A conspiracy of central bankers – January 18th 2015

It is way past time that we had a collective noun for central bankers? So how about a “conspiracy”? Don’t believe me then read on…

Hey Mario it’s the Milky Bar Kid here and I need a bit of help. You see I have been selling chocolate for euros and seem to have accumulated rather a lot of them.

Well Kid I am rather busy right now with the Greek hummus trade warming up a bit and there’s also going to be a bit of trouble with the frankfurters in Germany. The Greeks can’t pay and the Germans won’t pay.

Then of course the whole European economy, which the unelected chocolatiers in Brussels tell us is doing fine, is heading for a deflationary bust. Your defence of the CHF/EUR peg hasn’t helped me either and this week I’m supposed to get off my butt and actually practise what I preach by announcing a humongous tranche of QE that will make everything right. And you think you have got problems Kid!

Well Mario I guess one too many cuckoos have flown your nest then! The gnomes over here are getting rather restless about the size of my balance sheet and the quality of the chocolate and there doesn’t seem any point in both of us trying to run mission impossible so I am going to pull the plug on the peg and let’s see if that helps at all.

Kid I thought it was the Brits that did the complete fruit and nut case thing when it came to monetary policy? You know green shoots and ramping rates three times in a day. Now you know I’ve been wanting to massage our beloved euro down, but do you have any idea what will happen if you do this? It will start behaving like the drachma or dare I say it the lira and you’ll just end up with more Russian laundry into the bargain. The rouble is rubble, the swissie’s been rolled and the euro will be toast – French toast quite likely.

Mario you worry too much, leave that to your mama. You tell me all your banks have reserves coming out of their ears so a little currency vol won’t play much havoc with their nice cosy VaR numbers and when you have told the Wideman at the Bundesbank that you are going to let the Greeks go hang, which should of course bury that nasty undemocratic socialist Tsipras’s chances in the election next Sunday, then you can take all this crappy euro paper off me I can start buying something useful like …oh I don’t know…gold…

Kid that sounds like a plan. Ciao good buddy. Super Mario signing off until Thursday when all the milky bars will be on me!

To read in pdf format please click here



Any volunteers? January 12th 2015

2015 has started much as 2014 left off which should come as no surprise as markets care little for arbitrary changes in dates after all; so no predictions!

Oil is one of many unknown variables including the fate of Greece the strength of the dollar the flight of Abe’s third arrow relations with Russia and the greater Chinese slow down. Then of course we have elections in the UK which will be interesting in the debate but almost certainly inconclusive in the outcome. It has been suggested a coalition government might be formed between Labour, the Scottish Nationals and UKIP; if so I’ll be catching the first flight to somewhere a long way off.

The central banks still appear to be in control; well they seem to think so. Now he is no longer in that particular club Alan Greenspan thinks things look a bit “risky”. Well risk is what investing is all about after all, but what is this elusive “particle” orbiting our portfolios? Some would have you believe that it’s all about volatility. If it goes up and down a lot the ride will be bumpy but you stand to make a lot more money than in something that gives you a smoother ride.

Looking back over the last 30 years or so that smooth ride would have been government bonds and for most of that period returns would have been better than equities. So a low risk portfolio should be stuffed full of them right? Yes indeed if your risk model looks purely at long term historical data and ignores where we are in the journey. But markets have an enormous propensity to make us look like fools. This time last year the predictors were saying, to a man, that sovereign debt was hugely expensive and due a very significant correction as rates were bound to rise weren’t they? If there is one data series that is consistently called incorrectly this is it – perhaps a reason why the largest component of the derivatives mountain is in interest rate futures!

So in the UK a gilt tracker would have made you nearly 15% against a pretty much flat equity market and the 10 year gilt now resides at a scanty yield of 1.6%. Over in Europe the 10’year Bund is at 0.4% and everything under 5 years duration pays a negative yield. Yes investors are willing to pay a premium just to get their money back!

As the 10 year Treasury yield shows, we have come a long way in the interest rate journey and whilst further gains are possible can yields go much lower. If we are going Japanese, and the Germans already are, then of course they can. Ten years ago, having 50% in investment grade bonds in a portfolio for a cautious investor would have been eminently sensible especially with one’s attention in the rear view mirror, but today?

The major unintended consequence of government and central bank intervention since Volcker’s stand against inflation has been to generate its nemesis; deflation. With interest rates near zero in the major economies, there is nowhere for rates intervention to go to provide a stimulus. Strangely the answer must be higher interest rates. We will then see some “creative destruction” which is what the financial system needs to reset and start a proper economic cycle, but with the investment banks, who stand to lose the most, controlling the strings (just how do you think the US Budget bill got changed to allow banks’ derivative positions to be included in subsidiaries covered by FDIC insurance? ie the taxpayer covers their losses) we need stronger hands at the tiller than a coalition of “politicians” or a lame duck president.

We need somebody with balls and I don’t mean the second fiddle in the Ed Miller band…any volunteers?



No time like the present – December 10th 2014

At the latest ECB press conference Draghi said that. “The monetary policy team had this week discussed buying all assets except gold”; qualifying a claim by fellow member Yves Mersch two weeks ago that gold bullion could be included.”

