Portfolio Manager Elias Bachman attended the 65th annual CFA Conference in early May in Chicago, where he listened to daylong presentations given by global investment professionals.
The never-ending crisis in Europe was uppermost on everyone’s mind. Not surprisingly, assessment of the situation depending greatly on one’s origin: those living outside the European Union saw an intractable mess that included insufficient accountability structures, limited financial discipline and the threat of rising nationalism, (seemingly insurmountable stumbling blocks), while Europeans expressed hope that a healthier structure for economic cooperation could be crafted. Many Americans saw default, departure and devaluation as the only ways to remedy the heavy debt burden and lagging competitiveness facing ailing countries like Greece and Spain. However, outright default and departure from the Euro zone of any one country poses serious risks in an interconnected global economy; markets hate uncertainty and no one could know what might follow next in the unfolding drama.
Randall Kroszner, former Governor of the US Federal Reserve Bank, later detailed how interconnectedness, leverage and the need for liquidity culminated in the 2008 US financial crisis. During this time, Dr. Kroszner and other Fed Governors carefully studied history to determine how the Fed could best support the troubled economy. In Europe we see the same vulnerabilities being exposed as markets shun bank assets such as Greek sovereign debt and Spanish mortgages. This underscores the need for the European Central Bank to prepare measures similar to the Fed’s response to the Lehman Bros. bankruptcy including standing at the ready to inject liquidity (additional funds) into their banking system to mitigate the shockwaves from a sovereign default and/or Greek exit from the Euro.
Next stop in the conference: Asia. Michael Pettis, Professor of Finance at the Guanghua School of Management at Peking University, discussed the growing imbalance facing the Chinese economy. China has grown much like Germany in the 1930s, the USSR in the early 1960s, Brazil in the 1960s and 70s, and Japan in the 1980s. Marked by massive expansion in infrastructure, housing and industrial capacity, the investment driven growth model initially provides much needed infrastructure and employment for citizenry, but eventually runs out of true value-creating projects. In an effort to not “kill the golden goose”, governments usually hesitate to curb investment growth until the gross misallocation of capital becomes evident to all. According to Pettis, in order for the Chinese economy to rebalance appropriately, personal consumption needs to increase. Three obstacles prevent this: an undervalued currency (effectively a tax on imported consumer goods), low wage growth relative to the concomitant rise in productivity (thus transferring wealth from laborers to owners) and artificially low interest rates (benefiting borrowers at the expense of savers). The solution seems obvious, but allowing Chinese currency and wages to appreciate would eliminate two key competitive advantages for China: cheap goods and labor. Pettis’ concluded that left unchecked, these imablances will eventually result in political instability.
On the lighter side, Daniel Kahneman, Professor of Psychology and Public Affairs at Princeton University and author of the book Thinking, Fast and Slow spoke regarding his work in behavioral finance. Basically, his work addresses the mental short cuts humans make and how the cognitive brain struggles to clean up afterwards. These short cuts can lead even very seasoned professionals to make bad decisions. To combat this tendency, he suggested using systems and processes that can check the “fast” thinking part of the brain that thrives on short cuts. What he proposed are essentially best practices in organizational communication, which enhance the consistency and objectiveness of sharing ideas and making decisions.
BSW team members attend conferences to actively absorb ideas regarding the world we invest in and to achieve a better understanding of the internal and external forces that shape how we view it. We look forward to sharing more of these experiences in the future.
Elias Bachmann, CFA, Portfolio Manager