Market Review: September 2009 London Commentary

Accepted Facts and Reality
In 1936, no doubt while rueing some of his own investment losses, the famous economist John Maynard Keynes noted that the business of financial forecasters was not to correctly predict what was going to happen to the real economy at any given time but to predict what the consensus would believe was going to happen at that moment. 

Ultimately, the consensus will predict correctly what will happen but for surprisingly long periods of time it is quite possible that the perception of reality can differ from the true situation (often with the help of a credit boom or bust) and thereby cause a sustained movement in share and other asset prices away from what might seem to be their fundamental position.  As Keynes noted, financial forecasters should at least attempt to incorporate this behaviour into their models.

As an investment strategy, we suspect that this approach still has much to commend it.  For example, six months ago - and perhaps even only a month ago - it clearly paid to believe in the China growth story because the consensus believed in the story regardless of the rather mixed - but generally negative - landscape portrayed by the reliable parts of the Chinese economic data.  

Quite simply, there was sufficient faith and credit growth in China to support the story of China's supposed ‘structural recovery' despite the evidence to the contrary.  However, when China's authorities hinted that they might curtail the rise in credit late last month, the consensus expectation shifted dramatically and some Chinese share prices tumbled by 40% in a matter of days.  Of course, little had changed in China's underlying economy between July and August - in both months it was a credit dependent economy with little consumer demand in high inventories - but changes in investor expectations caused dramatic reversal in fortunes for those invested in the concept.