What is the dominant guiding principle of western societies today?
At the risk of sounding crass, let me suggest that it is the “cover your ass” or CYA principle. This principle has always been fairly prominent in participative democracies. But now it has gone into hyper-drive - so much so, that the CYA principle is also now an important driving force even in financial markets.
CYA and Covid-19
Take the response to Covid-19 as an example of the CYA principle in action. Is there any doubt that the rush to lock down economies and suspend normal civil rights—to go to church, to attend school, to visit friends—in the face of Covid was driven largely by policymakers’ fears that if large numbers of people died, they would be held accountable in the court of public opinion?
Of course, no policymakers want a surge in deaths on their watch. But economies did not get shut down during the 2009 swine flu pandemic, nor during Sars in 2003, the Hong Kong flu pandemic of 1969, nor even the Spanish flu pandemic of 1918. So what changed between the time of Sars and the time of Covid? One obvious answer is the rise of social media.
Now that every policy choice is reviewed and debated in real time by millions of people around the world, CYA has become all-important. Politicians have to put policies in place to hedge against the wildest tail risks imaginable. At the same time, the first instinct of policymakers (and of investors—but more on this later) is to avoid doing anything that diverges too far from the pack. Any policymaker anywhere looking at the opprobrium heaped on Sweden will surely agree with John Kenneth Galbraith’s observation that “it is far, far safer to be wrong with the majority than to be right alone”.
Once Denmark and Norway had decided to follow Italy’s lead and lock down their populations, any western government that did not follow suit risked being accused of playing Russian roulette with people’s lives, regardless of the epidemiological evidence. Unfortunately, we still seem stuck in this mindset, even as the weekly death tolls across western countries have dipped to generational lows, almost regardless of the Covid policies they adopted (see the chart below).
So, we should all be grateful that Donald Trump appears to be bouncing back from his brush with Covid having taken little harm. Firstly, of course, Trump is human, and it doesn’t do to wish harm on another human. Secondly, if Covid were to have taken Trump’s life, it would have claimed the highest profile victim possible. And after the death of the US president, who can doubt that anti-Covid measures would become even more liberticidal. Regardless what you think of Trump, that would be a very bearish development, at least for “Covid-victims” such as energy names, airlines, casinos, hotels, and restaurants, all of which are desperate for policymakers to acknowledge that Covid-19 no longer seems to be as lethal as it was six months ago.
CYA and the fiscal and monetary policy mix
Moving on to the far less controversial fiscal and monetary policy responses to the recession, can there be any doubt—again—that policy is being driven above all by the CYA principle? What policymaker wants to espouse the Hippocratic principle of “first, do no harm,” and let markets and prices find their own footing? None. As Anatole has argued, policymakers are scrambling always to do more, with ever-bigger budget deficits funded by ever-more money printing (see Will A Keynesian Phoenix Arise From Covid?).
Can this new enthusiasm for budget deficits and money printing guarantee prosperity? It seems to for some individual stocks. But for the broad market? Perhaps not, or at least not in “real terms”. Take the equal-weighted S&P 500 as a proxy for the typical equity portfolio (appropriate now a handful of mega-cap names dominate the cap-weighted index), and discount it by the gold price to get a picture of equity returns adjusted for currency debasement.
When US governments keep spending under control, as Bill Clinton’s did in the 1990s or the Tea-Party-led Congress did after 2011, the broad equity market goes through long phases of “rerating” against gold (see the chart below).
And when the government embraces expanding budget deficits funded by the Federal Reserve, as with George W Bush’s “guns and butter” policies or Donald Trump’s rapid deficit expansion, gold massively outperforms the broad equity market. Where does this leave us today? Since 2014, the equal-weighted S&P 500 has delivered the same returns as a pet rock—gold. This is because the index has lost a third of its value since making a high in September 2018, and has basically been flat-lining since late April (see the chart below).
This may help to put the current debate on US stimulus into context. First, does anyone doubt that the US government will release a tsunami of new spending after the election? Because of the CYA principle, what policymaker will want to be seen to be blocking recovery? Secondly, will this increase in budget deficits, funded by the printing press, trigger stronger economic growth? If so, why weren’t we doing it before? Will it lead to higher asset prices? If so, why are we so far off the 2018 high? Or will it mean further currency debasement? Looking at the ratio between the equal-weighted S&P 500 and the gold price, will a new round of stimulus mean a return to the February 2020 high? Or will it see the March 2020 low taken out?
Another way to look at this problem is through the prism of the US dollar. Will another round of fiscal stimulus be dollar-bullish? Or will it be dollar-bearish? The answer matters greatly to all those foreign investors currently seeking shelter in US equities. For them, the return on US equities has been flat since late May - and going further back, flat since mid-2019.
