Blain's Morning Porridge - Nov 16th 2017. Minor Market Wobbles, but bear in mind what going to h
Blain’s Morning Porridge – November 16th 2017
“The frog was prince, the prince was a brick, the brick was an egg, the egg was a bird.. fly away you sweet little thing..”
For the avoidance of doubt – the Morning Porridge is unrestricted market commentary freely available to all qualified investors on an unsolicited basis. It is not investment advice…
What can possibly go wrong when a Da Vinci is a “bargain” at $450mm?
Or is the record price achieved for “Salvator Mundi” telling us something? When it comes to market worries, there is no smoke without fire. Recent wibbles in the Nikkei, High yield and global bonds aren’t a blazing conflagration, but some of the commentary makes it sound like we’re already “burning down the house”… (Love that song!)
Whoa, and check the numbers – we’ve seen some minor slides after a superb summer! The Nikkei is down a bit, there have been some selective sells in EM and high-yields, and the number of articles talking about a bond sell off say a reassessment of bond yields is underway… But there is nothing to panic about. Yet.
Nothing to see here folks.. move along…
It’s very tempting to say…(so I shall:) “ah, the avalanche starts with just a single snow flake…” or “It’s that moment of calm before the earthquake – as a few pebbles tumble down the hill, and the hairline crack in the damn wall starts seeping water..”
But… what’s really happening is less dramatic: after a superb year, folk are not going to let complacency grind them down on the final stretch, they are thinking about risks – especially in the bond market! Many of our main accounts are already squared away – protective into year end. I suspect this is how markets trade till January.
The recent slide in High Yield bonds has been attracting much comment. There has been selective selling of the perceived risky parts of the market – most obviously in highly leveraged plays. It’s not an indiscriminate sell off, and that can been seen in the fact EFT declines are limited, reflecting its selective credits under pressure.
But, there is pressure.
So, here is a very simple statement of fact: bond investors face increased risks of capital loss as rates rise. In High Yield its blindingly clear tightening policy means risks are escalating.. 4 things to worry about when it comes to credit markets and HY especially:
Quantum Price Risk: as bonds sell off all bond classes will suffer loss, which are heightened in HY due to…
Decompression Risk: as the riskiest part of the bond market, the effects of a bond sell off means losses multiply the deeper you go down the risk curve. A 10-cent widening in govies may translate to a dollar wider in BBs.
Credit Risk: Highly levered high yield issuers are most sensitive to interest rate rises – even a relatively small rise can trigger zombiedom for many issuers. Investment grade issuers are more likely to tumble into Fallen Angel status (Junk) as rates rise.
Liquidity Risk: And…. suddenly that nice young chap from the investment bank that sold you the bonds last week isn’t picking up your calls…
All these things worth thinking about.
But, what could really turn around markets? Once more, I’m indebted for my colleague, our economist Martin Malone. He’s still a “max bull”, but admits he needs to keep validating his “Goldilocks” world view! There are basically 10 potential shock areas he’s got his eyes on:
Inflation – a rising threat, potentially driven by China and full employment.
Long Term Interest rates – rising rates may destabilise as the term premium reverses and the Break-Even Inflation (BEI) rises.
Policy Risks – more central banks will follow Fed tighter, and mis-communication risks are higher.
Stocks – could correct.
Commodities – a dramatic shift higher in oil or food prices could destabilize sentiment.
Dollar – a strong dollar will trigger a global reval.
Volatility – could rise and overturn current complacency, creating contagion.
Geopolitics – Korea, Middle East right the way down the scale to Europe micro-crisis in Spain and Italy
Politics – Trump, Trump and Trump and others…
Trade – Protectionism, NAFTA or Brexit breaks.
Pick what you like out of that… I was listening to one client wondering what rising VIX means for markets… good question..
One signal of further stability to come might be the Greek bond exchange. Out EM team are looking at it in detail – deconstructing the whole deal. Their conclusion is its pretty clever – coming out net flat for investors. There are no sweetners, and no premium, but critically the exercise created a liquidity opportunity in Greek paper. This is well worth a look at – and if you want to play make sure you speak to Alejandro and George on the EM desk. Will be happy to connect you if you don’t already talk to them.
Something interesting happening in Germany as US PE firm Cerberus takes a 3% stake in Deutsche Bank (alongside its Commerz position). What’s the game? Consolidation? I’d be surprised if its banking opportunities – Germany may be big and successful, but the banks seldom thrive. Being a non-German in a German market is not a recipe for restful nights. (I know… many years ago I tried to manage a bunch of Germans from London.. Never Again!)
Finally, I’ve been keeping a close eye on the Dubai airshow and trying to discern some trends and how they may impact my favourite Real Asset Market – Aviation. We think there is some very positive developments buried in the news, and if you’d like our thoughts on how these impact aviation opportunities, please give me a shout!
Out of time and back to day job.
Bill Blain