Blain's Morning Porridge - October 4th 2017. "Europe lurches from crisis to crisis - Unscat

Blain’s Morning Porridge – October 4th 2017

“Gentlemen, you can’t fight in here. This is the War Room...”

For the avoidance of doubt – the Morning Porridge is unrestricted market commentary, it is not investment advice…

A very clever chum told me yesterday to stop stressing so much about Europe, reminding me of the default position: “Europe lurches from crisis to crisis unscathed.“ He’s right. It doesn’t matter how FUBAR Europe looks, what the Spanish King said, what Poland is doing, what Germany isn’t, or whatever France is smoking….. Crisis is the European normal and it’s not a problem. SNAFU is SOP, as they say..

I will stop worrying about Europe and learn to love the contradictory bluster that characterises the Heart of Brussels.

And with stock markets hitting new highs, corporate bond spreads tighter than the proverbial gnat’s crotchet (in some classes tighter than pre-crisis 2006), VIX (despite a tiny rise y’day), still close to all-time lows, and folk blithely talking about increasing investments in Russia, new Middle East bonds, and asking where they can buy Nigerian regional bonds… what can there possibly be to worry about?

Of course there is the UK… the aged legions of Theresa May fans in Manchester are likely to need deliberators to get them excited about whatever cataclysm of clichés she comes out with today to remedy her reputation as the WORST PRIME MINISTER ever – at least until the next one. (There you go, subtly insulted both parties – don’t say I’m not even handed..)

However, my main worries this morning are the same as they always are… where does this market go next, and where are the likely sources of trouble.

My conclusion is America.

Regular readers will know I’ve been semi-seriously predicting Thursday 12th October as the day the stock market breaks. That date was arrived at after deep fundamental analysis and wiggly lines drawn on centuries of market charts, the fact it’s a Friday 13th the following day, and a not a little Llagavulin (which I was taking for medicinal reasons: since I started drinking it as a kid in Hot Toddies I’ve not had Ebola once).

The flaw in my analysis thus far is identifying a trigger that’s going to push markets over the edge.

Despite the doom and gloomsters like myself predicting the imminent end of the world, markets don’t look to be anticipating a correction. Quite rightly the macro economists point out most economics are now in growth and looking set for expansion. There is a general agreement among central bankers about normalising monetary policies, while governments are all considering positive fiscal steps.. (except in Europe where positive thinking about fiscal spending remains Thought-Crime).

We’ve got the CNN Fear and Greed index at 92 (Extreme Greed) and Larry Fink of Blackrock assuring us “Markets are fine and will be fine this year..” (Seriously.. an eejit like me can confidently predict the end of everything because I don’t really count and my readers know I’m sort of joking, but why would the leader of the largest fund on the planet say something like that? Oh, because he can… and may just have the market buying power to be right..)

But… what has been driving the stock markets higher? On one hand is normalisation – higher rates infer growth and are de-facto bad news for bonds. The financial press is full of stories about how investors are ramping up short positions against US bonds to record levels in anticipation of a rate hike in December, and the expected tax cuts and reform causing the economy to go into overdrive.. That means more money going into stocks.

Meanwhile, it’s the prospect of these US tax-cuts and reforms that are driving stocks. (In fact I read a great piece yesterday about how the proposed repatriation tax will greatly improve the credit of US corporates, thus driving corporate spreads tighter even as rates rise. Strong credits mean strong stocks – perversely it all makes sense..)

But…

What if Trumps tax cuts and reforms don’t happen?

I am assured by macro economists and Washington Watchers the probability Trump will get his reforms and cuts passed is much higher than the market believes. I’m told it’s inconceivable they won’t happen – Democrats know they make sense, and Republicans need success ahead of the mid-terms next year. American politicians would need to be mad to block them.

Therein lies a problem..

Every last person with a functioning economic mind knows they make sense… but, sadly, that doesn’t necessarily include all the denizens of Capitol Hill. US senators from the less well visited parts of the USA tend to think and preach to the electorate that raising the deficit by a cent is a one-way ticket to hell.

Consider White House budget director Mick Mulvaney’s line: “If we simply look at this as being deficit neutral, then you’re never going to get the type of tax reform and tax reductions that you need to sustain 3 percent growth”… He sums up the problem well – already senators and congressmen are finding reasons to say no. It points to difficult negotiations, compromises and loads and loads of pork barrels.

Others observers, including the Vampyre Squid, believe there are too many vested interests at work in the Washington swamp who will refuse to let go existing deductions to make tax-reform work. It’s worth reading through Goldman’s arguments. They are up on Zerohedge: http://www.zerohedge.com/news/2017-10-03/what-could-possibly-go-wrong-tax-reform-answer-goldman-finds-plenty

If we see more folk taking the view Tax Reform and Cuts are likely to prove yet another non-Triumph for Trump.. then the current positive sentiment could take a walloping.

That said, I remain convinced, it will be a correction rather than a crash.. So buying boots ready.

Its nearly 30-years since the Great Storm and Great Crash of 1987 – I remember it well. I was a journalist with Euroweek at the time, and I think I first used the phrase: “It’s a dead-cat bounce.. drop a dead cat out a window and it bounces, but not a lot.” How wrong I was.. stock markets do correct, and typically they rally again when the underlying macro behind them remains strong!

Meanwhile, very interesting comment from Bloomberg Intelligence looking at the ECB’s broad employment rate” which is now up on BBerg. They reckons it shows plenty of slack still in the European economy (hence the lack of trad Philips curve inflation). When yoof unemployment remains as elevated as it is across the Med nations, then maybe things in Europe aren’t as good as we think… (Oops, sorry, said I wasn’t going to do Yoorp again..)

Out of time, back to day job..

Bill Blain