A WORLD ON EDGE 2018 INVESTMENT OUTLOOK - A - Old Mutual
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2018 A WORLD ON EDGE A A WORLD ON EDGE 2018 INVESTMENT OUTLOOK
WHAT’S 01 / A WORLD ON EDGE
INSIDE SIBONISO NXUMALO, GLOBAL EMERGING MARKETS
02 / EXECUTIVE SUMMARY
2018 INVESTMENT OUTLOOK
04 / ARTIFICIAL INTELLIGENCE (AI) – overhyped or the next
revolution in asset management?
HYWEL GEORGE, OLD MUTUAL INVESTMENT GROUP
08 / HARNESSING THE POWER OF AI IN INVESTMENT
MANAGEMENT
SALIEGH SALAAM, WARREN MCLEOD AND GRANT WATSON,
OLD MUTUAL CUSTOMISED SOLUTIONS
11/ DECODING CURRENCIES – from gold to paper to e-money
ZAIN WILSON, MACROSOLUTIONS
18 / THE MYSTERY OF LOW INFLATION
DAVID COOK, OLD MUTUAL TITAN
24 / GLOBAL EQUITIES STILL THE PLACE TO BE IN 2018
JOHN ORFORD, MACROSOLUTIONS
28 / HERE COMES THE EMERGING MARKET CONSUMER
SIBONISO NXUMALO, GLOBAL EMERGING MARKETS
32 / WHEN SUSTAINED LOW ECONOMIC GROWTH
BECOMES BOND BEARISH
WIKUS FURSTENBERG, FUTUREGROWTH
34 /
WHERE WE SEE OBSTACLES, WE SEE OPPORTUNITY
JONATHAN LARCOMBE, OLD MUTUAL EQUITIES
38 / WHAT FULLY VALUED GLOBAL EQUITY MARKETS WILL
MEAN FOR PRIVATE EQUITY
PAUL BOYNTON, OLD MUTUAL ALTERNATIVE INVESTMENTS
40 / THE FUTURE OF FOOD
THEO VAN DER VEEN, UFF AFRICAN AGRI INVESTMENTS
44 / CLIMATE CHANGE DRIVING MACROECONOMIC
POLICY – SA IN 2018
JON DUNCAN, OLD MUTUAL INVESTMENT GROUP
52 / THE INCREASING ROLE AND RESPONSIBILITY OF ASSET
MANAGERS IN AN ECONOMY
TREVOR PASCOE, OLD MUTUAL MULTI-MANAGERS
54 / 2018 MARKET FORECAST: FINANCIAL SERVICES TO
FOCUS ON WOMEN
ELIZE BOTHA, OLD MUTUAL UNIT TRUSTS
2018 A WORLD ON EDGE
A WORLD 1
ON EDGE 2018 01
A WORLD
ON EDGE
The future dreamt up in the 2000s tech bubble
arrived in 2017.
2017 has to be the year tech investors in gazing into the crystal ball and making a
the tech bubble envisioned back in the late forecast that has to come true in the financial
90s and early 2000s. In investment circles services industry (see Elize Botha's article on
2017 will be remembered as the year of the women in financial services on page 54).
FAANGs*, the BATs# and bitcoin. The future
So we gaze out into 2018 in a world of
arrived with some hefty investment returns
elevated valuations in certain significant
sparking fears, opinions and debates on
markets, uncertain politics, rapid disruption
bubbles, disruption and what really constitutes
of long-established norms and a world whose
a “currency”.
increasingly unpredictable weather patterns
It turns out the ideas imagined in the tech illustrate that climate change is real. We
bubble actually had some credibility. Turns out are responsible for the preservation and
“eyeballs” do matter, that everyone will have growth of client funds in a world of increasing
a “computer” (smartphone) and it has proven complexity, where a very divergent range of
true that long-established companies will find potential outcomes and ever-heightened levels
themselves under threat from new competitors. of geopolitical risk exist.
Back in the 90s investors simply overlooked an
What’s most perplexing about the markets
important adage when it comes to investing…
today is that despite the uncertainty, the actual
“A great company is not a great investment if
perception of risk is very low. The VIX (volatility)
you pay too much for the stock.” – Benjamin
index, a measure of risk in the S&P 500 (the
Graham
largest and most influential market globally), is
It was the year a new car brand (Tesla) currently near 23-year lows.
became more valuable than companies that
So perhaps it’s fitting to close off with a quote
had been making cars for over a century. It
from Howard Marks while wishing you happy
was the year that the most valuable retailer in
reading and a fruitful 2018.
the world (Amazon) earned its founder the title
of the “richest man in the world”.
Looking into 2018, the future looks even more
uncertain. In this publication we will examine “SKEPTICISM AND
the ideas that will be of meaningful importance PESSIMISM AREN’T
in 2018. We highlight some of our thinking SYNONYMOUS.
across all our capabilities. These articles SKEPTICISM CALLS FOR
make for some great reading as we delve into
PESSIMISM WHEN
artificial intelligence, bitcoin, asset allocation,
emerging markets, private equity opportunity,
OPTIMISM IS EXCESSIVE.
agriculture in sub-Saharan equity and climate BUT IT ALSO CALLS
change. We close off the publication by FOR OPTIMISM WHEN
PESSIMISM IS EXCESSIVE.”
– HOWARD MARKS
Siboniso Nxumalo
*Facebook, Apple, Amazon, Netflix and Google
#Baidu, Alibaba and Tencent JOINT BOUTIQUE HEAD
GLOBAL EMERGING MARKETS
02 2
A WORLD ONAEDGE
WORLD ON EDGE 2018
2018
INVESTMENT OUTLOOK 2018
EXECUTIVE SUMMARY
AI – H YPE OR IN V E S TM E NT T H E M YST E RY O F L O W I N F L AT I O N Why?
REV OL UTION?
Getting to the bottom of the mystery of low • Global growth is likely to continue
For many, the AI milestones that have been inflation in the developed world is going to be performing reasonably well, driving
achieved over the last five years have set us up an important determinant of financial market global earnings.
for the greatest technological revolution in history fortunes next year. Some reasons why inflation
• Should global inflation remain relatively
over the next decade – but will this revolutionise may be so low are:
modest, the US Federal Reserve would
the investment industry?
• Technology and the rise of the super- be most likely to continue with a steady
Hywel George, Old Mutual Investment Group computer and gradual approach to raising interest
Director of Investments, believes so, and while rates.
• Globalisation and the ongoing
this raises the spectre of a future where computers
deflationary forces in the East If that is the case, it would be appropriate to
have superintelligence that surpasses our own
maintain an overweight allocation to global
he is convinced it will be a matter of human and • Unemployment not being as low as it
equities. However, any signs that the US
machine being better than human alone, rather seems
economy is beginning to overheat or inflation
than human versus machine. • Inflation expectations proving to be a is on the rise would be cues to investors that
self-fulfilling force the bull market in global equities is nearing its
AI’ S DISRUPTI O N O F IN V E S TM E NT end.