So, if another round of stimulus weakens the US dollar, as seems likely if the stimulus is funded by the Fed, then foreign investors will have to hope that increased equity values will more than compensate for their foreign exchange losses.
CYA and indexing
This brings me to what is likely the most important element of all this for readers: the CYA principle and investing. Gavekal has written at length about the dangers of indexing (see, for example, Exponential Optimization). We have also argued that indexing is the new in-vogue form of socialism. Capital is not allocated according to its marginal return—the foundation on which capitalism rests. Instead, capital is allocated according to the size of companies. Just as in the days of the old Soviet Union or Maoist China, the bigger you are, the more capital you get. It is hard to think of a stupider way to allocate one of the key resources on which future growth relies. So why is indexing so popular? Simple: it is the ultimate CYA strategy.
As Charlie Munger likes to say: “Show me the incentives, and I will show you the outcome.” In a world where every money manager is told his or her target is to achieve a performance close to that of the index, it is hardly surprising that ever-more money ends up getting indexed (see Indexation = Parasitism). As a consequence, over the years the dispersion of results among money managers has become smaller and smaller.
Now, the Holy Grail of money management is to achieve decent long term returns combined with low volatility in those returns. However, in a world where ever-more capital is directed into investments that outperform— playing momentum rather than mean reversion—you inherently end up with greater volatility all round. Take the past few years as an example: since January 2018, the S&P 500 equal-weighted index has suffered six corrections of -10% or greater, including one -20% drop and one -40% drop. In contrast, in the preceding two years—January 2016 to January 2018—the S&P 500 did not see a single -10% drop, while the July 2016 to January 2018 period didn’t even see a -5% drop. Clearly, something in the environment has changed.
More indexing makes sense from a CYA perspective, but ends up delivering lower returns and higher volatility all round. This stands to reason. If capital is allocated only according to marginal variations in the price of an asset, then the more the asset’s price rises, the more capital money managers will allocate to that asset. And the more an asset’s price falls, the less capital is allocated to it. Such momentum-based investing inevitably creates an explosive-implosive system, which swings wildly from booms to busts and back again. And in the process, capital gets misallocated on a grand scale.
In the 20th century, the goal of every socialist experiment was for everybody to earn the same salary. In the 21st century, it seems that the goal of indexing is for everybody to earn the same return. As we now know, fixing everyone’s return on labor at the same price was a disaster. People stopped working, and economic growth plummeted. Fast forward to today, and why should we expect a different outcome if the end-goal of our investment strategy is to ensure that everyone gets the same return, not on the their labor but on their capital? Isn’t the entire world of money management now oriented towards delivering this remarkable ambition?
And should we really be surprised if the growth rates of our economies continue to slip? Why should we expect a positive growth outcome from an epic misallocation of capital? Take the current Big Tech craze as an example: everything is organized for investors to sink ever more capital into those very companies that need it least, and whose best use for this gusher of money is typically to buy back their own shares.
This CYA investment-decision-making process appears to be one of the key drivers behind the recent divergence between the S&P 500 market-capitalization-weighted index, and the S&P 500 equal-weighted index.
But it may also explain an interesting point raised by my friend Vincent Deluard, strategist at StoneX. In a recent tweet (he’s well worth following) he noted that each of the last four major market corrections bottomed out in the last week of the quarter, just after the index futures expired. Now, this could be a remarkable coincidence. On the other hand, it might say a great deal about how capital is allocated today.
In A Study Of History, Arnold Toynbee reviewed the rise and fall of the world’s major civilizations. He showed that throughout history, when any civilization was confronted with a challenge, one of two things could occur. The elite could step up and tackle the problem, allowing the civilization to continue to thrive. Alternatively, the elite could fail to deal with the problem. In this case, as the problem grew, their failure led to one of three outcomes.
1) A change of elite. An example is the clear-out of the French political class at the time of decolonization. As the old Fourth Republic stalwarts struggled to meet the challenges of Asian and African independence movements, they were replaced by Charles de Gaulle who brought in new personnel and established the institutions of the Fifth Republic.
2) A revolution. Obvious examples include the French revolution, with the bourgeoisie taking over from the aristocracy, and the American revolution, with the local elite taking power from the British king.
3) A civilizational collapse. Examples include the collapse of the Aztec, Mayan and Inca civilizations following the arrival of the conquistadores. Another is the disappearance of the Visigoths in Spain and North Africa following the Arab-Muslim invasions at the start of the eighth century.
