Bill Blain: "I Have Never Seen So Many Extraordinary Events In One Year, And I’ve Been In Markets Since 1985!"

We don’t think 2018 is going to be the End of the World. There will be opportunities and mistakes. Winners and grinners, and more than a few losers. Sure, we’re looking forward to the new MiFID regime – isn’t everyone? (US Readers…..)

Our broad brush picture is a continuation and acceleration of the Global Macro Alignment theme – a stronger global economy, cautious normalisation, continued upside for risk assets (stocks and alternatives), but a negative outlook for the bond markets with rates set to rise as Central Banks pull back from distortion. They will remain nervous about financial market instability.

If things wobble, them my personal view is the High Yield market is where we will see the most dramatic losses start in bonds. We still see a strong chance of equity market correction – and will buy into it because the global economy is expanding. Our big Macro Threat for the coming year is resurgent inflation – how quickly will it mount and will it take out market sentiment.

The devil is in the detail. We’re positive across all the developed economies and expect to see growth expectations raise. Although the US, UK and Europe will be moving into Normalisation with tightening, while inflation remains sub 2% Japan will continue its ZIRP (zero interest rate policy) which is massive yen negative and therefore stock positive – my Japan-watching macro man Martin Malone is calling for further massive gains in Japan Stocks.

A number of clients are also positive Europe. Despite my scepticism, I can see why. Finally it looks like the European employment crisis is being addressed – unemployment is set to fall below 8% in 2018. That is still intolerably high in social terms, but it’s a massive improvement on where we were. All the other growth drivers for Europe are now positive – strongly suggesting the ECB will ease back on QE and tighten policy. Rates will probably not rise immediately – but the hints will be there.

The US remains problematical – where is tax-reform, protectionism, Trump and all that going to lead us? In the UK it’s a balancing act on Brexit uncertainties, and inflation driven by the week currency. In both case I doubt the authorities will risk market instability though rash action.

Through the coming year, I’ll be providing free and open commentary on these themes on daily basis through the Morning Porridge. We’ve checked and it’s going to be MiFID 2 compliant. The aim of the legislation is to make markets transparent – that’s what I’ve always looked to do! 

I opened a Christmas card this morning from an old market mate in Switzerland this morning who wrote: “2018 might be quite an exciting year!”

If it’s anything like 2017, then he’s going to be right – but the past is not necessarily a guide to the future. I don’t think I’ve ever seen so many extraordinary events in a single year – and remember I’ve been in markets since 1985!

I guess on theme for 2017 has been: New disruptive technology + massive global central bank liquidity + global interconnected markets.

That’s glib enough to explain some of it.. But much of the stuff that happened is completely off the wall, but how markets react tell us lots about market phycology and what drives investors in times of ongoing yield repression (QE & ZIRP), too much money chasing too few assets, and massive FOMO (Fear of missing out):

Markets remain distorted: 10 years after the crisis begain, Global Bank QE has added some $2 trillion to markets, causing severe distortion effects to leap from countries and across asset classes.

Common Sense is an uncommon commodity: Theresa May chucking away her political majority and plunging the already difficult Brexit talks into a mire with the Northern Irish Taliban.

The markets have no memory: Argentina – a country we reckon goes bust every 18-years, successfully issuing a 100 year Century Bond.

Equity and Debt are not aligned: Junk bond issuers selling massively oversubscribed $1 bln deals, the sole purpose of which is to pay a dividend to the private equity owners!

Never mind what it is – Just Buy: Greed and avarice is alive and well as speculators pile into the BitCoin Ponzi – convinced they know what it is. They don’t. Never buy stuff you don’t understand.

An illustration of real value: Earlier this year I was asked to find buyer for some bonds guaranteed by the Scottish Government. The lack of interest demonstrates clearly the significance of confidence in government.

What is it worth?: Salvator Mundi, a painting that may be tangentially by Leonardo sells for $450mm, funded by a Saudi Prince – who is desperately trying to reform his country while shaking down its business classes to pay for it..

I suppose I could add lots more to that list… but lets just think about a few threats for the coming year:

In Europe we’ve got downside from German Politics, the Italian Elections, Separatism in Spain (and maybe Italy), and Brexit, upside from renewed Federalism from France and the German SDP, plus a recovering economy taking some of the pressure off. I guess we will crawl our way around these.

In the States is a question of where Trump is headed. Tax reform? And what will the new Fed do. And what about China?

Sell Bonds and buy Risk Assets – Stocks and Alternatives.. Can it really be that simple?

Elsewhere? Who knows, who can tell..  Anyone for last mince pie?

So nothing left for 2017, except to say Have yourselves a Merry Christmas and a Guid and Prosperous New Year!

It’s certainly going to be “interesting”

Via Bill Blain of Mint Partner

Bill Blain: "Stock Markets Don't Matter; The Great Crash Of 2018 Will Start In The Bond Market"

The Great Crash of 2018? Look to the bond markets to trigger Mayhem!

I had the impression the markets had pretty much battened down for rest of 2017 – keen to protect this year’s gains. Wrong again. It seems there is another up-step. After the People’s Bank of China dropped $47 bln of money into its financial system (where bond yields have risen dramatically amid growing signs of wobble), the game’s afoot once more. The result is global stocks bound upwards. Again. It suggest Central Banks have little to worry about in 2018 – if markets get fraxious, just bung a load of money at them.