• Deficiencies in how we measure or
MANAGEMENT
define inflation
Big Data and AI can help active investors seek H E R E C OM E S T H E E MERGING M ARKET
Solving this could result in inflation being
out informational advantages to achieve alpha C ON SU M E R
measured at higher levels than it is today and
but AI and Big Data will be best leveraged by
thereby having a material knock-on effect on What with rapid urbanisation, rising incomes,
those investment professionals with practical,
interest rates and asset prices. rising global political influence and favourable
real-world experience of managing money and
demographics, the emerging market consumer
implementing quantitative outcomes.
G L O B A L E QU I T I E S ST I L L T H E P L A C E T O is taking centre stage.
The explosion of data, processing power and B E I N 2018 The most visible sign of this: in Asia,
algorithmic techniques over the past few years
While it’s unlikely that global equities will where China’s Singles Day has become a
can help investors obtain insights into non-
experience the same magnitude of returns in shopping day many times bigger than the
traditional factors that can affect markets and
2018 as they did in 2017, we expect this US's renowned Black Friday weekend (the
company valuations.
asset class to still deliver the best returns in biggest shopping weekend in the US’s annual
2018. shopping calendar).
DECODING CU R R E N C IE S FR O M GO LD
TO PAPER TO E - M O NE Y
There are plenty of signs that bitcoin and the
broader cryptocurrency market are in the midst of
a bubble, including the astronomical rise in price;
a sudden proliferation of “expert” opinions and
BITCOIN MARKET CAP IN US DOLLARS (BILLIONS)
articles; the market for the asset being dominated A S AT 1 5 N O V E M B E R 2 0 1 7
by speculators, and the “smart money” beginning
$130 000
to take profits.
$120 000
The key things investors need to consider: $110 000
• Regulation remains an obstacle globally and $100 000
$90 000
locally for cryptocurrencies.
$80 000
• The competitive edge of any one $70 000
cryptocurrency over the next is weakened $60 000
by intense competition and the absence of $50 000
intellectual property protection. $40 000
$30 000
• Valuation remains distorted by the amount of
$20 000
speculators active in each currency.
$10 000
Our view: cryptocurrencies offer an exciting $0
and interesting – but a speculative – investment January14 July14 January15 July15 January16 July16 January 17 July17
opportunity.
Source: Blockchain.com
EXECUTIVE SUMMARY INVESTMENT
2018 A–WORLD ON EDGE
OUTLOOK 2018 3 03
WHEN SUSTAI NE D LO W E C O N O M IC W H AT F U L LY VA L U E D G L OB A L E Q U I T Y While renewable energy is challenging the
GROWTH BEC O M E S BO N D BE A R IS H M A R K E T S W I L L M E A N F OR P R I VAT E myth that fossil and nuclear power are needed
EQUITY to provide “baseload” electricity supply when
The South African government, with the
the sun isn’t shining or the wind isn’t blowing,
exception of brief periods, has been If markets are set for a period of volatility and
the quality and strength of our national
consistently running budget deficits. Though price revaluations in 2018 or 2019, private
leadership will determine what happens to the
not bad per se, this does require a healthy equity will be a major beneficiary as investors
IRP process.
economy for the level of borrowing to be seek safer havens and large, well-managed
sustainable. African infrastructure projects will continue
to attract global investors’ funds as they offer T H E I N C R E A SI N G R OLE AND
When it is not, quick fiscal fixes, like increasing R E SP O N SI B I L I T Y OF AS S ET
steady and reliable returns.
taxes as opposed to reducing expenditure, M A N A G E R S I N A N E CO NO M Y
could have potentially unwelcome longer-term
consequences like lower consumer demand TH E F U T U R E OF F O OD Asset managers play a critical role in the
and downward pressure on growth. South African economy, with their allocation
By 2050, Africa’s population will swell to
decisions helping to determine the efficiency of
Government would then have to rely more on 2.4 billion – that will be 25% of the global
the economy and financial market stability.
borrowing to fund the deficit and the resultant population. That means food production in
increase in bond issuance would lead to rising sub-Saharan Africa needs to increase by 60% As an industry that manages and controls
yields. over the next 15 years to feed our growing about R4.4tn, asset managers need to be
population. The solution: African agriculture brave if they want to have a role in limiting
WHERE WE SE E O BS TA C LE S , W E S E E needs a transformative process towards economic damage during a year when
OPPORTUNITY alternative approaches, such as climate-smart political developments loom large and the
The outlook for low economic growth is a agriculture and technological improvements. macroeconomic outlook is more favourable for
reality and set to play out in South Africa into global equity markets.
2018 and beyond. C L I M AT E C H A N G E D R I VI N G M A C R O -
E CON OM I C P O L I C Y – SA I N 2018 F I N A N C I A L SE R VI C E S T O F O CU S O N
While it may appear that the opportunities to
WOMEN
invest in this environment are mainly in offshore Decisions taken regarding the Integrated
companies, in fact many well-run, locally Resource Plan (IRP) in 2018 will largely The financial services industry is still male
focused companies have performed well on determine the scale of renewable energy dominated, both in terms of the people it
the JSE. These companies are often mispriced, investment in South Africa – and our future employs and the clients it serves.
driven by investors’ “fear” in these uncertain growth.
Financial services need to spearhead a much-
times, and, as such, present great investment needed change in gender diversity, otherwise
opportunities. companies become susceptible to “group
think” and we miss a great opportunity to
empower more than half the population and
positively impact our nation and the world.
S I N G L E S D AY V S B L A C K F R I D AY W E E K E N D
A L I B A B A ’ S N O V. 1 1 S A L E T H E B U S I E S T U S S H O P P I N G P E R I O D
$25
$20
$15
$10
$5
2011 2012 2013 2014 2015 2016 2017
U S B L A C K F R I D AY 3 - D AY T O TA L S I N G L E S D AY
Sources: Markit Manufacturing Purchasing Managers Index, FactSet
04 4
A WORLD ON EDGE 2018
ARTIFICIAL
INTELLIGENCE (AI)
OVERHYPED OR THE NEXT REVOLUTION
IN ASSET MANAGEMENT?
2017 SAW THE
ADVENT OF THE FIRST
FULLY AI-POWERED,
DAILY TRADED ETFS,
WITH SOME VIEWING
THIS AS HERALDING
A SHIFT INTO A NEW
INVESTMENT PARADIGM,
AUTONOMOUS
LEARNING INVESTMENT
STRATEGIES (ALIS).