With this framework in mind, how does CYA as an organizational policy approach help in dealing with challenges? The obvious answer is that if CYA is your guiding principle, the problems you chose to tackle will be those where there is little controversy within the elite about the required solutions.
This explains the constant hectoring about tackling climate change. Here, policymakers can promise to spend lots of money, without leaving their backsides too exposed. This accounts for the dramatic divergence between the performance of green energy producers (who produce energy) and carbon energy producers (who also produce energy).
It may also explain the rush towards ever-more European integration, as if the real challenge facing Europe today is a resurgence of the Franco-German rivalry that tore the continent apart in the 19th and 20th centuries. Policymakers can spend entire weekends in summit meetings debating European integration. This allows them to feel useful and important, even if their debates increasingly seem about as relevant as the debates of the Byzantines over the gender of angels even as the Turks were storming their city. But while pushing for more European integration might not tackle any of the issues European voters actually care about, at least it doesn’t leave your behind exposed.
This brings me back to Karl Popper’s theory that at any one time, there is a set amount of risk in the system. Any attempt to contain this risk either displaces it to somewhere else, or stores it up for later. If Popper was right, then the extreme aversion of our policymakers to taking risks means that the risk must appear elsewhere. But where? Perhaps in financial markets? It does seem not only that spikes in the Vix have been getting sharper lately, but that the Vix is also staying more elevated than you would expect in the middle of a roaring bull market.
Or, to put it another way, over the past few years, it does seem that the “downside gaps” in markets have started to become more vicious.
So perhaps CYA makes sense in today’s financial markets. The challenge, of course, has become finding the instruments that allow you to cover your posterior. In March 2020, as equity markets tanked, government bonds did not diversify portfolios adequately. And in September, as equities fell -10% from peak to trough, bonds also failed to deliver offsetting positive returns.
This new development—that US treasuries no longer offer CYA protection for equity investors in difficult times—is an important one. It makes allocating capital to either equities or bonds a lot more challenging. Or at least it becomes a lot more challenging if you are compelled to follow contemporary western society’s all-important guiding principle: CYA.
Las Vegas Strip faces growing bed bug problem
With huge events including Formula 1, CES, and the Super Bowl looming, the Las Vegas Strip faces an issue that could be a major cause for concern.
Las Vegas beat the covid pandemic.
It wasn't that long ago when the Las Vegas Strip went dark and people questioned whether Caesars Entertainment, MGM Resorts International, Wynn Resorts, and other Strip players would emerge from the crisis intact.
In the darkest days, the entire Las Vegas Strip was closed down and when it reopened, it was not business as usual. Caesars Entertainment (CZR) - Get Free Report and MGM reopened slowly with all sorts of government-mandated restrictions in place.
The first months of the Strip's comeback featured temperature checks, a lot of plexiglass, gaming tables with limited numbers of players, masks, and social distancing. It was an odd mix of celebration and restraint as people were happy to be in Las Vegas, but the Strip was oddly empty, some casinos remained closed, and gaming floors were sparsely filled.
When vaccines became available, the Las Vegas Strip benefitted quickly. Business and international travelers were slow to return, but leisure travelers began bringing crowds back to pre-pandemic levels.
The comeback, however, was very fragile. CES 2022 was supposed to be Las Vegas's return to normal, the first major convention since covid. In reality, surging cases of the covid omicron variant caused most major companies to pull out.
Even with vaccines and covid tests required, an event that was supposed to be close to normal, ended up with 25% of 2020's pre-covid attendance. That CES showed just how quickly public sentiment — not actual danger — can ruin an event in Las Vegas.
Now, with November's Formula 1 Race, CES in January, and the Super Bowl in February all slated for Las Vegas, a rising health crisis threatens all of those events.
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The Las Vegas Strip has a bed bug problem
While bed bugs may not be as dangerous as covid, Respiratory Syncytial Virus (RSV), Legionnaires’ disease, and some of the other infectious diseases that the Las Vegas Strip has faced over the past few years, they're still problematic. Bed bugs spread easily and a small infestation can become a large one quickly.
The sores caused by bed bugs are also a social media nightmare for the Las Vegas Strip. If even a few Las Vegas Strip visitors wake up covered in bed bug bites, that could become a viral nightmare for the entire city.
In late-August, reports came out the bed bugs had been at seven Las Vegas hotel, mostly on the Strip over the past two years. The impacted properties includes Caesars Planet Hollywood and Caesars Palace as well as MGM Resort International's (MGM) - Get Free Report MGM Grand, and others including Circus Circus, The Palazzo, Tropicana, and Sahara.
