What is the difference between a Mazars CIO and a boiling frog?

As an analyst I hate metaphors. While they are a very useful tool to turn my thorough -but often thoroughly boring- analyses into actual readable pieces, they also almost always convey a false sense of proportion. One of the most successful, yet dangerously misleading narratives I’ve read lately is one that equates investors to slowly boiling frogs.

Like frogs who don’t understand they are being boiled alive as the temperature rises, central banks are making investors slowly insensitive to the real risks building up in the economy. That seems true enough. Stock markets, some of which are at all-time highs, seem to completely defy gravity. Bubbles spring up all over the place. Meanwhile, bond yields at all-time lows, or thereabouts, would normally signal a very deep recession, but we can all understand that it’s really central bank buying, rather than the market having a long term bout of extreme pessimism.

All that market optimism comes against an increasingly ugly -“challenging” sounds better but it is an understatement- macroeconomic backdrop. Covid-19, the ultimate arbiter of economic performance nowadays, is peaking in most of the G7 countries, at a time when last year we thought it might be behind us. 2022 has become the new 2021, as economists and analysts are pushing projections for a full recovery further into the future. Scientists might say mutations are mostly covered by vaccines, but truth is scientific evidence is still scant. There’s a real probability we could be living with this for some time. Meanwhile, as Italy sleepwalks towards a potentially messy general election with its Credit Default Swaps higher than Greece’s, yields on bonds remain extremely low, with the ECB in fact picking up the purchases, allowing for more “moral hazard” (you’d be excused if you don’t recognise the term, we haven’t used it since Bush was President). The global economy is wildly out of sync, supply chains are in disarray, unemployment is rising and our response to this pandemic is just to borrow now and figure out what to do with the pile of debt later, as the world reorders itself again. That debt of course will either hamstring debtors (the west) or creditors (the east and central banks), but this battle has yet to be fought.

Back to our analogy. The main question from clients across the board is: Have central banks made us so insensitive to risk, like the proverbial frog, that we have are oblivious to bubbles building around us and threatening a market crash?

And this is the time to point out that the analogy is demonstrably false. The cook’s aim is to boil the frogs and eat them. The central bank’s aim is to keep capitalism going at all costs. In real life finance, if the frog dies, the cook dies along with him.

Central banks are in this together with investors. They are explicitly telling investors to take risks. If they don’t, “Secular Stagnation”, a savings-based stagnating economy where people just don’t lend out or risk their money in any way, is just around the corner. There isn’t a rate hike surprise looming here. Central bankers have expanded their balance sheets multiple times and can continue to do so, as long as long-term inflation doesn’t become an issue (short-term inflation could give us a scare this year, however). Even more so if they do this in concert, so that money printing or -God forbid- debt cancelling doesn’t degenerate into a competitive growth strategy and currency wars. 

So what is a Chief Investment Officer to do?

a) They can participate in this “game”, knowingly accepting investments as currently a government-subsidised exercise and with full disclosure of risks towards clients that a policy error could have an outsized effect on their portfolios, unless of course it’s eventually corrected.

b) They could have just stayed out of the markets and, assuming one is not subject to negative rates in Europe, the gain would have been almost zero (minus inflation).

So far, Mazars has chosen the former: Participate in the market and be transparent about what markets currently are. Our balanced portfolio made 138% after fees since the trough in 2009, or 8.22% per annum . For comparison purposes, before fees financial canon expects stocks to deliver 8% per annum and an average balanced portfolio after fees around 5% .(The calculation of course includes only the rebound after the 2008-2009 downturn to compare against a sluggish economic performance of 2-2.5% during the same period).  

Of course, as everyone else, the investment committee always worries about the endgame. Can we just print wealth ad infinitum? No. If an economy is steadily better and more efficient than others on its own right, investors should eventually poor their money into real businesses and not in paper profits.

But money printing has engulfed all of the western economies at the same time, so much so that there’s little alternative to engaging with it. Realistically, the only substitute would be China, which might look like a more “real” and less like a “paper” economy. Nevertheless, the country still has to content with a different style of Capitalism which it does not intend on adjusting to western standards (listen to Xi Jinping’s Davos speech carefully), state-owned enterprises with lower efficiencies and a more arbitrary regulatory system. If western money is to flow into China, it can’t expect conditions, returns or guarantees, similar to western markets.

Fact remains that, as far as risk markets are concerned, the US markets, and up to a point their European counterparts (including the UK), are so deep and corporate governance is so transparent that it would take decades and strong will to develop alternative venues on a global scale. Even more importantly, the almighty Dollar faces no serious competitors to its place as the de facto global reserve currency (60% of all reserves, a position that allows for unilateral sanctions and nearly infinite money printing), no matter how many thought papers the EU comes up with.        

Metaphor lovers can go ahead and call global markets a “House of Cards”, or talk about boiling frogs. Fact is that global capitalism remains “our house” altogether, a house on which we depend for capital allocation, pensions, fiscal payments, wealth management etc. Central banks are not the cook to a boiling frog, and certainly not planning a sinister way to defraud us of our savings. They have spent the decade propping up the house and hoping that economic policy decisions, or technological advancements will once again foster high(er) growth in western markets. The question isn’t whether we trust them to be honest. They are. The question is whether we trust them to succeed. Can they forever reinvent capitalism in order to save it?  And the answer has to be a firm yes, if for no other reason than because the alternative could be detrimental to the liberal western way of life and systemic risk would be so high that there would be nowhere to alternatively store wealth.