HYWEL GEORGE
DIRECTOR OF INVESTMENTS,
OLD MUTUAL INVESTMENT GROUP
2018 A WORLD
AI – THE EDGEREVOLUTION
ONNEXT 5 05
hat’s new about these investment computers could potentially have superintelligence
W
processes is that the technology that surpasses our own and which could, it is feared,
COMPUTERS COULD learns and adapts as it goes ultimately put humans out of business.
along based on the information
POTENTIALLY HAVE But have we truly crossed the AI Rubicon or is this all
and enormous data sets the
SUPERINTELLIGENCE algorithms have access to and
just a matter of hype?
THAT SURPASSES OUR on which they are basing their For many, the AI milestones that have been achieved
OWN AND WHICH investment decisions and solving problems. All with over the last five years (see AI timeline) have set us
COULD, IT IS FEARED, no human input. up for the greatest technological revolution in history
over the next decade – and the investment industry
ULTIMATELY PUT As in other fields of AI, this has raised the spectre
will undoubtedly be at the centre of this.
HUMANS OUT of Singularity – a much-vaunted future state when
OF BUSINESS
TIMELINE OF AI MILESTONES
The first Dartmouth College summer AI conference is organised by John McCarthy, Marvin
1956 Minsky, Nathan Rochester of IBM and Claude Shannon
Joseph Weizenbaum (MIT) builds ELIZA, an interactive program that carries on a dialogue in
1965 English language on any topic
Herbert A. Simon wins the Nobel Prize in Economics for his theory of bounded rationality,
1978 one of the cornerstones of AI known as “satisficing”
Vernor Vinge publishes The Coming Technological Singularity, predicting that, within the next
1993 30 years, humankind would have the ability to create “superhuman intelligence”
The Deep Blue chess machine (IBM) defeats the (then) world chess champion,
1997 Garry Kasparov
2009 Google builds self-driving car
2011 IBM’s Watson computer defeated television game show Jeopardy! champions Rutter and Jennings
Google DeepMind's AlphaGo defeats 3x European Go champion Fan Hui by
2016 5 games to 0
Google's AlphaGo Zero – an improved version of AlphaGo – learns by playing only
2017 against itself and beat its predecessor 89:11 after only 40 days
Sources: Wikipedia, Old Mutual Investment Group
06 A WORLD ON EDGE 2018
ARTIFICIAL INTELLIGENCE (AI)
overhyped or the next revolution in asset management? continued...
But artificial intelligence and talk of technological Inevitably, the advances in AI have spurred robust
revolution has been around for a while. It was first debate about what impact AI will have on the
talked about in 1965 when a British mathematician investment world.
and cryptologist brought up the concept of an
To get a balanced perspective, it’s worth considering
intelligence explosion. Then in 1993, a sci-fi writer and
why AI is developing so rapidly.
computer scientist said that within 30 years we would
have the means to create superhuman intelligence. AI advances have primarily been made possible by
the sharp decline in the price of graphics processing
There are many definitions of AI but Forbes
units (GPUs) in recent years driven by gaming. This
magazine contributor David Thomas puts it most
has enabled AI to access immense amounts of data
succinctly: “Artificial intelligence is a branch of
of all types (numerical, image, voice), which are
computer science that aims to create intelligent
being made available from companies such as
machines that teach themselves.”
Google, Facebook and Microsoft.
There are different levels of AI, with each level
Cloud-based hosting has also provided access to
becoming more sophisticated and autonomous in the
extremely strong AI platforms. For instance, you can
tasks computers can do without human intervention.
use IBM or Google’s AI platforms to take advantage
There is machine learning (or structured learning),
of work that they have already done and build on
which is the ability of computers to learn and
top of this.
improve at tasks with experience. Then there is deep
(or unstructured) learning, when a computer uses Why is this important?
algorithms that adapt to new data and thus trains – It allows for quick-to-market implementation
itself to perform tasks. The best known examples of when you have enough data to teach your
deep learning are IBM Watson and driverless cars. algorithm.
– With so much data being made available, you
don’t even need to come up with a hypothesis to
A D E E P E R U N D E R S TA N D I N G code in, you can throw mountains of data at the
OF AI AI and, through deep learning, it will figure out
the pattern.
– Platforms are cheap/free, so the barriers to entry
are low. The main barrier is access to enough
Artificial Intelligence – Computers rich data.
with the ability to reason as humans
Notwithstanding the increasingly fast-paced
Machine Learning – innovation we’ve seen and the growing excitement
Computers with the ability
to learn without being
about the potential of AI, it is not likely to be an
explicitly programmed investment panacea – and it’s premature to think that
fundamental qualitative investment professionals will
Deep Learning – no longer have jobs as a result of AI.
Network capable
of adapting itself to
new data
Source: Forbes Magazine
AI – THE NEXT REVOLUTION 07
Instead, some of the things the investment More important for the investment industry is to
industry needs to be thinking about are: consider how can we use AI to improve portfolios,
how we can use AI to take the repetitive, grudge
IT IS NOT HUMAN – If you pick the incorrect data, you will get the
work out of our jobs in order to concentrate more
VERSUS MACHINE; IT incorrect result (which will come in as the correct
time on the hard thinking work and how we use AI to
result, but is based on the wrong information).
MEANS HUMAN AND augment what we do, as opposed to worrying about
MACHINE IS BETTER – An algorithm learns as time goes by, but it cannot it replacing what we do.
determine an upcoming black swan event unless
THAN HUMAN ALONE In other words, it is not human versus machine; it
it has a previous black swan event to have
means human and machine is better than human
learnt from.
alone. ¢
– AI is very good at doing one thing well, but not
at integrating many things into a “super-solution”.
For instance, you can use AI to determine what
the market may do using machine readable
news as a factor in an investment portfolio, but
you are not able to just “ask AI to come up with a
portfolio” and let it just figure it out.
1965 1993
WAS THE YEAR THAT A SCI-FI WRITER AND COMPUTER
ARTIFICIAL INTELLIGENCE AND SCIENTIST SAID THAT WITHIN
TALK OF TECHNOLOGICAL 30 YEARS WE WOULD
REVOLUTION WAS FIRST HAVE THE MEANS TO CREATE
MENTIONED SUPERHUMAN INTELLIGENCE
08 A WORLD ON EDGE 2018
HARNESSING THE POWER
OF AI IN INVESTMENT
MANAGEMENT
A TREND THAT IS INCREASINGLY will more likely be successful at using this data if
they already have a culture that has a track record
SIGNIFICANT IN THE of incorporating data into the investment process. THIS EXPLOSION OF
SEARCH FOR INVESTMENT You can’t go from being an active manager to a
DATA, PROCESSING
quantitative manager overnight.
OUTPERFORMANCE (ALPHA) POWER AND
AI and Big Data also need investment professionals
IS THE RISE OF BIG DATA AND ALGORITHMIC
with practical, real-world experience of managing
ARTIFICIAL INTELLIGENCE (AI). money and implementing quantitative outcomes.