"Now, that number is nine with the addition of The Venetian and Park MGM. According to the health department report, a Venetian guest reported seeing the bloodsuckers on July 29 and was moved to another room. An inspection three days later confirmed their presence," Casino.org reported.
The Park MGM bed bug incident took place on Aug. 14.
Bed bugs remain a Las Vegas Strip problem
Only Tropicana, which is soon going to be demolished, and Sahara, responded to Casino.org about their bed bug issues. Caesars and MGM have not commented publicly or responded to requests from KLAS or Casino.org.
That makes sense because the resorts do not want news to spread about potential bed bug problems when the actual incidents have so far been minimal. The problem is that unreported bed bug issues can rapidly snowball.
The Environmental Protection Agency (EPA) shares some guidelines on bed bug bites on its website that hint at the depth of the problem facing Las Vegas Strip resorts.
"Regularly wash and heat-dry your bed sheets, blankets, bedspreads and any clothing that touches the floor. This reduces the number of bed bugs. Bed bugs and their eggs can hide in laundry containers/hampers. Remember to clean them when you do the laundry," the agency shared.
Normally, that would not be an issue in Las Vegas as rooms are cleaned daily. Since the covid pandemic, however, some people have opted out of daily cleaning and some resorts have encouraged that.
Not having daily room cleaning in just a few rooms could lead to quick spread.
"Bed bugs spread so easily and so quickly, that the University of Kentucky's entomology department notes that "it often seems that bed bugs arise from nowhere."
"Once bed bugs are introduced, they can crawl from room to room, or floor to floor via cracks and openings in walls, floors and ceilings," warned the University's researchers.
spread social distancing pandemic
Americans are having a tough time repaying pandemic-era loans received with inflated credit scores
Borrowers are realizing the responsibility of new debts too late.
With the economy of the United States at a standstill during the Covid-19 pandemic, the efforts to stimulate the economy brought many opportunities to people who may have not had them otherwise.
However, the extension of these opportunities to those who took advantage of the times has had its consequences.
A report by the Financial Times states that borrowers in the United States that took advantage of lending opportunities during the Covid-19 pandemic are falling behind on actually paying back their debt.
At a time when stimulus checks were handed out and loan repayments were frozen to help those affected by the economic shock of Covid-19, many consumers in the States saw that lenders became more willing to provide consumer credit.
According to a report by credit reporting agency TransUnion, the median consumer credit score jumped 20% to a peak of 676 in the first quarter of 2021, allowing many to finally have “good” credit scores. However, their data also showed that those who took out loans and credit from 2021 to early 2023 are having an hard time managing these debts.
“Consumer finance companies used this opportunity to juice up their growth at a time when funding was ample and consumers’ finances had gotten an artificial boost,” Chief economist of Moody’s Analytics Mark Zandi told FT. “Certainly a lot of lower-income households that got caught up in all of this will feel financial pain.”
Moody’s data shows that new credit cards accounts that were opened in the first quarter of 2023 have a 4% delinquency rate, while the same rate in September 2022 was 4.5%. According to the analysts, these levels were the highest for the same point of the year since 2008.
Additionally, a study by credit scoring company VantageScore found that credit cards issued in March 2022 had higher delinquency rates than cards issued at the same time during the prior four years.
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Credit cards were not the only debts that American consumers took on. As per S&P Global Ratings data, riskier car loans taken on during the height of the pandemic have more repayment problems than in previous years. In 2022, subprime borrowers were becoming delinquent on new cars loans at twice the rate of pre-pandemic levels.
S&P auto loan tracker Amy Martin told FT that lenders during the pandemic were “rather aggressive” in terms of signing new loans.
Bill Moreland of research group BankRegData has warned about these rising delinquencies in the past and had recently estimated that by late 2022, there were hundreds of billions of dollars in what he calls “excess lending based upon artificially inflated credit scores”.
The Government's Role
Because so many are failing to pay their bills, many are wary that the government assistance may have been a financial double-edged sword; as they were meant to alleviate financial stress during lockdown, while it led some of them to financial difficulty.
The $2.2 trillion Cares Act federal aid package passed in the early stages of the pandemic not only put cash in the American consumer’s pocket, but also protected borrowers from foreclosure, default and in some instances, lenders were barred from reporting late payments to credit bureaus.
Yeshiva University law professor Pam Foohey specializes in consumer bankruptcy and believes that the Cares Act was good policy, however she shifts the blame away from the consumers and borrowers.
“I fault lenders and the market structure for not having a longer-term perspective. That’s not something that the Cares Act should have solved and it still exists and still needs to be addressed.”
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Inflation: raising interest rates was never the right medicine – here’s why central bankers did it anyway
We need to start cutting rates, but there’s something that has to happen first.