Personally, I’m not convinced how the tau of monetary market distortion is a good thing? Markets have become like Pavlov’s dog: ring the easy money bell, and markets salivate to the upside.

Of course, stock markets don’t matter.

The truth is in bond markets. And that’s where I’m looking for the dam to break. The great crash of 2018 is going to start in the deeper, darker depths of the Credit Market.

I’ve already expressed my doubts about the long-term stability of certain sectors – like how covenants have been compromised in high-yield even as spreads have compressed to record tights over Treasuries, about busted European regions trying to pass themselves off as Sovereign States (no I don’t mean the Catalans, I mean Italy!), and how the bond market became increasingly less discerning on risk in its insatiable hunt for yield. Chuck all of these in a mixing bowl and the result is a massive Kerrang as the gears of finance explode!

Well.. maybe..

I’m convinced bond markets are the REAL bubble we should be watching. 

I’m convinced it’s going to start in High Yield.. so let’s start by talking about Collateralised Loan Obligations – the CLO market. Did you know that since the Global Financial Crisis (GFC) in 2008 only 20 out of 1392 deals have seen their riskiest tranches default? (I pinched the numbers from a Bloomberg article.) When I quoted these numbers in the office everyone was surprised.. Surely losses were greater?

Of course not.

It wasn’t just banks that benefitted from Too-Big-To-Fail. (TBTF) Most CLOs did very well. In 2008 smart credit funds realised they would benefit on the back of TBTF and did exceeding well out buying cheap CLOs from panicked sellers. As the GFC unfolded in the wake of Lehman’s default, the global financial authorities pulled out the stops to stop contagion. Banks were unwilling to realise further losses, interest rates plummeted, meaning the highly levered companies issuing the debt backing CLOs survived and were better able to repay their existing debt.

The 2008 GFC was about consumer debt – triggered by mortgages. We still have consumer debt crisis problems ahead (in credit cards, autos and student loans). There is also the fact Consumers have suffered most these past 10-yrs as massive income inequality has left them paid less and paying more for everything – which is most definitely going to come back and haunt markets at some point.

But, I do think the next Financial Crisis is likely to be in Corporate debt, and will be an credit market analogue to the consumer debt crisis of 2008. The Hi-yield market is the likely source - as markets recovered banks started lending again, and low rates forced investors out the credit-risk curve to buy returns. The funds who used to buy nothing but AAAs are now buying speculative single B names. Such is the demand for assets, these companies have been able to lever up and refinance, increase leverage and refinance further, at ever faster rates.

It’s been exacerbated by private equity fuelling returns through debt.  As demand has increased exponentially, borrowers have been able to slash Covenants, making it easier and simpler for over-indebted companies to raise more and more dosh.

Where does it end?

As rates rise we’re going to see the “Toys’R’us” moment repeated on a grand scale. The rise of and fall of Zombie companies that simply can’t meet debt payments is bound to contage not just the rest of the credit market, but also stocks. 

More immediately, the realisation a crisis is coming feels very similar to June 2007 when the first mortgage backed funds in the US started to wobble. (The first few pebbles rolling down the hill before the landslide?) It explains why we’re seeing the highly levered sector of the Junk bond markets struggle, and companies correlated to struggling highly levered consumers (such as health and telecoms) also in trouble.

Basically, the very little is really fixed since the 2008 financial crisis. 10-years later, here we are with the next bubble about to burst. Corporate debt watch out.

Which leads us to the UK Housing Sector…

A few days I commented on how UK house prices have risen 50% over the last 5-years – a period which has seen incomes stagnate. The result is its practically impossible for anyone on a normal salary to even contemplate ever affording their own house – a very good article in the FT yesterday saw the author explain he’d have to save 20% of his gross income for 60 years to be able to put down a deposit on the bed-sit he lives in!

In short, the great myth of the Thatcher generation is dead. The dream of home ownership in the UK won’t happen for our children’s generation.. They will be forced to rent, and that’s a very expensive market here in London. At the moment a mortgage is far cheaper than renting – but as rates rise that will correct a little. 

Somehow we have to create decent rental accommodation at a cost comparable or below mortgages. After all, if you own a house you save money on accommodation, and you get all the upside from appreciation of the asset. Historically, housing has been a better performing asset to own than even stocks - so perhaps there is even a tax angle there, but one no sane politician would date to broach. 

To make it happen we need to encourage public and private landlords with the where-with-all to build new quality rentals - and surprisingly this may be possible under current government polices announced yesterday such as privatising the Housing Associations. As this point regular readers will be in shock – “Blain praising the government? Pass the smelling salts”!

Insurance and pension funds will fund the assets - they know house are literally "safe as houses"!  There is a clear role for Housing Associations to become even more important quality providers of rental/social accommodation.

The big risk is some political fool will decide to enhance their electoral prospects with some ill-conceived "right-to-buy" policy which will simply fuel expectations, drive up consumer borrowing, and fuel a boom market once more putting property out of reach for the masses. 

Meanwhile, I suppose we should be worrying about the fact Merkel still can’t put a government together, the fact it’s now pay to get out of jail in Saudi, and all the other noise. Will anyone be listening to Theresa Maybe in Brussels today?

Blain's Morning Porridge, Submitted by Bill Blain of Mint Partners