Fake prices, genuine risks

On 15 January, the Swiss National Bank abruptly removed the Swiss franc’s peg to the euro. Having been set at a parity of 1.20 for more than three years, the Swiss franc promptly gained 30% during trading before finally balancing out in the following days at a rate of 1.03 to the euro. This sudden adjustment in the value of the currency was a reminder that the laws of finance are similar to those of fluid mechanics: when a dam breaks, the flow is brutal.  

The UK market witnessed a similar episode around 20 years ago. In contrast to the Swiss peg, which aimed at slowing the increase in the currency, the Bank of England was at the time defending its currency from devaluation. When it finally gave up in September 1992, faced with the extent of flows, the adjustment was just as violent: a collapse in sterling, a withdrawal from the European monetary system, and glory for Georges Soros, the smart investor who had bet on the trend.

Fake prices are more widespread throughout the world than it would seem. Both in the micro-economy, once prices are governed by a law (French notaries and taxi drivers know all about this), and in the macro-economy, once a central bank or state intervenes to influence the markets. Whatever the methods used, particular care is then needed to identify and keep an eye on these artificially created prices.

The massive asset repurchase policies (quantitative easing) undertaken by central banks are genuine machines for controlling and transforming the price of assets. The fact that NESTLE has seen the rate on its three-year debt fall into negative territory (up to -0.6% last week), has not been due to a seppuku* by lenders, but indeed because the ECB’s interventions are bringing out a new rates universe.

In this environment favouring a multiplication in “fake prices”, should we expect further spectacular adjustments? A number of dams have already given way in a controlled way: the 16% devaluation of the euro over one year is one example, but other consequences are clearly likely.

Positive consequences probably for global champions who can therefore roll out their investments at no or even negative costs. But we should be careful: free money significantly increases the risk of bad capital allocations, which in the past have been rife in subsidised sectors, as the solar energy segment reminds us! The scenario generally starts with massive investments and an excess of initial confidence followed by sudden disappointment.

Quantitative easing is a machine for sponsoring the entire economy. Let’s make the most of the attractive bull market for the time being and the nascent recovery in corporate borrowing… and make hay while the sun shines! However, we should not lose sight of our long-term view: when confidence finally returns to Europe, bad investment allocations are likely to return and protective dams could give way. In which case, it would be better to be situated upstream, alongside companies that have efficiently allocated their capital. Its up to us to identify them well!

 Marc Craquelin

^{* Seppuku or hara-kiri is a ritual form of suicide that appeared in Japan in the XIIe century among the samourai warriors.}