The budget has pretty much killed off any chance of Labour getting another 5 years; not that the odds were very good anyway; or that the Tories would have done much better. Politicians are in denial as are many investors who think it’s all over. Well as much as I would like to believe that, the tea leaves (charts to those of you who think you can do without them) tell me we are still in a long term downtrend and that wont change until the Dow gets above 10,000 and the FTSE 100 above 5,000. A very profitable rally but experience suggests that most people will climb on board as we reach those targets rather than the 6,600 and 3,500 lows, when Armageddon seemed the only option
The big issue is still debt; government, corporate, personal; there is too much of it and its getting bigger. On Tuesday the Fed spent $10 billion buying 7-10 year Treasuries yet prices still fell on the day and both the US and the UK have huge funding programs to come; the UK will be issuing £175bn of gilts this year alone. Their only salvation is that deflation is still centre stage in the short term. In the 90′s Japanese bond yields fell from 8% to sub 1% (at the same time JGB issuance went through the roof and found willing buyers) and whilst 10 year bonds in government debt are circa 3% on both sides of the Atlantic they are still the safe haven for many. The Chinese have been adding to their holdings despite the world and its dog proclaiming how expensive they are. Compared with deposit rates, 3% from a triple AAA lender is really rather attractive isn’t it?
If the top US banks mark their derivative/loan positions to market 16 out of 19 would be insolvent. The optimists say that mark to market is irrational as in a “few years” liquidity will return and market values will re-establish themselves. If you will excuse the vulgarity “you can’t polish a turd”. Yes – much of this debt smells to high heaven. Western economics was founded on the Darwinian principle of survival of the fittest. If the business model is bust so is your business but bankruptcies and dole queues don’t buy votes.
The Austrian economist Schumpeter put forward the theory of “creative destruction”. A painful but effective course of action that has been shanghaied by the vote grabbers. An industry selling expensive and largely inefficient products that no one wants unless you give them away and which is run by the government is what my father would have labelled communism. In the US they call it General Motors…and “buy American” is the catch phrase.
We tried that (Buy British) back in the 70’s when we still made “things”, but not very well. It didn’t work then and it wont now. In June I am off around the world on a motor bike (more anon) and the only thing on the bike that’s British is me! And please don’t tell anyone I might know that I am actually one-eighth French!!
There seems to be a quiet regaining of confidence in the markets from the January lows; not surprising given the very oversold conditions back then. The huge sums earmarked for government inspired bailouts are slowly improving liquidity and reducing interest rates; the emphasis being on “slowly”.
The G20 meeting ended in some sort of consensus and the amendment to the mark to market rules in the US (albeit minor tinkering at the edges) have both helped confidence. The “failure” of the last UK gilt auction was not exactly a big surprise but 10 year yields are still below 3.5 per cent which perhaps is to some. The gold buffs are also facing the prospect of IMF sales and the “recycling” of scrap which has turned India from a net importer to an exporter.
On the other hand hedge funds are getting some traction again as figures show improving performance for the long/short brigade with lower volatility as an added bonus for the doubters. Risk adjusted returns have long been the mantra for the shrewd asset allocators and no more so than right now. Short term equity returns have been mouth watering in some markets but high volatility remains a concern. “Betting it all on black” is tempting but avoiding getting whipsawed will be only for the very nimble and how many of those do you know?
The latest US initiative to deal with “toxic debt” looks like foundering. The original TARP bail out required all the major US banks to take money from the government regardless whether they needed it or not. The “big issue” then raised its head as it was discovered that this “free” money was, in some cases, being used to pay exorbitant bonuses to executives in “failed” companies. Congress then started making noises about banning any form of bonus structure where bail out money had been supplied. Those that didn’t need the TARP weren’t allowed to pay the money back with the result that some “high fliers” have left to set up their own businesses so they can pay themselves the “going rate” without a dozen angry politicians on their backs.
The latest wheeze is to allow the FDIC (Federal Deposit Insurance Corporation) to gear up six times to buy toxic debt off other banks that are also allowed to buy debt off each other, (does this sound like the merry go round is still in full swing?), but with the taxpayer footing 90 per cent of any downside. The take up has thus far been very small as the banks fear further retribution if (when) someone finds a fault in this scheme and the banks are seen to be making money at the taxpayers’ expense!
So the question is will the fragile confidence last as we climb the wall of worry or is there another big pot hole down the road apiece? And how deep could that pot hole be? Well try the near $700 trillion in outstanding derivatives. Some very big positions in interest rate futures are purported to have gone “very wrong”, so Q1 results from the beleaguered banking sector may make interesting reading. The fat lady is not yet on the horizon so to quote Art Cashin at UBS “stay very, very nimble” … if you can…