TECHNIQUES OVER
HOWEVER, IN UTILISING AI TO They need to be able to identify new sources of data THE PAST FEW YEARS
that are usable within a quantitative process and CAN HELP INVESTORS
ACHIEVE ALPHA, NOT ALL ACTIVE leverage this to gain outperformance. OBTAIN INSIGHTS INTO
MANAGERS ARE EQUAL. NON-TRADITIONAL
AI and Big Data can therefore – with the right
S A L I E G H S A L A A M , WA R R E N manager – play a central role in investment FACTORS THAT CAN
M C L E O D A N D G R A N T WAT S O N , management. To demonstrate this, we reflect on the
PORTFOLIO MANAGERS, AFFECT MARKETS AND
typical investment process (see Chart 1 below).
OLD MUTUAL CUSTOMISED COMPANY VALUATIONS
SOLUTIONS
R E SE A R C H : B o t t o m - u p m o d e l a n d i n s i g h t s
A DATA-CENTR IC IN V E S TM E NT C U LTU R E
from new data sets
seeks to enable computers with
Currently, there are approximately 500 specialised
AI
human-like cognitive intelligence,
data providers globally and the market for
and in the case of investment
alternative data providers is estimated at around
management, active investment
US$130 billion and expected to grow to
strategies seek to use and analyse
US$200 billion by 2020. Investment managers, in
publicly available data (financial,
particular, are currently estimated to spend around
economic, risk, management,
US$2-3 billion on big data and this number is
valuation etc.) to provide an informational advantage
expected to grow by 10% to 20% by 2020. (Data
to generate outperformance.
sourced from JP Morgan’s report “Big Data and AI
The attraction of Big Data and AI is that it can help Strategies”, May 2017.)
active investors seek out informational advantages
This explosion of data, processing power and
for the ultimate benefit of their clients. Companies
algorithmic techniques over the past few years
and investors can indeed use AI to their advantage.
can help investors obtain insights into
However, it must be noted that an active manager
CHART 1: THE TYPICAL INVESTMENT PROCESS
RESEARCH PORTFOLIO MODELLING EXECUTION AT T R I B U T I O NTHE POWER OF AI 09
non-traditional factors that can affect markets and One of the new and alternative data sets Old Mutual
company valuations. For instance, management Customised Solutions has tested and implemented
conference-call data is available that tracks within our investment process is machine readable
management calls with analysts and determines, on a news. An algorithm “reads” the news and scores
balance of probabilities, whether management’s tone an article as being, on balance, positive, neutral
and line of questioning with analysts were positive or negative. It then allows us to “read the mood” of
or negative. Machine learning and AI can also be millions of articles published on the financial news
used to provide real-time dynamic estimates of credit wires and objectively determine market sentiment.
risk and create more accurate real-time economic In his investment classic, The Intelligent Investor,
forecasting models. Savvy investors can then use author Benjamin Graham stated that the market is a
these and other insights from non-traditional data voting machine in the short term. Machine readable
sources in their investment research processes. news therefore allows us to objectively count the
market’s votes.
BA NKS’ GOLD ’S G O L D ’S
SENTIMENT SENTIMENT S EN T I ME N T
POST POST BREX IT P O S T T R U MP
NENEGATE
M AT E R I A L LY P O S I T I V E X X
NEWS FEED
SENTIMENT
POSITIVE
N E G AT I V E
M AT E R I A L LY N E G AT I V E X
Source: Old Mutual Customised Solutions10 A WORLD ON EDGE 2018
HARNESSING THE POWER OF AI IN
INVESTMENT MANAGEMENT
continued...
PORTFOL IO MO DE LLIN G: To p- down an d current market conditions as reflected in the real-time
b uild ing the E x per t M odel attribution data, that conditions are not ideal for an
investment strategy, then risk tolerance and portfolio FUNDAMENTAL
Machine learning is the term used to describe when
construction parameters may be automatically
a system processes data to assess its predictive INVESTORS CAN
adjusted − thereby preserving a client’s wealth.
ability. It then uses this information it has “learnt” USE INSIGHTS FROM
to further improve its predictive ability for the next Conversely, if the algorithm determines, via the
MACHINE LEARNING
successive iteration. near real-time attribution, that market conditions are
ideal for the investment strategy, risk tolerance can
IN THEIR PROCESSES
Fundamental investors can use insights from
be increased and portfolio construction parameters BY BUILDING AN
machine learning in their processes by building an
“Expert Model”. This model will essentially allow
relaxed, thereby maximising a client’s wealth. “EXPERT MODEL”
the codification and formalisation of the stock Algorithms mimic mother nature
selection criteria and allow the team to repeatedly
We currently use “genetic” algorithms within our
and consistently apply the criteria to an investment
portfolio construction process to create an optimal
universe. The shares identified as “buy” and “sell”
portfolio. The genetic algorithm borrows logic from
may then serve as an objective recommendation,
genetics and repeatedly modifies a population of
eliminating the danger of behavioural bias.
individual portfolio solutions.
EX EC UTION: E n h an c ed tradi n g At each step, the genetic algorithm selects individual
portfolios at random from the current population of
An area of the investment process chain that has
optimal portfolios to be parents, and uses them to
made extensive use of machine learning and
produce the “children for the next generation”. Over
algorithms is trading, or execution. Machine learning
successive generations, the population “evolves”
and AI at the pre-trade compliance stage can
towards an optimal portfolio solution.
systematically learn from previous trading errors and
proactively predict where future trading errors are
I T C O M E S D OW N T O A PA RT N E R SH I P O F
likely to occur. Pre-trade compliance rules can then
AUGMENTED INTELLIGENCE
be established to block these potential trading errors
before they occur. AI is indeed a disruptor in the asset management
sector. And although some – investors and managers
At the execution level, via our broker relationships,
alike – are somewhat intimidated by this trend, it is
we use algorithmic trading to execute trades. These
actually unearthing new investment opportunities
algorithms use machine learning and AI − taking into
for managers with the right culture, experience and
account the size of the trade, the participation ratio,
approach. AI-driven asset management is really
the time of the day, market liquidity, bid-offer spreads,
still at the genesis stage, but over the next decade
real-time tick (price changes) and flow data, among
we will see this change as asset managers turn
other factors. These algorithms allow us to obtain cost-
increasingly to technology in their search for alpha.
effective best execution for our investors and ensure
that investment views are implemented efficiently. However, AI, and all other technologies, have
limitations, especially regarding investment
ATTRIBUTION: R eal- ti m e i m pac t on management and other areas of complex decision-
p or t folio c onstr u c ti o n making. Even at its most advanced, the technology
still requires human intervention in some form – either
Portfolio construction is where the investment strategy,
as a final decision or in the creation and modification
client mandate requirements and risk tolerance
of the algorithm. The future of active management is
intersect on an ex-ante basis. Attribution, on the other
therefore augmented intelligence.
