![Howard Marks, offers this advice over coffee at the Opera House: "When it comes to investing, focus on getting things ...](/content/dam/images/g/s/n/f/u/e/image.related.afrArticleLead.620x350.gtzbd5.png/1485471132127.jpg)
The billionaire founder of distressed debt investor Oaktree, Howard Marks, offers this advice over coffee at the Opera House: "When it comes to investing, focus on getting things right in the present rather speculating on the far-fetched future".
This gels with this column's philosophy that it is better to continuously capitalise on modest mispricings that have high probabilities of reverting to the mean than targeting long-shot returns via big bets characterised by large amounts of exogenous uncertainty.
Funnily enough, Henry Kissinger, the former US secretary state, proffered similar counsel in 2003 while I was undertaking post-graduate study.
In his guttural Frankish accent, Kissinger said his Harvard peers had "these grand five-year plans that were a waste of time".
![Crazy house price growth might explain the leap in consumer inflation expectations despite the weak official data.](/content/dam/images/g/r/z/f/j/5/image.imgtype.afrArticleInline.620x0.png/1476148293555.jpg)
"I aimed to leverage every opportunity to the maximum extent possible as and when it was presented to me on a day-to-day basis. It's like tennis---win each point and the games, sets, and matches look after themselves," Kissinger said. The long-run is, after all, just a sequence of short-run events.
Former Reserve Bank of Australia governor Glenn Stevens used to talk about how important "now-casting", or divining current economic activity, was before one could contemplate the future.
"Some central banks actually "backcast" the recent past, deciding their own version of GDP, not necessarily the same as the one published by the statisticians, foreshadowing revisions to come," Stevens pointed out.
"When all is said and done, however, it remains the case that 'forecasting is hard, especially about the future'."
It is curious to think that we do not know with certainty the current state of economic affairs, let alone that which might materialise 12 or 24 months hence.
The RBA was slashing rates last year because it was worried that Australia's weak inflation pulse would pull down consumer expectations for future price growth that could make achieving its official 2 per cent to 3 per cent inflation target hard.
Inflationary pressure
And yet the latest ANZ/Roy Morgan survey reports that consumer inflation expectations hit a five-year peak of 4.8 per cent in January, miles above the top of the RBA's target band. The Melbourne Institute's measure likewise jumped to 4.3 per cent in January, its loftiest level since 2012.
Commsec's Savanth Sebastian says that "inflation expectations have now held above 4 per cent for the past six months", opining that "there is no doubt that inflationary pressures have bottomed out and are starting lift".
HSBC's Paul Bloxham and Goldman Sachs' Tim Toohey agree. Both argued that the December quarter inflation data published this week implied that price pressures had "troughed" with domestically produced, or "non-tradeables", inflation accelerating from 1.6 per cent over the year to June to 2.1 per cent in December.
"The platform is now set for inflation to surprise RBA forecasts to the upside through 2017," Toohey surmised.
A second (now well-documented) flaw in the RBA's intellectual framework last year was the presumption that rate cuts would not fuel the flames of the housing bubble because "supervisory measures are strengthening lending standards".
The RBA said in May: "At present, the potential risks of lower interest rates [with respect to housing] are less than they were a year ago."
Of course there was a subsequent resurgence in speculative investment lending, with house prices growing at a 10 per cent annualised pace over the six months to January 25.
Crazy house price growth might explain the leap in consumer inflation expectations despite the weak official data.
It was, ironically, Stevens who warned central banks in 2009 against relying on supervisory constraints on credit creation to staunch asset price imbalances.
"One should be realistic that while using balance sheet regulation as a macro-prudential tool may have attractions, it is no panacea," Stevens cautioned.
"As those with any recollection of Australian experience of the 1960s and 1970s will know, if the fundamental problem is actually that financial conditions are just too easy – that is, interest rates are too low – balance sheet regulation won't ultimately constrain credit growth."
There aren't many trades I like right now given that most asset-classes are dear (equities and property are stand-outs).
Our long-held central case of a tightening US labour market---with the jobless rate falling well below 5 per cent—pushing wages and inflation higher and forcing an upward re-rating of interest rates favours floating-rate hedges.
Deutsche Bank's Torsten Slok wrote last Saturday that "leading indicators of core inflation point to upside risks to the consensus view that the Fed will raise rates three times this year".
The Philly Fed's inflation index, which leads the Fed's preferred index, has spiked to its highest level since 2008 and well beyond the Fed's 2 per cent target.
To fix or float
Goldman Sachs credit strategist Lotfi Karoui concurs, advocating "a preference for floating vs. fixed-rate spread products" predicated on his "expectation that higher yields will cause price declines for fixed rate bonds while higher policy rates will boost the carry on the floating side".
Within this space, we like senior-ranking, major bank-issued floating-rate notes with less than 12 months to maturity as a cash surrogate, and the same paper issued on a 5-year term that has priced in far-from-certain rating downgrades.
You have been able to buy major bank senior floaters with less than seven months to maturity paying interest rates of about 0.75 percentage points above the cash rate (ie, 2.25 per cent).
These are incredibly liquid assets that can be bought and sold intra-day in large $10 million plus parcels and are eligible for the RBA's liquidity facilities.
Unlike a term deposit you are not locked up for 30 days nor punished with a penalty if you want to break it. Whereas at 2.2 times book value CBA's equity looks expensive, its bonds have been pricing at historically cheap levels.
Traders spoke this week of being cleared out of their floating-rate inventory as investors carrying too much fixed-rate exposure tried to mitigate these risks, which makes sense.
The author is a portfolio manager/director of Coolabah Capital Investments and Smarter Money Investments, which invest in fixed-income securities.
AFR Contributor