may see deflation outside of the raw commodity sector during the next few years. If precious metals are anything to go by - I think gold is headed for $150+/- $50. If one sees the capacity of the Internet to strip out massively the profits of intermediaries (such as travel agents), then imagine what might happen in the next recession. I think falling prices after a decade of deflation (slowing inflation) are entirely possible if not likely.

Against this background bonds should perform well with a move of 1 1/2 - 2% lower in US treasury yields quite achievable on a 2/3 year view.

This deflationary collapse will likely terminate the Kondratiev cycle from the 1930's and be followed by a reemergence of performance by Real Assets (e.g. hard commodities). Be prepared at some stage over the next few years to swim against the tide. No doubt the end of inflation will be signaled as a "new paradigm" by economists, but invariably the suggestion of "new paradigm" only emerges during the final excesses of a directional move. Economists cannot explain what's happening in conventional terms so they assume a quantum shift in the world order has occurred. In fact what is happening is the final momentum of moves that have been happening over a number of years. Invariably "new paradigms" do not exist and are aggressively reversed thereafter. The first decade of the next century will likely be an inflationary one following the low of global prices early in this decade.

Markets

So if bonds are bullish and commodities are bearish, where is the stock market going? I believe that the US Market will spend much of the next twelve months in a 3000/4000 range below 12000. In fact as we have probably seen the high and should drift lower followed by more aggressive falls in early 2000 it is my preferred scenario.

I have been tormented for suggesting that Y2K will come to anything by readers I have met over recent months. I am not suggesting global Armageddon, but if one analyses the impact of the dioxin spoilage of feed in one plant on the whole Belgian economy or the impact of a computer virus taking out a suppliers network, you soon realise that in a complex economic system, a malfunction can have a very wide reaching effect. Who would have guessed how close a very small number of hedge fund operators could have brought the global banking system to crisis.

On this basis, the failure of one European Country's power system for a week or two would disrupt terribly as could for instance even the traffic light system in Dublin. In essence in developed countries we will likely see pockets of disruption which will amplify and in turn hit equity markets.

Outside of developed countries, we may well see wider disruption. This will naturally affect their markets as well as global operations or banks with exposure to them.

The Euro has been recovering for a week or two following a decline without remission from its inception. I find it harder to call its fate on a long term basis as a lot will depend on the strength of its current reversal. I think one can expect Euro strength against the dollar and sterling over the summer. Beyond that I'd prefer not to call it, but with a gun at my head, I go with a continuation of the dollar and sterling Bull markets that have been in place for a number of years.

Ireland

Although we should avoid being too cocky, it's reasonable to be relatively self-congratulatory about our economic performance over the last decade. Our success has not just been a function of exogenous factors but also of many inspired strategy decisions and changes in national psyche.

At a policy level, partnership consensus and a focus on technology / pharmaceuticals/ financial services are worthy of praise. At a national level our final disposal of our post-colonial baggage whether in the establishment of a new work ethic, respect of fair taxation or criticism of political corruption are all steps in the right direction.

I have little doubt that American companies locate in Ireland not just because of our tax rate and the fact that we are English speaking, but also because we are happy with a less regulated reward driven work environment (one they use back home). In this respect, we have a huge benefit over continental Europe, and we should do all in our power to widen it. Restrictive employment legislation from Europe should be vetoed at all costs.

On the policy front moving forward I would love to see progress in the following areas by my return.

* There is a profound need to address the wide disparity between the number on the live register (>200k) and the number seeking work according to the Labour Force Survey (<100k). There is no political will to tackle this gap which has widened not shrunk as the economy has progressed. Dole money is not a benefit to supplement income, but a safety net for those seeking work or unable to work. There is no justification for this level of fraud, paid for by taxpayers.

* The fruits of the golden age of our economy should be invested wisely. I have often written that public expenditure has been ballooning unnoticed against a background of buoyant revenues. There is a once off opportunity to reduce government involvement in the economy not to expand it as has been happening. The flotation of the semi-states is a good first step (though giving employees over £100k of shares is completely unjustifiable - again at taxpayers expense). The flotation 'windfalls' are not windfalls at all, but the result of many decades of taxpayers investment in loss making industries. They should be used wisely. I'd still like to see our debt being paid down in classic Keynes style, 'borrow in the bad times repay in the good'. This is likely to be a hopeless aspiration however, so at least it should be used to invest in important infrastructural projects: the development of the road network, real third level access for all and the development of satellite towns for Dublin with appropriate infrastructure (schools, regular train service etc).
* The drive to lesser government should be continued beyond semi states and the 'windfall' could be well invested in settlements towards a viable and permanent withdrawal of government / devolution of power.

* I'd finally like to see something done to resolve the property market but I have no 'Holy Grail'. The recent report that highlighted Ireland along with Holland at the height of the affordability (more correctly non-affordability) stakes is a big concern. Needless to say in a lower interest rate environment, house price/disposable income ratios can shift, so it is natural that ours is now higher now than it was a decade ago. That we are in the top two in Europe is cause for concern however. The top two during the 1989 survey were Finland and the UK. We all know what happened the UK but few of you will know that Finnish property prices fell 40-60% from their peaks and the country came close enough to the brink. In Ireland where we have very high ownership and ownership aspiration, a property shock would hit very hard. I see no immediate threat beyond the continuation of the bubble. In terms of solutions, the suggested remedies of high density and satellite towns are preferable to part-ownership which will only leave the state 'carrying the can' if things go wrong.

* Finally, it's time to recognise that we do not live in a low inflation economy. I have no interest in economic arguments that property inflation, for example, is not actually inflationary because for each seller that loses there is a buyer that wins. If one sector (the young) lose and another sector (the old) win, this is inflationary, as the younger sector of society will demand higher wages. I have strong doubts that the basket used to measure inflation comes close to a representative basket either, with the demonstrable inflation in service pricing. It would be very interesting to see some data on price inflation on a demographic basis. I'm sure it would confirm that price inflation among the basket of goods consumed by the young and affluent is very significant indeed.

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