Inflation remains too high in the UK. The annual rate of consumer price inflation to September was 6.7%, the same as a month earlier. This is well below the 11.1% peak reached in October 2022, but the failure of inflation to keep falling indicates it is proving far more stubborn than anticipated.
This may prompt the Bank of England’s Monetary Policy Committee (MPC) to raise the benchmark interest rate yet again when it meets in November, but in my view this would not be entirely justified.
In reality, the rate hikes that began two years ago have not been very helpful in tackling inflation, at least not directly. So what’s the problem and is there a better alternative?
Right policy, wrong inflation
Raising interest rates is the MPC’s main tool for trying to get inflation back to its target rate of 2%. The idea is that this makes it more expensive to borrow money, which should reduce consumer demand for goods and services.
The trouble is that the type of inflation recently witnessed in the UK seems less a problem of excessive demand than because costs have been rising for manufacturers and service providers. It’s known as “cost-push inflation” as opposed to “demand-pull inflation”.
Inflation rates (UK, US, eurozone)
Production costs have risen for several reasons. During the COVID-19 pandemic, central banks “created money” through quantitative easing to enable their governments to run large spending deficits to pay for furloughs and other interventions to help citizens through the crisis.
When countries started reopening, it meant people had money in their pockets to buy more goods and services. Yet with China still in lockdown, global supply chains could not keep pace with the resurgent demand so prices went up – most notably oil.
Oil price (Brent crude, US$)
Then came the Ukraine war, which further drove up prices of fundamental commodities, such as energy. This made inflation much worse than it would otherwise have been. You can see this reflected in consumer price inflation (CPI): it was just 0.6% in the year to June 2020, then rose to 2.5% in the year to June 2021, reflecting the supply constraints at the end of lockdown. By June 2022, four months after Russia’s invasion of Ukraine, CPI was 9.4%.
The policy problem
This begs the question, why has the Bank of England (BoE) been raising rates if it’s unlikely to be effective? One answer is that other central banks have been raising rates. If the BoE doesn’t mirror rate rises in the US and eurozone, investors in the UK may move their money to these other areas because they’ll get better returns on bonds. This would see the pound depreciating against the US dollar and euro, in turn increasing import prices and aggravating inflation.
Part of the problem has been that the US has arguably faced more of the sort of demand-led inflation against which interest rates are effective. For one thing, the US has been less at the mercy of rising energy prices because it is energy self-sufficient. It also didn’t lock down as uniformly as other major economies during the pandemic, so had a little more space to grow.
At the same time, the US has been more effective at bringing down inflation than the UK, which again suggests it was fighting demand-driven price rises. In other words, the UK and other countries may to some extent have been forced to follow suit with raising interest rates to protect their currencies, not to fight inflation.
How harmful have the rate rises been in the UK? They have not brought about a recession yet, but growth remains very weak. Lots of people are struggling with the cost of living, as well as rent or mortgage costs. Several million people are due to be hit by much higher mortgage rates as their fixed-rate deals end between now and the end of 2024.
UK GDP growth (%)
If hiking interest rates is not really helping to curb inflation, it makes sense to start moving in the opposite direction before the economic situation gets any worse. To avoid any damage to the pound, the answer is for the leading central banks to coordinate their policies so that they cut rates in lockstep.
Unless and until this happens, there would seem to be no quick fix available. One piece of good news is that the energy price cap for typical domestic consumption was reduced from October 1 from £1,976 to £1,834 a year. That 7% reduction should lead to consumer price inflation coming down significantly towards the end of 2023.
More generally, the Bank of England may simply have to hope that world events move inflation in the desired direction. A key question is going to be whether the wars in Ukraine and Israel/Gaza result in further cost pressures.
Unfortunately there is a precedent for a Middle East conflict leading to a global economic crisis: following the joint assault on Israel by Syria and Egypt in 1973, Israel’s retaliation prompted petroleum cartel OPEC to impose an oil embargo. This led to an almost fourfold increase in the price of crude oil.
Since oil was fundamental to the costs of production, inflation in the UK rose to over 16% in 1974. There followed high unemployment, resulting in an unwelcome combination that economists referred to as stagflation.
These days, global production is in fact less reliant on oil as renewables have become a growing part of the energy mix. Nonetheless, an oil price hike would still drive inflation higher and weaken economic growth. So if the Middle East crisis does spiral, we may be stuck with stubborn, untreatable inflation for even longer.
Robert Gausden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.recession unemployment economic growth reopening bonds monetary policy mortgage rates currencies pound us dollar euro governor lockdown pandemic covid-19 recession gdp interest rates commodities oil uk russia ukraine china