Monthly Letter February 2012
Liquidity. With the LTRO programmes in December and February there has been an abundance of liquidity in the system. We are convinced that the equity market would not have had the great start to the year it has had without the the help from benign central bankers. As an equity investor you might be happy, but this is just another way of kicking the can a bit further down the road. The LTRO is not a solution but rather a way for the politicians and central bankers to buy the world some more time. The easiest way, in the short run, to do this is to make sure that the price of money is too low. This has been the case for much of the last decade and it is still the case. The 3 year LTRO at 1% distorts the pricing mechanism, but for now it works. Italian and Spanish government yields are coming down quite dramatically. Corporate bond yields are coming down. Equity markets are going up.
The liquidity will keep trickling in to the financial system for the next couple of quarters. We believe this will be evident in a continuation of the trend we have seen in the beginning of the year. The pace might be slower, but real assets will continue to increase in value. At least when measured in traditional currencies. We at Madrague believe that the best way to be positioned in this environment is to be long equities. The longer term impact, however, is not so rosy. When the price of money is wrong it tends to create bubbles somewhere in the economy. We’ve seen that in the last decade in housing and commodities. The recent liquidity injection is likely to inflate asset-prices as well. The limited (3 year) duration of the LTRO might mean that the bubbles will occur in assets with limited duration. Time will tell. One thing that all of us with children knows though. Once you started giving the kids candy on Tuesdays it is very hard to stop doing so at a later stage. Taking back liquidity from the market will crave a strong macro environment.