If central bankers truly believed in sound monetary policy the headline would have said “We’ll buy all your gold”. That would have propelled both gold and the European equity markets upwards. As it is markets on the continent get cheaper as the good doctor fiddles. “We may not do anything until January at the earliest”. Code for “It’s taking us longer to convince the Germans than we thought”. This has all the makings of a horrible policy mistake when one of the protagonists blinks. Draghi may even decide he has had enough and return to Italy to be president of the country there. With Merkel and Schauble in control of “finances” Draghi won’t beat the Bundesbank at poker and Jens Weidmann at the ECB helm would complete the German triumvirate, which would put the French in a spot.

Bond markets in European sovereigns continue to display heroic confidence in the central bank when in reality it has done nothing – the buying of ABS and MBS securities, hailed as a success by some European fund managers, has been an abject failure. “Banks can borrow at 10bps and lend at a tasty margin to eager borrowers, thus in one swoop solving bank profitability and boosting economic activity”, they said. Not so M’lud; the ECBs balance sheet continues to shrink.

And with the latest fall in the oil price (Brent was over $70 when I started writing this piece) deflation is a certainty, but for how long? There are a lot of marginal producers out there in shale world whose pips are squeaking as are their bondholders who have lent with expensive oil as collateral. Once wells start getting moth balled and bond holders get a series of haircuts (at best) the oil price will sky rocket, high yield will actually revert to being proper high yield ie junk and the myth of cheap oil and its “benefits” for the global economy will be over. In Japan oil is now more expensive in yen terms as the BoJ manage the erosion of the currencies purchasing power in true central bank fashion.

As ever it’s all in the timing, but do remember that when the bell rings the door will instantly turn into a cat flap. Now is the time to take risk off the table and add to those berated insurance policies of cash, ultra-high quality bonds if you can find any, deep value equities with more than a semblance of a decent balance sheet and some gold. As Kyle Bass eloquently put it, “gold is simply a put against the stupidity of the political system”.

With deflation lurking in the background cash becomes a much more attractive asset in the short term as does gold which is nobody else’s liability, unlike fiat money which in many instances in the past has been transformed into decorative wallpaper. Credit markets will also throw up value but don’t get greedy for yield and be prepared to be a long term investor. Liquidity in bond markets is going to disappear one day soon, but if the companies have the balance sheets to redeem the debt then hang on in there.

Same story with deep value equities. There aren’t too many bargains around right now as valuations get stretched higher and higher. If we are about to get a significant market correction – and we are starting to hear this refrain more often from market “professionals” – then market psychology tells us that as prices fall most investors will find it difficult to “pull the trigger” and buy at cheaper prices and then when the recovery phase kicks in it becomes even harder to get on board. So better to have a small toe in the water now and remember why you bought deep value in the first place. After all value managers are never wrong just early.


The Ides of October – October 6th 2014

To read the “View” in pdf format click here

Back in early August we suggested that we might have seen a few chinks in the armour of the markets only to be derided when the powers that be pressed the “buy me now” levers yet again. The central bankers have truly been the markets best friends and Dr Aghi and Kuroda-san have been taking over where Ms Yellen has all but left off, but even they can do little in the face of protest and dissent by various members of the global populace and the continuing stupidity and arrogance of our “democratically” elected representatives.

One area of the market that is returning to its senses is high yield or junk bonds as we affectionately used to call them. The realisation that yields were perhaps a touch on the low side has happened slowly but like bankruptcy it could all too quickly come all at once.

In Europe all bond yields are artificially low courtesy of ECB policy, but, historically, in the high yield sector they have tended to be higher than in the US. Some catching up is on the cards here which will be painful for bond holders. The “Bill Gross” effect will also be putting upward pressure on yields. The King of Bonds has moved to Janus (any similarity to the Roman god is merely a coincidence) and redemptions from his PIMCO funds are likely to continue at significant levels. There will inevitably be some “round-tripping” if the redemptions get reinvested with his new company but some bond investors may take this opportunity to look elsewhere; in fact they should be encouraged to.

Quite when interest rates are going to rise is anyone’s guess and sovereign bond yields could yet follow the Japanese path below 1% – German 10 year Bunds are already there and French OATS, would you believe, are at 1.26%. Did anyone say deflation? This would be the last thing the central bankers would want, but Draghi’s TLRTO initiative and ABS bond buying programme have been abject failures. Under TLRTO banks can theoretically borrow from the ECB at 10 basis points and any loans they make as a result would come at a very attractive rate. The only problem is that no one ex the student loan fraternity and the Top Gear wannabees are interested. The ABS market is tiny and the ECB’s scheme will just encourage the investment banks to dream up more bond erotica for the unsuspecting, which is how we got into this jam in the first place Stanley!

Low bond yields should theoretically support higher equity prices in a normal world where stock valuations are generally driven off the risk free rate, but if that rate is artificially low, which they are courtesy of central bank manipulation, then equity prices are too high are they not? This is nothing new and until very recently markets have been a one way bet driven by money searching for a return – any return – better than cash. This is not a rational way to invest it is speculation pure and simple.

I can do no better than quote from a recent John Hussman newsletter.

“As I did in 2000 and 2007, I feel obligated to state an expectation that only seems like a bizarre assertion because the financial memory is just as short as the popular understanding of valuation is superficial: I view the stock market as likely to lose more than half of its value from its recent high to its ultimate low in this market cycle.”

“At present, however, market conditions couple valuations that are more than double pre-bubble norms (on historically reliable measures) with clear deterioration in market internals and our measures of trend uniformity. None of these factors provide support for the market here. In my view, speculators are dancing without a floor.”

“Dancing on the ceiling” is not an option either…Beware the Ides of October.