hand, is the intersection of all these elements, but on
an ex-post or after-the-fact basis. So, rather than AI being the “enemy” of human
managers, it is fast becoming the secret weapon
Using machine learning and AI, an algorithm may
of enlightened active managers. By utilising the
use the insights learnt from the real-time attribution
technology correctly, we believe we can generate
to self-adjust the risk tolerance of a portfolio. For
alpha by focusing our own energy on what we do
instance, if the algorithm determines, based on the
best, and leaving AI to do the rest. ¢DECODING CURRENCIES FROM GOLD TO PAPER TO E-MONEY BITCOIN, THE BLOCKCHAIN, AND CRYPTOCURRENCIES HAVE RAPIDLY RISEN UP THE WATCH LIST OF THE INVESTOR COMMUNITY IN 2017. I WOULD HAZARD A GUESS THAT THE QUESTION OF WHETHER OR NOT “BITCOIN IS IN A BUBBLE” IS RIGHT UP THERE WITH “WHO WILL RISE VICTORIOUS OUT OF THE ANC’S DECEMBER ELECTIVE CONFERENCE?” ON THE LIST OF KNOWN UNKNOWNS. ZAIN WILSON I N V E S T M E N T A N A LY S T, MACROSOLUTIONS
12 12
A WORLD ON EDGE 2018
DECODING CURRENCIES FROM GOLD
TO PAPER TO E-MONEY
continued...
BITCOIN AS A DIGITA L PAY M E N T S Y S TE M (imagine an online payment through PayPal using a
credit card for an international purchase).
o understand the disparity in
IT REPLACES
T
opinions around bitcoin and As an alternative form of digital payment, bitcoin's
its fellow cryptocurrencies, we unique commercial value proposition is that it THE COMPLEX
need to understand the potential tackles the same desire for convenience and ease INTERNATIONAL
technological revolution they of execution, but also does the job of the banking
BANKING
bring, the problems they are network in verifying and keeping record of the
purporting to solve and what living “ledger”. It replaces the complex international
NETWORK WITHOUT
underpins their value proposition – commercial banking network without jeopardising the validity JEOPARDISING
or otherwise. and security of individuals’ and institutions’ ledgers THE VALIDITY AND
Bitcoin was created as an alternative means of
and the related transactions. This cuts out numerous SECURITY OF
middlemen and reduces costs, while also leveraging INDIVIDUALS’ AND
digital payment and as a new digital currency. As
off the larger and broader network to reach parts of
you stand, you likely have several forms of digital INSTITUTIONS’
the world traditional financial networks cannot easily
payment systems accessible within your immediate LEDGERS AND
reach, or that are not financially viable.
reach – in your wallet, a credit or debit card issued
THE RELATED
by your bank; on your mobile phone, a banking app
and any number of payment applications; and on B I T C O I N A S A D I G I TA L C U R R E N C Y TRANSACTIONS
your laptop, desktop or tablet device, access through Bitcoin goes a step further than just offering a
your browser to your online banking portal through broader and cheaper payment service. It also acts
which you may make direct payments, purchases as its own separate currency. Payment interfaces like
or transfers. PayPal, ApplePay, Visa and FNB process, record
While the technology used varies, all forms of digital and validate transactions in US dollars, euros, rands
payments refer to any non-cash transaction where or other government-issued currencies (fiat money).
there is a transfer of actual value. These applications Bitcoin, on the other hand, provides the same service
and services are essentially user interfaces aimed in… erm, bitcoins. The debate around government-
at providing improved convenience and ease of issued fiat money has been around since its first use
execution of payment, without jeopardising security in China around 1 000 AD. Before that, money was
for either party in a transaction. commodity based – initially rare stones, shells, grain
and livestock and later almost exclusively gold and
All forms of digital payments are built on silver. These commodities either possessed a use
the same underlying local and international outside of acting as money or had a degree of rarity,
banking infrastructure, which is conferred with and could be assigned some “intrinsic value”. Fiat
the responsibility of keeping a living record (or money emerged as it reduced the cost and difficulty
centralised ledger) of all individuals’ and institutions’ of storing and moving money (imagine having all
monetary assets. This ensures the legitimacy of of your savings as a silo of wheat that has an
every transaction, without which, buying and selling expiry date!).
goods and services would be virtually impossible
without physical cash, as there would be little basis Through time, different regions around the world
for trust between the payer and recipient. The simple adopted “hard” fiat money, linking the ratio of
interfaces we use daily belie the elaborate network the paper money to a fixed amount of a physical
required. In any one transaction there is the owner of commodity to underpin its value. This solved
the digital payment interface (for instance, PayPal), the problems of portability and storage, while
the payee’s bank (Capitec) and the recipient’s bank promising that it could be exchanged for the physical
(FNB). The banks, as gatekeepers of the “ledger”, commodity on demand. Without exception, each
remain embedded in the chain, while the number of of these experiences ended in the fiat money being
other intermediaries can easily go upwards of five inconvertible into the promised quantity of theDECODING CURRENCIES 13
commodity − often as governments were tempted The global financial crisis further highlighted some
to simply create new money (to finance wars and of the vulnerabilities within the global fiat money
expansions). Each fiat money regime inevitably and banking system, keeping a few ardent believers
collapsed and ended in periods of high inflation as calling for the return to some form of hard fiat or
the money rapidly devalued (debasement), eventually commodity-based monetary system.
to be re-pegged at a new, more appropriate, ratio to
It is no coincidence that bitcoin was launched in
the chosen commodity. As such, governments have
August 2008, in the midst of the crisis. Built into its
fluctuated between “hard” fiat money (pegged to a
design is a limited amount of bitcoins that can be
commodity) and “soft” unpegged fiat money, with
created over time − controlling the supply of the
its value effectively reliant on the widespread trust of
digital currency, to be capped at 21 million bitcoins
the users. Which system is preferable, each with its
by 2040. The limited supply eliminates the ability of
own flaws and advantages, is a shifting debate of
individual governments and the banking network to
ideology shaped by the most recent crisis.
simply create new money, while the fact that each
Examples of this destruction in trust continue to this bitcoin is an easy-to-store and a transferable digital
day in Argentina, Venezuela, and our neighbour, code makes it more appealing than a clunky piece of
Zimbabwe. In all cases, the preferred alternative metal.
currency of choice to which these broken paper
Whether or not bitcoin or other cryptocurrencies
money economies resort has been the US dollar,
supplant our rands and US dollars is far more difficult
benefiting from its role at the centre of global finance.
to assess compared to the commercial value of a
As the world’s reserve currency, the US dollar exhibits
digital payment system, given that the usefulness of
the favourable feature of having the broadest
any form of non-commodity money is reliant on the
network of use.
trust in it and a sufficiently large network of users.
