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?



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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.


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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.


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Central reservation – September 8th 2014

The key take away from Thursday’s ECB announcement was that nothing has changed. Jaw boning is still the main policy tool and further cuts to interest rates and purchases of asset back securities are further fleas on the back of the EU elephant. A 10bps (0.10% if you like) interest rate cut is hardly going to make the good citizens of Europe rush to their bankers for a loan. Not that those banks would be interested in granting them one if they did!

The interest rate on the deposit facility which banks “earn” when they deposit money with the ECB (because they are reluctant to do anything else with it) will be decreased by 10 basis points to -0.20%. So now if they are thinking of “borrowing” money under the targeted long term financing operation (TLTRO) they will be paying 20bps to park the money while they decide if they want to lend it out – assuming there is demand in the first place, which there isn’t! So the banks won’t be rushing out to use this facility either will they?

The ECB press release included this statement which has been the apparent trigger for upward moves in eurozone equities and the short end of the bond markets – “The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP).” In simple terms they are buying a bunch of repackaged mortgages and private loans.

This theoretically allows the banks to recycle capital so that they can issue more debt which is one of the ways RBS got into so much trouble. The European ABS market is still pretty small so any funds raised this way are not going to be of any great significance and won’t help the countries that need the help the most ie Southern Med. The Germans on the other hand don’t need any help at all!

The most obvious, and necessary, effect as far as the ECB is concerned is to weaken the euro, but by nowhere near enough for Greece, Spain and Italy.

In Japan Abe’s third arrow has failed to gain escape velocity and he is relying on the BoJ to keep printing. Kuroda also spoke at the recent Jackson Hole meeting and confirmed that if need be further QE would be forthcoming. The BoJ not only buy JGBs (they now own more than one third of the entire market) but they also buy Japanese equity ETFs. Just imagine where the S&P 500 would be if the Fed were allowed to do this (assuming they aren’t already…). They are trying desperately hard to get some inflation into the system to generate some scope for companies to start paying higher wages, but with the threat of a further sales tax hike from 8% to 10% it is a difficult target they have set themselves. The sales tax regime was introduced as part of the third arrow economic reform package; might be a good idea to let this one go Abesan.

Janet Yellen spent most of the time talking about labour statistics at Jackson Hole and summarised by saying that economic conditions were perhaps still too fragile to start raising rates soon. Last month’s employment figures have confirmed her view although pundits are using the usual smoke and mirrors about seasonal adjustments et al to make the disappointing numbers seem of little consequence; closing on a new all-time high on Friday, S&P 500 aficionados apparently agreed with this sentiment.

Yellen’s counterpart in London has been keeping a low profile lest he is asked why he hasn’t raised interest rates in the UK yet given the apparently strong numbers emerging from the economy. It has been suggested that Carney won’t intervene before the election next May. Traditionally the Bank has not raised rates in the six month period before the event so that means he has another couple of months to go and could still surprise us.

Trying to follow a sane investment strategy when all the cards are held by the central banks is becoming increasingly difficult. Sovereign debt has surprised so far in 2014, but now, as a safe haven, only the very short end of the curve has any attraction. European ABS have a support level courtesy of the ECB, but do you want to be holding them in weak currency? The BoJ are committed to supporting their equity market too and the S&P can seemingly only travel in one direction. There are some markets still playing catch up; the baton here has been passed to China and the Shanghai A-shares index, which after a decent pause for breath in August, is beginning to get a move on again.

But the game of risk is being gamed ever upwards. Small savers and large institutions alike are being pressured into asset classes to generate a “decent” return that will not afford them any protection when the central bank merry go round stops.

Finally another quote from Dr Aghi. “It’s completely wrong to suggest we want to expropriate savers”; but you have Mario haven’t you?

To read the latest View from the Bridge in pdf format click here to view pdf 


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