Paradigm Shift – Part 1

David L posted this comment on my Journal on 11 July 2012.

“The comments above are interesting , however I believe there is a paradigm shift (growth is stalled) for investors with regards to equities and markets will remain soft (difficult) for some considerable time (years) a riskier trading (cfd’s) as opposed to investor equity strategy may become relevant? Australia will continue to lower interest rates to stimulate the market. QE3 will only be a band aid , China is having to adapt to lower growth prospects . It will be interesting to have some news from Gary regarding the Forex mechanical system.”

Whilst I did post a response to David’s questions about the Forex mechanical system I also mentioned writing a separate Journal post with a more detailed response to the paradigm shift he refers to.

Firstly, is there a paradigm shift on the go for investors wrt financial markets? Paradigm shift has big meaning. Here are some definitions:

• “A cultural transformation, a change in consciousness, a new way of thinking, understanding and explaining reality.”
• “A complete change in thinking or belief systems that allows the creation of a new condition previously thought impossible or unacceptable.”
• “Transforming or transposing the representative example that serves as a model or pattern.”
• “Changing one’s concept as what was believed to be correct.”
• “A radical change in the theories and concepts used to explain the world.”

As you read these definitions I’m sure many will instinctively feel that these definitions certainly do apply to the current financial situation in the world and that we are indeed undergoing a paradigm shift wrt investing in financial markets.

In my view there is undoubtedly a paradigm shift taking place in the attitude of the populations and leaders in and of ‘developed’ countries, but not necessarily in financial markets. There has been a slow incremental shift in values for many years, and it is still ongoing, whereby a greater percentage of developed countries’ populations believe that their lot in life is somebody else’s responsibility and many political leaders have taken advantage of this by making their citizens and companies more and more dependent on government support and handouts, and the citizens and companies have lapped it up.

Now I know that this is a sweeping statement and readers might want more detail on my research that has led to these statements. And sure, there will be degrees of this occurring in different countries. If you are interested in such matters then I would rather encourage you to do your own objective research.

In this Journal we discuss financial matters. The paradigm shift in values is important because it is one of, if not, the main fundamental cause of the state of the world’s financial markets. It is plainly obvious that there have been financial ramifications to this slow incremental paradigm shift away from basic values:

• Many governments have ‘lived beyond their means’. Visit www.tradingeconomics.com for details of different countries Debt to GDP ratios. Note that the debt is only public sector (government debt), not private debt.
• Individuals have lived beyond their means. It’s their right to, but it was somebody else’s fault that they got into the situation! The public sector Debt to GDP ratio for the USA is 103% but total debt including private sector debt the ratio is over 400%. In Australia it is 22.9% and approx. 150%, respectively. There doesn’t appear to be an agreed ‘tipping point’ but government Debt to GDP Ratio > 50% and growing will probably be very difficult to recover from.
• Leaders of some large businesses that employ 10 of 1000’s carry debt that might be impossible to ever repay and current leaders of these companies are doing very little to reduce debt while they collect massive salaries and bonuses leaving it to the next ‘leader’ to sort out, i.e. it is somebody else’s fault and hence not my responsibility.
• Leaders of large businesses using financial instruments to move millions and even 100’s of millions of dollars of shareholder’s equity into their own names.
• Corruption, stealing, misuse and scamming by leaders of all types of organisations that have a position of trust to a group of many individuals, such as Ponzi schemes, union leaders, politicians, financial institutions etc.
• Large companies taking huge risks, typically using leverage, with massive amounts of money to continue chasing relative growth in performance that might just not be possible any more as they have ‘run of out of market’, i.e. there will never be enough liquidity to keep growing at a rate many times greater than organic growth rates.
• Leaders of countries hanging onto power at all costs, including huge financial costs, without putting the interests of the nation before their personal gain, interests and ideals.

As much as is made public there would multiples more occurrences of doing the ‘wrong thing’ and of corruption in all walks of life that the public are unaware of. All basically caused by greed and selfishness. Many also do the ‘right thing’ and are honest but unfortunately the balance has tipped and is tipping further and further away from the doing the ‘right thing’.

The financial ramifications of this shift have hit home in the last 4 – 5 years. It is important to search for and understand the causes as it will probably take many years, if not decades, to remedy and investors will need to devise strategies to keep their head above water in this environment. It will probably need another paradigm shift back to a set of values that stand human beings in good stead. One major problem with defining what such a set of values may be that, whilst we think we do, collectively we may not actually know what is good for us.

The motivation to remedy the causes might only come about because of the huge negative financial ramifications. Human beings collectively have difficulty seeing the big picture and are desensitised to small incremental (decremental?) changes that result in paradigm shift. It’s only when the shift has gone too far and results in massive downside (= financial, mental and physical pain) that we wake up to what’s been going on and at that stage the change required to get back on track is massive and takes huge effort and hence typically a long time. Whilst I’m sure readers would be able to quote examples of never being able to get back on track I am a believer that we can.

It typically requires a reprogramming of the entire population and might even require a generation or more to move on before it can be affected. Examples are communism, slavery and apartheid. Yes, the shift that is happening is this big and it is the financially developed ‘western’ countries that have suffered the biggest shift so far.

So is there a paradigm shift in financial markets? My view is not and that they are reacting to this shift as discussed above, as they have reacted to other paradigm shifts, similar and different, in the past such as two world wars and previous periods of massive leverage. We will discuss the financial markets ramifications more in next week’s blog and potential strategies to endure the ramifications of the shift.