Blain's Morning Porridge - April 25th 2018. Markets - why do we get it wrong, and what goes wron
Blain’s Morning Porridge – 25th April 2018
“I don’t think he knows about second breakfast..”
The Morning Porridge is unrestricted market commentary freely available to all investors on an unsolicited basis. It is not investment research.
Marvellous day yesterday. The 10-year US Treasury broke through the “You Shall Not Pass” 3% barrier and the dollar went up. Panic! It might be the end of the world, but I least I called it right! Relax… the sun still came up this morning.
I spent time y’day in the City and West End talking to journalists and clients, and picked up further clues as what’s been going wrong right through my 30 year plus career in finance. I’ve come to a stunning and shocking conclusion. People just aren’t as smart as we think. Folk get it wrong. Repeatedly. It was such a stunning moment of clarity I’m awarding myself one of my coveted “No Sh*t Sherlock” awards.
The business of markets is as much about economic forces as it is about watching the mistakes and behaviours of others. Definitionally, its mistakes that drive the most exciting market action!
Investors find themselves on the wrong side of little mistakes all the time – like the market waking up to major corporate changing the guarantees on its bonds, pushing bond holders down the capital ladder to make them more subordinated – as has happened with Softbank.
When the mistakes are so large and so egregious they have the capacity to cause a WTF “moment” – like we saw in 2007/08 when we realised unemployed bus drivers were unlikely to pay off massive mortgages, and over-levered banks stuffed to the gunnels with illiquid risk weren’t sustainable.
Such lightbulb moments occur infrequently – but often enough to define our careers. Based on my ongoing discussions, I sense more and more market participants fear we’re about to face another. This where it gets interesting – nobody can agree what its likely to be!
Do they fear another crash because they are scared because its been so good for so long, or do they have valid grounds to be afraid? And, do these fears mean small mistakes will get magnified into bigger, more inclusive ones? Markets are all about the behaviour of crowds and what they believe. Do we face yet another period of suddenly blinding clarity, as the lightbulb of realisation goes off.. Or will we just continue on worrying, letting our fears multiply until they trigger meltdown?
What are the main concerns?
Is it a collapse in the bond market? Looking at the investment bank estimates, most of their analysts see the 10-year Treasury at 3.15-3.25% by year end – which hardly sounds like the bond rout so many fear. But, and but again... experience teaches us when it goes wrong in bonds, it goes wrong very quickly! These analysts may be a great example of getting it wrong. I reckon we could hit 3.5% or drop back to 2.5% just as fast in these fraxious times.
Another aspect is Global Synchronised Growth – Macro Alignment. That’s been the basis of the fundamental analysis narrative telling us the whole globe is aligned and growing. Yet how can we have alignment when the US is rising rates, Japan is still devaluing, Europe looks trapped in a perpetual zero-rate trap, and the we’ve got increasing protectionist policy? If we’ve got that wrong (which we actually aren’t so concerned about; we still think global growth is on the cards), then maybe the flattening yield curve is right and we’re headed back into slowdown. Who knows? There are two sides to that trade! (And buying 2yrs instead of duration is one of the them!)
The other big concern is Tech. We pride ourselves for living in a fascinating technological age. For the past few years the Stock Market’s darlings have been dimly understood Tech ventures. We’ve accepted the disruptive narrative – but now its looking kind of jaded. Telsa and Facebook are examples where its clear market participants are struggling to understand the rules of the game, and the valuations. Apple is an evolutionary story as we wonder if the smartphone/bright shinny thing days are over. Most Tech firms are good/great companies, but do they deserve such stellar pricing and are they immune to everything we learnt in Credit 101? Have we forgotten the tenants of Ben Graham’s Intelligent Investor to our detriment?
I read a very interesting research note on Emerging Markets y’day – pointing out EM has become a tad boring in the wake of all the Tech noise. While stock market volatility has risen, EM has proved less volatile and produced better performance. On a relative basis, they look likely to continue to deliver decent returns. On the other hand, EM can prove a liquidity trap.
Although US rates burst thru the 3% panic-ceiling, rates remain benign. Investors are scrambling for the next thing now the Tech sector seems to be deflating – and were underweight EM. Commodity prices are rising – positive for most. Rumours of the demise of Oil have proved premature. Our EM team are waiting to take your call!
Elsewhere, lots of great stuff on the go at the moment.. so I better get back to my day job and get on with it!
Out of time..
Bill Blain