Blain's Morning Porridge - 13th June 2018: Fed, Stratospheric dangers, US corporate leverage and
Mint - Blain’s Morning Porridge – June 13th 2018
“Of all extinct life-forms, dinosaurs are the most popular. Why that should be is not clear… ”
The Morning Porridge is unrestricted market commentary freely available to all investors on an unsolicited basis. It is not investment research.
All eyes on the Fed today. They will hike by 25bp to 2% – the 6th hike in 7 quarters. Slow and gradual. This is something of a one-off in terms of the economic environment – unconventional being the word. Easy financial conditions in terms of growth, inflation, jobs and the ongoing fiscal spending and tax boosts. Plus, we’ve got the positive sentiment effects of strong equity and real estate markets – when folk feel rich they feel positive! Plus plus, with the rest of the world still on negative or zero interest rates, then money continues to pour into Treasuries making the ballooning deficit a SEPT (Someone Else’s Problem Tomorrow). Asset prices are inflated, but still weakness in consumer prices and wages.. This remains an “interesting” space in terms of the potential policy pitfalls, and the “swing” moment – when suddenly balance is lost and the centre cannot hold...
Perhaps the writing is already on the wall? I was slightly concerned to read the National Federation of Independent Business (the US SME organisation) believes: “Main Street optimism is on a “stratospheric trajectory” thanks to recent tax cuts and regulatory changes”. Stratospheric is often confused with ballistic. Stratospheric could mean its’ going into orbit, or simply that a ballistic launch will reach the stratosphere. Sadly, ballistic means the kind of trajectory Kim Jong Un claims to no longer be interest in…`
(Last time someone was talking “stratospheric” it was in relation to Bitcoin, and that’s not ending well. Final comment on ballistic trajectories….I note a headline about Telsa slashing salaried staff.. )
Market mood this morning feels a little subdued. The judgement on yesterday’s gabfest in Singapore is Trump grandstanded and got very little in return. Perhaps, Donald is not the statesman he thinks he is?
Next week, Tuesday 19th I’ll be debating the markets at the Euromoney Global Borrowers and Bond Investor Conference at the Hilton in Hyde Park London. Its’ the largest and longest established event of its kind. I’ll be proposing the motion: “this House believes that every security is currently overvalued”. If any readers are attending, I’ll be looking for your support! (Any ideas gratefully accepted on how I win this thing….)
There is a lot of negativity out there. Yesterday I wa s reading about Euro buyers are pre-empting the end of the ECB’s corporate binge buying programme – (I don’t think so!) - and we’re already seeing it reflected in prices. This morning, its’ an article in the FT telling us, quell surprise, BAML has noticed: “Fund Managers are getting twitchy about corporate debt.” A “No Sh*t Sherlock” award for services in spotting the bleeding obvious is winging its way to Merrill as you read this.
Even as Jeff Gundlach, CIO of Doubleline comments about the US being on a suicide mission as the deficit rises as rate rises, and predicts 6% 10-year in 2020, the BAML June fund manager survery says 42% of fund managers are worried about overleveraged companies. (!!! Ding ding ding !!!)
And, if US Corporates are over-borrowed at a time when interest rates were effectively negative that’s a concern as rates are rises. And, of course, all that money they borrowed was actually spent on buying back their own stock (boosting executive bonuses) rather than building plant, machinery and stuff that produces a return. The money spent on stocks is no longer available to pay back lenders…. and there is no new plant making things to pay them back either. Ooops?
Funnily enough, the most crowded trades the BAML survey notes are long FAANG+BAT, Short Treasuries and Long the Dollar.
Another eye-opener, and significant moment, for the future occurred yesterday. The Japan Government Pension Investment Fund – the largest fund on the planet running $1.5 trillion has just done a remarkable thing with the money it hands to external managers – it’s no longer going to pay them fees for their expertise. Instead, it’s going to treat them as trackers and only pay them if they pay above index results. Its changing the model by moving to a performance based fee structure for external managers.
That’s a fundamental shift likely to impact the whole fund management business! And maybe its about time…
There is a great story on Bloomberg by Mark Gilbert on the subject, which I would link to the porridge, but Bloomberg has gone subscription only. Fortunately, my own macro economist Martin Malone has also been watching this development and quickly concluded when the Japan Pension Fund goes, the rest will quickly follow.
From Mark’s comment: “As an incentive to generate alpha, there will be no limit on how much a manager can earn by outperforming. That’s a groundbreaking development.” Over the past few years the fund has seen the amount of fees it pays to external managers balloon. When it was just a bond fund buying JGBs, then fees were modest. Now it’s a major international player in stocks and seen its fees explode. Its reigning them fees back!
About 20% of the Japan funds assets are managed by external managers, but only a small number of these have actually beaten the indices and achieved targeted excess returns. While the fund will no longer pay fees for underperformance, they are committing to multi-year contracts to give external managers the incentive to make medium-to-long-term excess returns.
The message is simple and unsubtle. Perform or don’t get paid. I’m worried many funds just won’t get it. Many have become rules drivern, run to meet regulations rather than return goals. Compliance and reporting outranks investment picks. Juniorisation is the norm (remember a number I quoted recently – that more than 40% of fund managers have been in the business less than 8 years!) I am not so certain many established funds today will have the evolutionary DNA to become more competitive into the future…
Do I smell opportunity? Yes I do!
Back to the day job…