Blain's Morning Porridge - June 29th 2018. End of Q2 - what next? More Contradictory Bluster, &q

Blain’s Morning Porridge – June 29th 2018

“Some is rich, and some is poor, that’s the way the world is, but I don’t believe in lying back, saying how bad your luck is...”

The Morning Porridge is unrestricted market commentary freely available to all investors on an unsolicited basis. It is not investment research.

End of the second quarter.. and how you doing? Half way through 2018 and where have we got? The numbers: as US rates rise, 10 year US Treasury yields have climbed from 2.45% to 2.85%, Bunds have been more volatile – falling from 0.42% to 0.34% while spiking to 0.77% in Feb. The S&P started the year at 2695, and is now 2716… Stunning? Not! The numbers don’t tell the story.

There is definitely a changed mood in markets. Stock markets are uncertain – unconvinced on valuations and tech weightings, but equally unconvinced the market is about to tumble. However, thin trading has many experienced market watchers convinced we’re running out of buyers willing to buy the next dip.

Bond markets are no better: as the Fed normalises, the BoE dithers, and the ECB angsts about ending its buyback programmes – supposedly by year-end – the crutch is tumbling from the market. Corporate spreads are ambling wider – new issues are struggling to catch the same fire as previously – especially as the ECB’s heat comes out the market. While rising US rates have caused many to declare the end of the 30 year bond bull market – as many are saying Treasuries look a great buy around 3%. What do they know that we don’t?

Many analysts fear recession and flat curves, fearing central banks don’t have anything left in the armoury to fight with. I’m sure they’ll think of something.. If it happens.. listen for the sound of helicopters..

Its’ the “noise” engulfing markets that’s been most interesting. If there has been a theme to 2018 thus far, I’d characterise it as “Contradictory Bluster” (and I know at least one senior HSBC exec will remember that phrase with a wry smile…) Contradictory Bluster as markets: try to strip out the bias, figure what Trump means, what tech and social media means, where rates are going, what Central Banks are saying, what populism can do to Europe, what’s really happening across Asia, and just why disappointing economic numbers have been spun into positive confirmations of globally aligned growth.

(There is then a second dimension to the bluster – just how deep does it go? A good measure of Bluster Depth is how long it takes a solution to become a new problem. For example – agreement on one aspect of trade ructions raises another crisis, questioning why has Trump got it so in for Europe, or does letting Italy score some cheap points in Brussels last night end up with the Eastern Europeans and Bavaria demanding more..?)

Meanwhile, another theme has been the dollar strengthen 16% since March (Bloomberg dollar Index), as investors pile into US treasuries as the only place to find “safe” returns. Really? They might get a shock as the rest of the world normalises and the US ballooning deficit comes back into focus – or they might not.

And… some things never change – like this morning’s headlines about European agreement on Italian demands for a migration package; agreed at 4 pm in Brussels this morning. The Euro strengthens on the apparent unity of purpose. It will probably tumble next week as it become clear how Italy’s win could unravel.

I suppose the classic “same-as, same-as” story this morning is Deutsche Bank – the only bank failing the US banking stress tests this week. Just a few weeks ago we were wondering how they’d managed to take a 12x VAR hit. Now, the Fed says its internal controls aren’t up to the job – especially in terms of “capital-planning.” Oops. We’ve been here before. “These weaknesses raise concerns about DB USA’s ability to effectively determine its capital needs on a forward looking basis”, said the Fed.

Failing the Fed Test isn’t a death sentence – but its’ hardly a ringing vote of confidence…. and a less than subtle message from the Fed to the bank’s management about their future business plans (ie, don’t bother.) Deutsche’s stock is now trading at its lowest this millennium – Euro 9.06. (Does that mean it’s a buy because its’ cheap as bratwurst?) The banks Contingent Capital deals have shown an equally steep downward trajectory this year – from a 4% Euro yield to 6.07% now. (Again, does that means it’s a screaming buy?) As BPE demonstrated last year – when it comes to “that moment” CoCos are a binary option with all the downside and none of the upside in crisis!

There are definitely games to be played in DB. One bank analyst I follow closely describes the stock as “option value”, but what’s the value in German banks? Having followed the German banking market for years.. I’m struggling to see the upside... Perhaps readers can enlighten me?

And on that happy note, have a great weekend. Lots to look forward to next week – we’ve a number of exciting things in the pipeline, including a superb new aviation deal to talk about.. (Let me know if you want an early look-see.)

Out of time and back to the day job..

Bill Blain