Money Makers

I thought the best comment on last week’s World Economic Forum came from the historian Niall Ferguson, who aptly summarised why so many powerful and power-needy folk feel the need to wend their way to the Davos get together every year. In addition to opportunities to network and do deals, he argued, Davos offers a third motivation for those who are there: “to establish, by comparing notes all day and all night, an elite consensus –  a set of views that for the rest of the year will ensure that one doesn’t say anything too ludicrous.”

For prominent public figures, most of who know that year-ahead predictions have little real value, this is clearly a useful function. Alas, the “prevailing consensus” at Davos is, as Prof Ferguson notes, often wildly misplaced. Things rarely turn out the way that the so-called elite expect. Their corridor chats reinforce their faith in the rightness of their views, but rarely convince anyone else. I can remember the year that emerging markets were all the rage, just as emerging markets were about to enter their recent four-year history of weakness.

But should investors also take note of the warnings that high profile speakers from the investment world also tend to deliver at these events? Warren Buffett aside, there is no bigger name in the investment business than George Soros – and it was he who made as gloomy a prognosis at Davos about the outlook for investors as I have heard this year (and there is no shortage of competition for that dubious honour).

Soros in effect predicted that China was set to inflict a rerun of the 2008 financial crisis on the world, thanks largely to an out of control explosion in debt which threatens to bring the economy grinding to a halt, while adding to the deflationary forces already affecting the rest of the world. Here is an extract from the Bloomberg report.

“It’s one of the sources of deflation,” Soros said [about China]. “You’ve got basically three major root causes. One is China, the other is oil and raw material prices, and the third is competitive devaluation,” he added. “You have all three.”

Deflation is a hot topic at Davos. Billionaire hedge fund manager Ray Dalio mentioned it in an interview on Wednesday: “I think the Chinese situation with the currency is very important – very important. If there is significant currency weakness for the Yuan that will mean more imported deflation and it will make things more difficult.”

Soros said that it has been 80 years since the world last faced a deflationary environment, and the world doesn’t know how to handle it: “None of us lived in that environment. Last time we had that was [in the] 1930s. While I was around then, I was not engaged in the markets. We just don’t know how to handle it. It’s a different environment. Now we have to face it.”

You can listen to his Bloomberg TV interview here. As Prof Ferguson says, it all sounds horribly plausible – but how seriously should we be taking it as a guide to the investment outlook? Mr Soros is one of the most successful investors of the last 30 years, having generated an annualised return of 30% per annum over a period of many years, so it would be stupid not to take note of his comments. Remember however that by his own admission the outsize returns he made were in good part attributable to his use of gearing and a tolerance for risk that most investors would be unwilling or unable to replicate even if they had the necessary skills and temperament.

Like Prof Ferguson, I can think of two other reasons for being cautious about taking his predictions too closely to heart, at least at this stage. One is that, after 30 years of following his sayings, I have never found Mr Soros’ public pronouncements that useful as guide to future market direction. Global macro traders, of whom he was once a prime example,  change positions very quickly and frequently – by the time you get to read about what their thinking is, they may well have already done a 180 degree turn.

More important however is that Mr Soros, who is now in his 80s, is no longer actively manging money professionally. His primary role these days is as a political and social activist, one who is determined to use the power and influence which his success gives him to achieve political change at the highest level, particularly in Europe. One of his primary objectives is to try and save Eastern Europe from Russian interference and aggression, another to persuade Mrs Merkel to ease up on the hounding of the Eurozone periphery over debt.

That is not to say that the major risks he sees – such as a “hard landing” for China being “practically inevitable” – aren’t for real. They may well come home to bite in due course. A lot depends on how the Chinese authorities handle the debt and currency issue. They can handle it, Soros says, but the cost will be felt in the rest of the world. Will central banks then try to print more money to escape from the fallout? We don’t know.

The other question for investors is how soon any of this happens. The more risk averse you are, the more seriously it will pay to take these warnings as the market cycle plays its way through. My view is that the only way to play these tricky periods is to set yourself some hypotheses about how the markets might behave and follow the technical behaviour of the markets very closely, looking for confirmation or otherwise of those assumptions – which is pretty much how Soros himself went about his trading activities in his glory days. Short term that means it is important for the leading market indices to hold around the lows they set last August.

Main image © www.georgesoros.com

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