Blain's Morning Porridge - March 22nd 2018 - The Fed, Dangerous Tailwinds, Facebook and investin

Blain’s Late Morning Porridge – 22nd March 2018

“Gybe: To shift suddenly and forcibly from one side to the other..”

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

Headwinds have become tailwinds, and Jay Powell opens his tenure at the FED by upgrading the outlook for the US Economy.

As a keen sailor, I have more than a passing interest in from where the wind is blowing. There are a number of things to bear in mind about tailwinds; i) they get you where you expect to go faster – meaning we shouldn’t neglect thinking about how this Goldilocks recovery ends. And, ii) sailing downwind (ie tailwinds) can prove the most dangerous point of sail – things can go from smooth and stable to disaster in frighteningly short moments as a result of a sudden windshift causing a crash-gybe to flick the crew into the water, or the mast to come tumbling down. I’ve attached a photo showing just how bad tailwind sailing can go….

The Fed’s message was simple: stronger growth, lower but stable full employment, modestly rising inflation, and rates set to double to double to 3.4% in 2020. Three, maybe four hikes this year, but three next year…. It should not have come as much of a surprise to the market. Some of the news reports say it was “Aggressive”, but what I heard was a dovish “middle-ground” back-loading of further tightening – further hikes to follow if justified. They are not slamming on the breaks, but gently brushing the pedals. Powell summed it up nicely: “The economy is healthier than it has been since before the crisis…”

Cynics might ask which particular crisis?

The world is an increasingly volatile place – a blustulous conflabulation of sentiment, facts, hopes and expectations that tends to spin very differently to Central Bankers scripts.

Perhaps its a modern update Chinese curse, but we live in “unconventional” times – while the Fed is considering tightening policy, the government is looking to Spend, Spend, Spend. We should be keeping a tight eye on employment – with the economy already looking inside NAIRU – how will tax-cuts and fiscal spending impact already tight labour costs? Meanwhile, what about the global economy? What about Populism? Or geopolitics and the threats of a trade-war with China? What about so many other unforseen things…. As we charge downhill with the spinnaker flying, just how stable is that mast?

Next on my worry list this morning is Facebook.

I was out with someone who knows about this kind of stuff – my 23 year old son Jack who is making a career for himself in advertising (and directing music videos in his spare time!). He explained it’s not just Cambridge Analytica that’s been exploiting Facebook and other social media sites through deep diving apps that amuse us with puppy pics, while measuring and tailoring product and messages to our desires and weaknesses.. Its happening across the board – it’s a dimly understood marketing revolution. We just don’t realise how social media users aren’t customers – we’re the product! It was a light-bulb moment…

Almost as revealing as Mark Zuckerberg’s dollar-late appearance last night on CNN. What struck me is that he has as little idea as the rest of us what a monster Facebook has become. Sure, he took responsibility – but does he actually understand what for? You can’t uninvent stuff – but last night I deep dived my social media pages, changed all the options, put in new passwords and wonder just what a mess we’ve created.

Back in the real world – or is it?

Some interesting thoughts on alternative assets yesterday. According to some US research, global investors now hold around 25% of their total assets – accounting to some $7 trillion – in the form of Alternatives – ie things that aren’t “financial assets” such as stocks and shares. We’re very aware that assets like property tend to yield significantly more than financial assets – properly reflecting their lesser liquidity, but also how stocks and bonds have tightened and become inflated as a result of QE policies.

I was reading stuff about how much investors should demand for illiquidity – a base guess being a 1% spread over the risk free rate if you are locked into an illiquid alternative asset for one year rising to 6% for 10-yrs plus. Others say managers should be earning at least a 3% illiquidity premium on illiquid alternatives to justify themselves.

The trick is finding the right people to manage alternatives – for instance a global aircraft leasing firm or a firm with a fleet of ships under management, with all the technical and professional management skills to understand why planes fly and ships float, while also making sure they are working hard to earn a return. Or guys who understand the intricacies of private equity. There aren’t that many conventional bond/equity long/short portfolio managers who’ve got a breeze of an idea on which particular renewable energy projects beats the rest – but there are specialists who do. One approach is to find the right experts to invest on fund’s behalf – and we’ve got such managers we recommend.

That said, the research note yesterday made the case that many investors are utterly unprepared for illiquidity risks of alternative / illiquid assets. While the best case is to plan and hold illiquid alternatives through to maturity, its equally important to plan for need – have a plan to sell if you have to.

That said, I think I’ll stick with my 2018 investment strategy: buy assets correlated to global growth, and avoid correlation with inflated liquid assets.

Back to the day job…