TRAITS OF PREFERRED COMMODITY F I AT C RY P T O
MONEY MONEY TRAIT (GOLD) (RANDS) (BITCOIN)
Secure
HIGH HIGH HIGH HIGH
(Difficult to counterfeit)
Durable HIGH HIGH LOW HIGH
Divisible HIGH MODERATE MODERATE HIGH
Transactable
HIGH MODERATE HIGH HIGH
& Portable
Sovereign
LOW HIGH LOW
(Government Issued)
STABLE AND
PREDICTABLE
Scarce HIGH LOW HIGH
SUPPLY
Non-monetary Use HIGH LOW LOW14 A WORLD ON EDGE 2018
DECODING CURRENCIES FROM GOLD
TO PAPER TO E-MONEY
continued...
BITC OIN, THE BU BBLE (17 November 2017) – a growth rate of 80% per
year. With it, the market capitalisation has gone
2014
The question of whether or not bitcoin is in a bubble
from just over US$9 billion to US$121 billion. If
relates to the price of bitcoin in fiat currency terms
the market capitalisation of bitcoin continues to
(US dollars) − analogous to whether or not the South
grow at the rate it has since 2014, it would be THE US DOLLAR
African rand might be “cheap” or “expensive”.
Given that bitcoin, the asset, is closer to a currency
the size of global GDP by 2028. For this to be PRICE OF BITCOIN
than an equity or a bond, one consequence of a
fundamentally justified, bitcoin would have to WAS US$747
become the globally accepted reserve currency −
possible bubble would be that the continued use
as the value of money as a medium of exchange
of bitcoin as money is closely tied to the stability of
cannot exceed the value of transactions it is used
NOW
its price. While shares can sustain periods of large
for. (Sources: www.blockchain.com, www.
drawdowns (as long as the underlying businesses
coinmarketcap.com)
do not go bust), excessive volatility and a collapse
in the price of a currency can perpetuate vicious 02. E
veryone around you is talking about it…
THE US DOLLAR
cycles, driving away those that use it as a means of PRICE OF BITCOIN IS
– You hear more and more anecdotal stories of
exchange.
friends, or acquaintances who have “invested”
US$7 300
There are plenty of signs that bitcoin and the broader in bitcoin and made a quick buck, paying for
cryptocurrency market are in the midst of a bubble: their next holiday, with a guarantee that the price
80%
can only go up.
01. The extent and pace of the increase in price,
and with it the market capitalisation, has been – Google trends reveal that the popularity of
astronomical. “blockchain” and “cryptocurrency” as search GROWTH RATE
– The US dollar price of bitcoin is up from
topics has increased by a multiple of PER YEAR
17 times over the past four years. By
US$747/BTC at the start of 2014 to
comparison, another disruptive technology,
US$7 300/BTC as I write
BITCOIN MARKET CAP IN US DOLLARS (BILLIONS)
A S AT 1 5 N O V E M B E R 2 0 1 7
$130 000
$120 000
$110 000
$100 000
$90 000
$80 000
$70 000
$60 000
$50 000
$40 000
$30 000
$20 000
$10 000
$0
January14 July14 January15 July15 January16 July16 January 17 July17
Source: Blockchain.comDECODING CURRENCIES 15
GOOGLE TRENDS: E-MONEY AND UBER
LEVEL OF INTEREST FOR A KEYWORD PHRASE
R E L AT I V E T O T O TA L S E A R C H V O L U M E
120
100
80
60
40
20
0
January 14 July 14 January 15 July 15 January 16 July 16 January 17 July 17
BITCOIN BLOCKCHAIN CRYPTOCURRENCY UBER
(WORLDWIDE) (WORLDWIDE) (WORLDWIDE) (WORLDWIDE)
Source: Google, to 12 November 2017
Uber, is lagging behind with an increase of only – The volume of transactions performed via
10 times (see the chart above). bitcoin (payments of bitcoin from one user to
the next) compared with the high volume of
03. There is a sudden proliferation of “expert”
trade on bitcoin exchanges (those buying and
opinions and articles on the subject − this one
selling bitcoin with fiat currencies) also gives
included!
an indication of the users of the digital payment
04. The market for the asset is dominated by system relative to the investors and speculators in
speculators, and with it, the use of borrowing the digital money.
to fund their activity.
– A more stable and functioning currency needs
– While there is no easy way to measure a foundation of active users (those using the
how many people have quit their day jobs currency as money), with the traders and
and registered bitcoin trading operations speculators being secondary and acting to
in their garages, the extreme price volatility grease the wheels and keep the system efficient.
and sensitivity of the bitcoin and other
– Measuring the use of borrowing to fund
cryptocurrencies to news and events suggest
speculative activity is impossible, given the
the role of speculators in driving the price
unregulated nature of cryptocurrencies.
is high.
B I T C O I N E S T I M AT E D T R A D E V O L U M E A S A P E R C E N TA G E O F
TRANSACTION VOLUME (USD)
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
January 14 July 14 January 15 July 15 January 16 July 16 January 17 July 17
Source: Blockchain.com16 A WORLD ON EDGE 2018
DECODING CURRENCIES FROM GOLD
TO PAPER TO E-MONEY
continued...
05. There is belief in a new paradigm and that “this 01. As a form of digital payment, bitcoin is
time is different”. underpinned by a viable value proposition.
Although not enabling completely free ONE MEASURE OF
– The potential of new and disruptive technologies
transactions, it presents an alternative form of
is notoriously difficult to measure, part of which THE GROWING
digital payment, which will find niche markets
makes them ripe for speculative bubbles. Some MICRO-ECONOMY
for transactions that are uneconomical for current
truly are transformative, while others fade.
payment systems. This opportunity is large, and IS THE NUMBER
– As belief in the technology and possibilities that meaningful. OF NEWLY ISSUED
come with it spread, new markets, businesses
– However, this is not a commoditised market – the CRYPTOCURRENCIES
and micro-economies are rapidly created
around the new technology. While many of
software on bitcoin is open source, it is free for – CURRENTLY
these are legitimate businesses (still tied to the
anyone to copy and attempt to improve upon. TOTALLING 1 293!
Thus, the only true advantage bitcoin has over its
success of the underlying technology), others
peers is the larger network of users it has already
don’t stack up quite as well under a critical eye.
established.
– One measure of the growing micro-economy
– For bitcoin to maintain its lead and remain
is the number of newly issued cryptocurrencies
ahead of its competing cryptocurrencies and
– currently totalling 1 2931 ! This is many times
the alternative technologies used by traditional
more than the roughly 185 sovereign states
payment providers, it would have to continuously
in the world − a decent proxy for the number
improve upon its technology and offering.
of independent fiat currencies. On top of that,
there are exchanges, wallet providers, detailed 02. Bitcoin as a digital currency is slightly more
research, data and analytic providers and, not complex. The success of any currency depends
least, the new applications of the technologies, on some failure or discontent in the currency that
which are attracting increasingly larger amounts precedes it, and a build-up in trust and usage
of funding. via a strong network in the new currency.
