History never repeats

History never repeats

It is not totally clear that Mark Twain ever penned these words and forgive me for using another hackneyed cliche, but it feels like deja vu all over again. The financial crisis from which we are recovering / have recovered depending on which government / talking heads mouthpiece you might care to listen to was preceded by increasing levels of corporate malfeasance, an ever burgeoning level of debt and a laisser faire attitude to problems of global conflict, stock market exuberance, “unfathomable” financial complexity – the junk bond complex – and central bank indifference (Bernanke – “the sub prime crisis has been contained” – “there is no bubble in the housing market”)

And so today we have Volkswagen owning up (after being prodded with a very sharp stick) to a quite staggering disregard for corporate governance – their now ex CEO ‘“knew nothing”, the EC in Europe and DEFRA in the UK knew, but did not tell and thus one of the most trusted and revered names in the auto industry is now dust. And that dust is a very long way from being in a settled state. The potential fines, penalties and costs of recalling 11 million Passats and Jettas et al, let alone the class action suits that will be legion, will pale into relative insignificance when put alongside the damage done to the German auto industry and the diesel brigade across the world (we suspect VW are not the only culprits) and the knock on effects to the economies at large. The US and Japanese auto manufacturers – predominately petrol engined – may well have pointed the finger…allegedly. Perhaps another case of be careful what you wish for?

If that weren’t enough to be getting on with the mining conglomerate Glencore is also teetering on the brink judging by the rise in its CDS price from €140 last October to over €700 currently and the continuing destruction of its share price. Glencore, a company not unaccustomed to controversy, acquired Xstrata in 2012, becoming one of the worlds largest mining and commodity broking organisations. It controls over 50% of trading in the global copper market along with similarly strategic positions in many other commodities. Its precarious financial position is of concern given the huge turnover in commodity futures where it performs the counter party role for a significant proportion of trades. A failure here would have severe financial repercussions and has already been dubbed “Lehman 2” in the making in some of the more “excitable” quarters.

If the financial crisis was caused by too much debt then the fact that globally there is a lot more debt in issuance than back in 2007 cannot be comforting. The central banks penchant for QE has hoovered up a lot of said issuance but over-regulation – to prevent such a financial crisis ever happening again; the regulators perpetual refrain – has reduced bond market liquidity to a fraction of its former self. That’s just fine when everyone wants to buy the latest high yield tranche – we used to call this junk remember – but when its time to pay the ferryman there will be precious little “coin” to be had as the rather large exit door will turn into a cat flap. With China now exporting deflation that may not happen for a while yet, but it is undoubtedly bubbling away and not quietly.

And talking of liquidity there is not much of it in the equity markets either. Since the financial crisis the S&P index for one has risen inexorably, on declining volume. And a major percentage of that volume is in the hands of high frequency traders. What are they you might ask? Well they are clever electronic trading platforms that supply lots of additional liquidity to markets; equities as a well as bonds and derivatives, so they are a jolly good thing yes? Well they think so but they would wouldn’t they? The whole HFT arena is shrouded in mystery as far as most people are concerned including many investment managers whose attitude is, “Well if they are shaving the odd penny off price quotes then that’s the cost of doing business isn’t it?”

But on the 24th August, the Monday morning when the recent “correction” started, many ETFs were unable to be priced, as on the NYSE close to half the stocks traded didn’t have an opening price as the gyrations caused by HFT triggered trading halts as prices traded outside normal limits. The HFT houses very kindly came up with a solution that simply suggested that ETFs shouldn’t price on a minute by minute basis – which is one of the major attractions over buying funds which only price daily. The best solution is to ban high frequency trading, or at least put everyone back on a level playing field; but don’t hold your breath waiting for the regulators to wake up to what is going on…One of the HFT firms proudly announced that August 24th was its most profitable trading day ever…Excuse me for a minute while I check up on the definition of hubris…

The central banks still believe in divine intervention and given the number of occasions recently when markets have slumped at the opening yet got back into the green at the close the Federal Reserve “put” is still very much in play. Much was made of the shall we / shan’t we dance over raising interest rates and Janet Yellen hasn’t come out of the encounter very well. There have been a number of conflicting comments on the direction of rates from fellow FOMC members; her job is not an easy one. Over here Mark Carney has appointed himself in charge of the global climate debate, perhaps to take our minds off the fact that he, like Yellen, has not overseen a rate rise since taking office. The economic data is as ever all over the place and for every positive item there is a negative number to choose from so the bulls and bears practise selective hearing as was ever the case.

So what are we to make of the current gyrations? There is much talk of value being spotted, but unlike previous “buy the dip” episodes where the recovery to new highs was marked in days we are now six weeks into new territory. This is a new pattern which could still resolve higher, but to quote Chou En Lai – the Chinese Foreign Minister during the reign of Chairman Mao – when asked what effect the French revolution had on the development of socialism, he said, “It is much too early to tell.”