Yet Glass may be Half Full

Markets have been suffering a lack confidence in the future and the resulting drag on world growth has been severe. Since the financial panic of September 2008, marked by the very messy handling of the bankruptcy of Lehman Brothers and the next-day bailout of AIG, the world has witnessed continuing erosion in the confidence accorded to policy-makers, technocrats, and political leaders to restore a long-term belief that the financial system can once again function smoothly. The most severe confidence problems are currently centered in Europe, but the problem is global and epidemic.

Market participants’ lack of confidence in political leadership has meant more volatile markets, has contributed to the risk-on/risk-off trading mentality, and has convinced corporations to hoard cash rather to expand. All of these manifestations of a lack of confidence in leadership have been self-reinforcing. Moreover, the erosion of confidence has obscured the progress that has been made on the economic front. The practical implication for investors is that risks are probably both lower and much more balanced than market perceptions may appear. If and when confidence slowly returns as time passes and no further system-threatening debacles occur, the one hypothetical possibility is that the next big bubble to burst may well be in the flight-to-quality sectors. That is, the best investments of the past few years during the erosion of confidence may be the worst investments if confidence starts to slowly improve. This suggest much more volatility and risk for the currencies of the funding countries, such as the US and Japan, as well the US Treasury market which is offering negative real returns even in long maturities. The compliance maxim – “past performance is not necessarily a guide to future performance – may be the watch word for the coming few years.

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