Our recent comments have mostly dealt with central bank policies and how they continue to distort markets. We also repeatedly pointed to the folly of ‘paradoxical thinking’ that had taken hold: bad economic news emboldened market participants, because they felt reassured that central banks would be forced to continue supporting markets. By mid-year, increasingly many investors believed that bad news equaled strong stock and bond markets.
The past few weeks have blown a few holes into such thinking. Bond yields have risen sharply, major stock indices have been under growing pressure and gold has rallied against all currencies. There are numerous theories of why this happened and why it happened at this time—we view it simply as the beginning of an inevitable return to a state of normalcy. Manipulation can have a large impact on assets values, but no matter how massive the manipulation is, eventually a return to the natural order of things must occur. And what is the natural order by which financial markets function? It’s simple: interest rates must be allowed to serve as a pricing mechanism for risk, yields must reward productivity, equity values should reflect current and prospective corporate success, and the value of currencies should mirror the economic and monetary integrity of their issuers. The path toward such a state of normalcy will be extremely difficult and disruptive, and may take place over many years.