‘Ewww… you’re leveraged!’
In previous articles we have tried to throw some light upon the tendency of the crowd to deny the validity of gains and losses as they are distributed in the speculative markets. Indeed, in our most recent post (titled ‘Are Crowds Capable of Identifying Stupidity?‘) we suggested that individuals aiming for gain are often faced with a surprisingly harrowing choice; between assuming the role of the ‘lucky fool’ or the ‘perennially unlucky genius’. Here I’d like to expand upon this insight as it relates to secular trends in the monetary sphere. Namely, I outline an implication of the forthcoming generation’s (potential) knee-jerk distaste for leverage.
I suspect that at least a few of our readers will be thinking something along the lines of; ‘Umm…well… duh!’ After all, in recent years it has become incredibly obvious that excessive leverage can result in the financial equivalent of third degree burns. What I would point out to these readers is that it is not the immediate-term distaste for leverage that I seek to address here — for I suspect that it is scarcely outlandish to suggest that those who have been hurt in recent years will be wary (and weary!) for years to come. Instead I’d like to consider the implications of this distaste for leverage as it affects the actors in the forthcoming chapter of history. Reason being that it is the generational trend that is really intriguing to us. It would seem that more often than not it is the allocation of capital on the generational timeframe that matters for the establishment (and disestablishment) of various classes of wealth.
Self-contradiction: Dogmatic about a future that is closed…
A crowd scarcely distinguishes between the subjective and the objective. It accepts as real the images evoked in its mind, though they most often have only a very distant relation with the observed fact.
The above quote from Gustave le Bon’s ‘The Crowd: A Study of the Popular Mind‘ is wholly relevant to this subject. The ferocity with which the crowd attempts to uphold contradictory positions never ceases to amaze us. In the same breath, the crowd arrogates that prescience is necessary for legitimate speculative gains and yet that certain consensual modes of conduct are imperatives for a successful future. The question that strikes the thinking man is this; if — at the same time — the future is closed to men and ‘knowing what’s going to happen’ is necessary for legitimate speculative gains, then upon what grounds do consensual conceptions of preparing for a successful career stand? For us, the answer can only be; upon very shaky grounds indeed.
Funny isn’t it?
To distinguish between the secular and immediate-term distastes for leverage, I invite you to consider the observation that students at ‘top’ western universities remain intent on pursuing careers in finance (aka paper shuffling). This may seem bizarre to some of our readers, for we have witnessed a profound unravelling of our preconceptions about finance. Major institutions have failed, and even very recent graduates have seen the cornucopia of high and increasing bonuses evaporate before them. And yet for their slightly younger peers, the alure finance remains surprisingly robust. The images that spring to mind upon the articulation of junk financial jargon remains akin to the heroic!
Likewise amongst the stratas of society that are less susceptible to herd opinion, it would seem that the legacy of a life in debt remains on the mind. The average European individual is yet to rid himself of the premise that owning a house via a gigantic, callable short position on central bank notes (i.e. a mortgage) is an inherent, necessary and unavoidable part of life. What all this reveals about herd behaviour is that it changes only slowly over time for matters that mean something over time. The risk-averse seem to have this peculiar tendency to prepare for the most well-established and long-standing trends of the past – and alas it is by this folly that they unwittingly nurture their young into repeating the mistakes of their fathers and grandfathers before them. The forms of preparations for future conditions that resonate with people as they advise their juniors seems to be; ‘if I had done such and such, then I would have got this and that!’. It is our strong suspicion that every once in a while (say every 25 years?) this form of preparing for the future become precisely the worst kind of preparation that you can do. Since the moment of peak interest in all things financial seems to be behind us, it is the precise opposite (a peak distaste for finance) that we eagerly await.
‘Ewww… you’re leveraged!’
And this brings us to the childish title of this article. For if these secular patterns (towards adoration and profound distaste towards leverage) are indeed in force, then we are headed towards a society where the knee-jerk reaction to things that pertain to leverage and debt is negative. We at greshams-law.com patiently await the day when the childlike statement in the title is expounded by every kid in school. We suspect that this requires a period where consensual conceptions of ‘prudence’ (as defined by the identifiable past) turns 180 degrees towards no debt ever (ever (ever!)). To get there, we require sustained pain, and sustained losses for this strata of society.
As Distant as it may seem to day, it is bullish and not bearish musings that will probably dominate greshams-law.com!
But there is a surprising revelation with all of this. We have already experienced a bear market in equities for 11 years, and startlingly it may well be the case that there is only another 10 years or so left. Moreover, since generational bear market bottoms often occur in the interim of a secular trend towards de-leveraging it may well be the case that the very beginning of the bull market accumulation phase maybe but a few years away. So, in fact one of the main challenges that we face is to maintain our existing capital (this may or may not coincide with large nominal gains). The challenge, then, is to avoid experiencing the evaporation of wealth that results from owning the liabilities of the flailing counterparties that populate the public and private financial realm of today.
So to conclude I might say that we have two main goals:
- To preserve capital so that one day we can engage in pro-leverage activities when it is considered the most revolting thing on earth.
- To identify the brief moments in time over the next 10 years that resemble the deep oversold levels of a bear market bottom.
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012