The hidden cracks beneath the rally – we can only know that which can be measured
On December 11, 1974, influential Austrian-born British economist and philosopher, Friedrich von Hayek, best known as a champion of free-market capitalism and classical liberalism, and a fierce critic of socialism and state intervention, delivered “The Pretence of Knowledge” as his Nobel Memorial Lecture. It was later published as an essay and remains one of his most famous critiques of central planning and hubris in economics.
He said, “We know, of course, with regard to the market and similar social structures, a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information. And because the effects of these facts in any particular instance cannot be confirmed by quantitative evidence, they are simply disregarded by those sworn to admit only what they regard as scientific evidence: they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.”
And while Hayek’s observations could be usefully considered, but likely ignored, by the ideologues* in Australia’s Labor Party, I will leave that discussion for another time. Today, it seems Hayek is also being channelled by CIO, Portfolio Manager, Global Macro and Geopolitical Strategist at Singapore-based Convex Strategies, David Dredge.
[*Ideologues: Uncompromisingly and strictly adhering to their ideology, often to the point of dismissing or ignoring opposing viewpoints, and often prioritising theoretical ideals over practical compromises and real outcomes.]
In a recent interview published online, Dredge makes the following observations, each of which is useful for today’s investor to ruminate on as they navigate the impacts of the war in Iran, and particularly, its inflationary impacts:
- “History alone is a very poor measure of risk. It only tells you what did happen. It doesn’t tell you what could have happened.”
- “Central banks should not be central planners trying to optimise some future outcome. They should be risk managers. They should be like the forest manager who’s keeping the forest floor clean, who’s doing controlled burns, who’s cutting fire breaks, et cetera. They shouldn’t be trying to optimise the perfect forest of something that they don’t understand and can’t control.”
- “The one thing I think [Warsh] can do and has to do is put the death nail in forward guidance. Why are we sitting here not just, not ever, adjusting our policy but telling people what our policy will be into the future with no knowledge of what the future’s going to be?”
- “If you couldn’t see already in March that the Iran War had a very likely potential impact on direct resource prices, indirect resource prices and second-order effects, and if you’re not aware of the long memory implications of having just come through a massive increase in your price level across the entire system, you’re fools. You’re outright fools. And the way they sit and misrepresent, “Oh, monetary policy is not the right tool to manage oil prices, and we’re going to look through the supply shock, and this is temporary, and it’ll come back down. We’re watching for indirect and second order…Garbage, garbage, garbage”
- “The forest accumulates risk through time. And so you shouldn’t be surprised that there’s fires when lightning strikes. You should have known it was already there. And this is really the fundamental flaw.”
- “…this new competition for debt issuance by governments, and after the long period of [Quantitative Easing] QE and zero interest rates and massive reserve accumulation and adding leverage to banks in the Basel I, II, III and zero risk-weighted assets and the proliferation of liability-driven investment and this massive absorption until you got to – I can’t remember the number, $17 trillion of negative-yielding debt and zero interest rates and the largest outstanding debt ever at the highest price ever, the mother of all bubbles – something happened and they lost control and so it was really easy. And so everybody blew through 100 per cent of debt to [Gross Domestic Product] GDP and people were still buying the bonds at zero yields and negative, even though they went through 100 per cent of debt to GDP, and now we can’t do QE anymore because we lost control of price stability, and the banks are all so full on bonds that they bought at 1 per cent yield and the yield’s now 4.5 per cent. And they have these massive unrealised losses, and this was the whole premise around, “Who’s going to buy the bonds?” and yet, the guys selling them still need to sell more.”
- As to whether it is ignorance, or just the academic condition, “Well, they’ve simplified the math down to make it easy. The whole premise of economic math, as Hayek said in his famous Nobel lecture, is “We’ve decided to treat as important that which we can measure.”
While Dredge advocates using volatility funds such as his to protect against the downside, noting it’s cheap to buy insurance against big drops, he’s also suggesting the market is inherently unstable. Perhaps we can add Dredge to the growing cohort of reputable investors who believe the market’s bull run is on borrowed time.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