06. Some of the “smart money” is beginning to take 03. The argument that bitcoin, the digital money,
profits. has no intrinsic value is misguided in that it is no
different from other forms of fiat money. Whether
This is by no means a comprehensive analysis of
or not there is trust and a large enough network
bitcoin and the world of cryptocurrencies. Nor are
of users, is a more appropriate question for
we experts on technology – there are many more
a currency to be legitimate. The two greatest
potential applications not discussed here, as well as
obstacles to expanding this network are the
some features I have not explored.
uncertainty around regulation from governments,
Instead, what I have attempted to do is frame a better and the high volatility in the price of bitcoin,
understanding of what cryptocurrencies are and, by which can dissuade an everyday mom and pop
drawing some lessons from history, highlight some of user.
the opportunities and risks:
04. Bitcoin, and the cryptocurrency craze more
broadly, exhibit definite signs of a bubble.
While the technology is potentially disruptive,
the balance of speculators to real users
appears unstable.
1 www.coinmarketcap.comDECODING CURRENCIES 17 WH AT DO E S T H I S M E A N F O R YOU R F U N D S? While there are a few cryptocurrency exchange In addition to the regulatory uncertainty, the highly traded funds (ETFs), futures and even dedicated mutual competitive market in which cryptocurrencies operate funds (investing ONLY in cryptocurrencies) in the US, and absence of intellectual property protection, weaken regulation remains an obstacle globally. For instance, the competitive edge of any one cryptocurrency over the it is not clear whether cryptocurrencies are considered next, while valuation remains distorted by the amount of currencies or commodities, and what the respective speculators active in each currency. For now, this would tax implications would be on any profits. Currently exclude bitcoin and other cryptocurrencies from being in South Africa, lack of regulatory direction leaves considered as an appropriate investment opportunity. cryptocurrencies as un-investible for our funds and, as Exciting and interesting, but speculative is a more such, MacroSolutions does not have any exposure. appropriate space. ¢
18 18
A WORLD ON EDGE 2018
THE MYSTERY
OF LOW
INFLATION
THE WORLD HAS COME
A LONG WAY SINCE THE
ROARING INFLATION
OF THE 70s, AND PAUL
VOLCKER’S SUCCESSFUL
ATTEMPT AT TAMING IT
WITH EYE–WATERINGLY
HIGH INTEREST RATES.
D AV I D C O O K
JOINT BOUTIQUE HEAD
O L D M U T U A L T I TA NINFLATION 19
ndeed, from where we stand monetary policy, which was designed to deal with
I
today, with central banks in the a time of crisis, even though unemployment is low
HIGHER INTEREST developed world conducting and average growth in the economy is in line with
RATES THEREFORE quantitative easing and a estimates of the economy’s potential. It is therefore
monetary policy of negative real clear (to my mind at least), that central banks will
RESULT IN LOWER
interest rates (or in some cases only meaningfully raise interest rates when faced with
ASSET PRICES, even negative nominal rates, rising inflation.
ALTHOUGH think Switzerland), it’s hard to imagine that the high
But why is inflation so low after so many years
SOMETIMES WITH A inflation of the 70s ever existed at all. But have you
of quantitative easing? Central bankers have
LAG AS THE INTEREST ever paused to wonder: what is so different about
collectively increased the monetary base by
the modern economy versus that of the 70s that,
RATE INCREASES $11trillion1, yet to date all this extra money supply
according to official statistics at least, this should be
has not resulted in any meaningful inflation.
the case?
In conventional economic theory, particularly that
The question is an extremely important one for
followed by central bankers, the Phillips curve is
investors, because interest rates are a sub-component
a favourite tool used to understand and predict
of the discount rates investors use to determine the
inflation. The Phillips curve holds that there is a
present value of expected future cash flows from
relationship between unemployment and the inflation
an asset, and are therefore a primary determinant
rate. As unemployment falls, potential employers
of asset prices themselves. Higher interest rates
raise wages to attract new employees, who then
therefore result in lower asset prices, although
spend more money on goods and services, driving
sometimes with a lag as the interest rate increases.
up inflation. The problem is that this relationship
Central banks, with their inflation targeting seems to have broken down in the developed world,
mandates, have shown that just about the only thing as inflation has been falling/remains low even as
they care about when setting monetary policy is unemployment has been falling, in the cases of both
current and expected inflation; no matter whether the US (where inflation is at a 16-year low!) and
this results in asset price bubbles, rising inequality Germany (where inflation is at levels below which
or the breakdown of efficient capital allocation they thought to be disinflationary).
due to the inappropriately based cost of capital.
1 www.forbes.com/sites/vincentdeluard/2017/08/03/
Indeed, in the US today the Federal Reserve (the Fed)
why-is-inflation-so-low-four-heterodox-
is persisting with its exceedingly accommodative explanations/2/#4778d9b94dc6
PHILLIPS CURVE IN GERMANY
2002 TO PRESENT
14
2005
12 2003 2004
2006
10 2007
2008 2002
2008 2010
8 2011
2014 2015 2013
2016
6
4
2
0
0 0.5 1 1.5 2 2.5 3 3.5
Source: Bloomberg20 A WORLD ON EDGE 2018
THE MYSTERY OF LOW INFLATION
continued...
It’s been more than two years since Stanley Fischer power of similarly sized integrated circuits will
gave his speech at Jackson Hole2 where he double every two years but will cost the same price), GLOBALISATION PUTS
expressed his surprise that the gradual reduction of on the other hand, we are seeing the rise of the DOWNWARD PRESSURE
slack in the economy (to the point that the economy super-computer and a level of artificial intelligence
ON PRICES DUE TO
was approaching its maximum employment that may surpass human intelligence in many respects
objective) had been associated with so much (see Hywel George's article on page 4).
THE AVAILABILITY OF
downward price pressure. He argued that the lack CHEAPER IMPORTED
of inflation was most likely a result of one-off factors, 02 G
L OB A L I SAT I ON – T H E ON G OI N G GOODS IN DEVELOPED
such as the fall in oil and other commodity prices, but D E F L AT I O N A RY F O R C E S I N T H E E A ST ECONOMIES, AS WELL
said that he expected the economy to return to the AS DOWNWARD
The integration of Asia, and China, into the global
Fed’s target of 2% inflation.
economy has acted as a multi-decade brake on PRESSURE ON WAGES IN
Fast forward to today, and Janet Yellen is still inflation. Globalisation puts downward pressure DEVELOPED ECONOMIES
expecting inflation to reach the Fed’s target, and on prices due to the availability of cheaper imported
still believes the fact that it hasn’t is also most likely goods in developed economies (from lower cost
related to one-off factors (this time one-off reductions labour in emerging countries), as well as downward
in the price of prescription drugs and wireless pressure on wages in developed economies (due
telephone plans). But the slower-than-signalled to the threat of offshoring production to lower cost
increase in interest rates shows that even the Fed countries).
doesn’t have confidence that inflation is really
While this deflationary force should persist for some
returning to its target, even though leaving monetary
time still with the baton of low cost manufacturing
policy too loose for too long increases the chance
centre passing from China to Vietnam, the magnitude
that inflation will overshoot the target.
of this will be more than offset by higher wage
So, what is going on? Why aren’t we seeing inflation in China, which will impact producer price
inflation in the US (or any developed economy, inflation (PPI) and pass through to inflation in the
for that matter)? Or, asked another way, what developed world in the form of higher prices of
is pulling down prices in the face of ever-falling imported goods.
unemployment?
