Systematic Relative Strength

Last fall and early this year, the financial crisis seemed exceedingly dire. Governments and citizens across the globe felt as if the entire commerce and banking system might implode. So governments rode to the rescue and pledged to bail out various banks and financial institutions, along with providing all sorts of related credit facilities and backstops.

According to the International Monetary Fund, it turns out that governments have only had to spend about 40% of the money they pledged so far. It’s a good thing that governments haven’t spent all the money, by the way. The forecast for the pile up of debt in industrialized nations over the next five years is not pretty, and the massive U.S. share can’t be too helpful to the dollar.

The economic crisis may not have been as bad as believed, but in my view, it is more likely that financial institutions adapted very rapidly to the new environment and stemmed some of their own bleeding. Even big banks are not fond of going out of business or operating under government mandate. The government kick-start might have been necessary, but the healing has happened faster than anyone guessed.

The underlying problem may really be one of forecasting. Economists often make straight line forecasts—which would be accurate if no one reacted to the situation. An economist would probably forecast that you would drive your car off the road at every turn. You don’t, because each time a turn comes up you react by adjusting the steering wheel. Adaptation is a wonderful thing—and a necessary one, since forecasts can often be so far off the mark.