Inflated asset prices, investor complacency and brewing crisis that could trip up the current happy equilibrium are the backdrop for Axel Merk’s warning that it is time for investors to start “taking chips off the table.”
But the key difficulty for the Merk Investments founder and portfolio manager in his latest investment analysis is where to hide in an environment in which “instability may be the new normal.”
To answer that question, Merk first locates tracks the market’s current state as one of complacency — which is the third of three states in a market crisis.
Typically, he says, equity markets sell off in a crisis; as that crisis evolves, markets tend to differentiate: For example, when Cyprus blew up, Spanish bonds were undisturbed. In the third and current stage of a crisis, risk seems manageable.
“When a Portuguese company didn’t pay its loans on time, the markets barely blinked,” Merk writes.
It is at this stage that pundits typically advise not to sell but rather to buy the dips.
And this approach is vindicated by central bank easy-money policies that have the effect of compressing risk premiums.
European Central Bank chief “Mario Draghi has promised to do ‘whatever it takes.’ So why shouldn’t investors chase yields in the weaker Eurozone countries?” Merk asks.
The currency portfolio manager similarly critiques Fed chair Janet Yellen, whom he assesses as having “all but promised … to be late in raising rates.” What’s more, he thinks any nominal rate increases will be meaningless, because of inflation, such that he expects real rates to remain the same.
The trouble lurking in this low rate, high complacency environment is the danger that risk premia will suddenly and unexpectedly rise.
And while the source of this shift could be as subtle as a change of perception (“the glass is suddenly half empty”) or a result of the Fed seeking to engineer an exit, Merk devotes much of his analysis to growing social and geopolitical disorder.
In the social sphere, central bank easy-money policies are destroying society’s social fabric because asset holders are benefiting disproportionately, thus enlarging the wealth gap.