Here are a few of the more plausible 03 U
N E M P L OYM E N T M AY N OT B E
explanations: A S L OW A S I T SE E M S
This is more applicable to the US than Germany
0 1 T ECHNOL O GY A ND TH E R IS E O F TH E (which really is at record low unemployment levels).
SUPERCOM P U TE R While the labour participation rate (the ratio of
Machines have been taking the jobs of humans employed population to working age population)
at a scale not seen since the invention of the in the US is still far lower than before the global
steam engine, and the tempo of this change has financial crisis (GFC), it also counts part-time
accelerated since the period of the 70s, thereby employment as official employment so the labour
acting as a deflationary force. participation rate measured on a full-time equivalent
basis indicates that labour slack in the economy is
It’s certainly beyond my abilities to weigh in on higher than official unemployment statistics suggest. If
the pace of technological innovation in the future. this holds, it would explain why we haven’t yet seen
But, while on the one hand, it appears that we are wage inflation in the US, but, with about 175 000
nearing the end of Moore’s law (that the processing jobs being added in the US every month, labour may
2 www.weforum.org/agenda/2015/08/why-is-us- be an inflationary force soon, if it isn’t one already.
inflation-so-low/INFLATION 21
0 4 I N FLATIO N E X P E C TAT I O N S – A SE L F - D E F I C I E N C Y I N H OW W E MEAS U RE O R
FU LFILLIN G F O R C E D E F I N E I N F L AT I ON
If people expect high inflation, it becomes self- In Economics 101, we were taught that the equation
fulfilling. As people demand higher wages to deal for inflation is:
with expected cost increases, more money chases
the same number of goods and services, pushing up
prices, and so the process continues (and certainly
P = MV/Y
this was the situation in the 70s). Conversely, given
just how long we have experienced low inflation in Where: P = overall price level
the developed world (developed world inflation has M = money supply
been less than central bank targets for at least eight V = the velocity of money
years, and hasn’t been a concern since the late 90s), (the number of times the money supply
the converse of this may hold true. washes through the economy)
Y = real GDP
Inflation expectations do seem to be marginally rising
(central bankers at least seem to be evermore fearful Given that the money supply has increased at a
of it), so it would seem that the balance of probability magnitude far greater than real GDP, proponents of
is that this will change from a deflationary force to an lower inflation would lay the blame at the door of
inflationary force in the near to medium term. lower velocity of money.
VELOCITY OF MONEY
U S N O R M I N A L G D P / M O N E TA R Y B A S E
2.3
2.2
2.1
2.0
1.9
ratio
1.8
1.7
1.6
1.5
1.4
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
VELOCITY OF M2 MONEY STOCK
Source: Copyright 2017 Bloomberg, France LP22 A WORLD ON EDGE 2018
THE MYSTERY OF LOW INFLATION
continued...
But the velocity of money is not something anybody What is apparent is that, while the cost of essential
actually measures directly. Rather, it’s the balancing services such as education, healthcare and food has
product of the equation on the previous page. been steadily rising relative to average inflation (i.e. WHILE THE COST OF
This means that if any of the other variables are real price increases), the major deflationary force has
ESSENTIAL SERVICES
calculated incorrectly, we won’t know it from this been the price of electronics (where both technology
equation. It’s therefore possible that velocity of money and globalisation, as discussed, have played an
SUCH AS EDUCATION,
hasn’t fallen to the extent we believe, but rather that outsized role). But, has the price of electronics fallen HEALTHCARE
inflation, money supply and/or real GDP isn't being to the extent official statistics claim? AND FOOD HAS
measured accurately.
Vincent Deluard of INTL FCStone contributed an BEEN STEADILY
Of the three factors, I believe inflation to be the most interesting editorial to Forbes magazine published RISING RELATIVE TO
likely candidate given the more rigorous theory and on 3 August this year, in which he asks the interesting AVERAGE INFLATION,
practices supporting how we measure GDP, and question of how the US Bureau of Labour Statistics THE MAJOR
certainly money supply. Inflation doesn’t consider (the BLS) calculates that the price of phones has fallen
DEFLATIONARY FORCE
rising asset prices directly (apart from assumed 62% in real terms, when the price of a leading phone
equivalent rent) but most people strive to own assets, in 2004 was US$500 (for a Motorola Razr V3) and HAS BEEN THE PRICE
so I believe there is a good argument as to why was US$650 (iPhone 7+) at the time he wrote the OF ELECTRONICS
the level of asset prices should be included when article (and now it is US$1 000 for the iPhone X).
measuring inflation. And, while the prices of goods
This is due to an adjustment called “Hedonic
and services haven't risen materially, the prices of all
quality”, which refers to a method of adjusting
assets have risen spectacularly. Could rising asset
prices whenever the characteristics of the products
prices be a function of private investors (as opposed
included in the CPI change due to innovation or the
to central banks who typically implement quantitative
introduction of completely new products3. The BLS
easing by buying government bonds) adjusting their
calculates its Hedonic quality adjustment by basing
asset allocations away from risk-free assets to higher
its inflation statistics not on the rise in price of the
yielding risky assets, thus driving up asset prices?
top-of-the-range phone, but on the rise in price of
Under this scenario, higher asset prices (as opposed
Motorola Razr V3 feature phone equivalents. There’s
to higher prices for goods and services) are the
no question that phones are far more capable than
release valve through which growing money supply
they were 13 years ago before the advent of the
gets unleashed.
smartphone, but how do you determine how much
Our definition of inflation could be wrong in another to attribute to the real increase in performance/
way too. The New York Times ran an article in 2004 features? What value do you put on having a
where they included this very interesting chart on powerful camera and social networking available
the change of the cost of goods between 2004 and
3 www.forbes.com/sites/vincentdeluard/2017/08/03/
2014 for Americans (see the chart on page 23).
why-is-inflation-so-low-four-heterodox-
explanations/#19d36473740f
62% 2004 NOW
IS THE IT WAS $500 FOR THE IPHONE X IS
CALCULATED A MOTOROLA GOING FOR
FALLEN PRICE OF RAZR V3 AND $1 000
PHONES $650 FOR THE
IPHONE 7+You can also read
