Tim Price – Capital and Conflict (United Kingdom) –
Today’s Capital & Conflict comes from the latest issue of The Price Report by investment director Tim Price.
Within my asset management business, we deal with two levels of emotional responses to the state of the financial markets.
At the level of hope or fear At the next level there is the hope or fear experienced by our customers.
While we may be completely relaxed about some of the investments we undertake, we might also be interested in our customers. At the extreme, if customers are uncomfortable with what we buy for them, we risk losing them forever.
They do not cover emotion in the financial textbooks. Which is odd, given that deep swings in emotion inevitably occur at market tops and bottoms, and those swings create what, in the fullness of time, become tremendous buying (and selling) opportunities.
But then most of the financial textbooks are useless. As most modern economics is useless. Utterly unfit for purpose.
If this view seems a little extreme, do not take my word for it. William White, the former chief economist for the Bank for International Settlements, said the following last month:
“All the market indicators right now look at the situation.
“Central banks have been pouring more fuel on the fire. Should regulators really be congratulating themselves that the system is now safer? No knows what is going to happen when they unwind QE [quantitative easing]. The markets had better be very careful because there is a lot of fracture points out there.
“Pharmaceutical companies are subject to laws forcing them to test their effects before launching a drug, but central banks have launched a huge social experiment with QE.”
Needless to say, I completely agree. (I recently published a warning on US and UK stock markets, qui, Regardless of the recent correction still look massively overvalued. You can read it here .) QE Was a leap into the unknown extremes of monetary policy experimentation, and yet central bankers conduct themselves with the confident demeanor of credentialed scientists, rather than the quacks they actually are.
Unusually for an economist, White has a habit of speaking his mind. Here, for example, is what he said during a previous moment of refreshing candor about his profession:
“The analytical underpinnings of what we [mainstream economists] are actually pretty shaky. A reflection of that fact, is that virtually every aspect of the world has changed over the past 50 years. So, this stuff is not science.
“Think about what’s happened recently. One, it’s completely unprecedented. People are making it up as they go along. This is hardly science – building on the pillars of the past. Secondly, what they’ve been making up as they go along differs across central banks. The Bundesbank, for example, is invariably fighting the threat of high inflation, while the US Federal Reserve is more concerned about the prospect of deflation. They can not even agree on themselves. I’m becoming more and more convinced that all of us are using uselessly.
“The best way to look at the economy is as an ecosystem. Some live, some die. There is no equilibrium as such; things are constantly growing. It’s surprising that we’ve had this huge crisis that the mainstream did not predict. It’s gone on for years, which the mainstream absolutely did not predict. I would have thought this was a basic statement about what we believed. But that has not happened. The policies that we’ve followed – on the monetary side at least – since 2007 are just more of the same. Demand-stimulating policies that we’ve been following, I think, erroneously, for the last 30 years.
“We’ve got the potential to do so much by not getting rid of money. We’ve got the capacity to do so much that we should not be doing much more.
Faced with the full ferocity of the global financial crisis in 2008, our politicians and central bankers had an opportunity to reset the system, and to allow capital to weak hands (bad banks) to strong hands ). They did not take that opportunity. Instead, markets have become cheaper with the QE process. Interest rates were driven down to rock-bottom levels – and in some cases below that. The can was kicked down the road. Now our central banks have run out of road, and that is a real problem.
I always expected to get a new share of the market. But incredibly, Alan Greenspan, the original architect of central bank intervention, left the Marriner Eccles building like some kind of conquering hero. I then hoped that natural justice would be successful, Ben Bernanke. No goal, ” the Ben Bernank ” survived too. And then Janet Yellen after him. Jay Powell is going to be the patsy on which the sucker finally goes down.
In line with the world’s other major central banks, including our own Bank of England, the Fed is now in a desperate bind. It is made to become standardize (ie, raise) interest rates. On the other hand, the financial markets are now distinctly fragile, and like, Pavlov’s dogs, traders are baying for more help. They would prefer to see a lot of money, but also to get a chance at a lower price. But if we were to reduce the trader to angst, let alone reintroduce QE, it would lose what fragment of credibility it now retains – and that has implications for, among other things, confidence in the currency system, bond yields, and so on.
Yields on long-term US government bonds have now risen to four-year highs as investors on economic growth and the prospect of rising inflation. Given how derisory bond yields still are, this is why I Elected to liquidate our last remaining bond investments in The Price Report Portfolio [NB Tim HAS aussi removed leaps from the London Investment Alert portfolio]. It’s still possible that a deflationary scare could be seen, but the overarching markets are all over the top. Any aggressively buying bonds are in the process of picking up nickels in front of a very fast steamroller.
You can see how the market is disintegrating in the following chart, which shows recent price declines in the ten-year US Treasury bond futures contract:
Ten-year US Treasury futures, last five years
Having reached a high of 134 during the summer of 2016, the contract is now trading at 122. In bond markets, a loss of over 10% is big news. And as I have pointed out on numerous occasions, what happens in the bond market, because the market for bonds dwarfs the market for stocks. Declining bond markets will inevitably impact equity markets, and probably not for the better. Prices in all things are relative, after all. All markets are ultimately a competition for capital. So when bonded cheapen, especially when they do so dramatically, expect stocks to cheapen too.
It’s still too early to say whether it’s a global crisis, or simply signs of investor skittishness, or a significant scale. One thing that is worth pointing out is that they are tending to show up in the US – which is a sign that investors globally are panicking, and, as ever, looking for North America to lead the way. (This may also mean that some foreign markets are trading off because of sentiment, and not because of fundamentals.)
My friend Jonathan Allum, for example, makes the following joke. Q: What’s the difference between the Japanese stockmarket and a supermarket trolley? A: A supermarket trolley has a mind of his own. He quoted the way that Japan’s Topix is just meekly trotting behind the US Dow Jones Future (in blue):
As Jonathan goes on to say,
The parallels with early 2016 are intriguing. Whilst most commentators stress the similarities between the recent market rout / collapse / turmoil (choose excessively melodramatic deion of your choice) and 2007-9, it is worth noting that things stand – and I accept that things can not stand still – the global We have seen this month and we have seen it less than two years ago.
This is certainly true in Japan. In the first two weeks of February 2016, the TOPIX index fell 16.5% – so far this month it is off 6.1%. There are, I suspect, two reasons why the media ignores the parallels with the events of two years ago. Firstly, it is because they ignore the 2016 correction at the time. Whilst financial markets are all over the world, they are very much restricted to the City sections two years ago.
Secondly, the 2016 correction does not lead anywhere and does not support the fate of financial Armageddon story in which so many pundits delight. It was one of the “false positives” so often thrown up by the markets. As Paul Samuelson famously observed, way back in the 1960s, the stock market has predicted nine out of the last five recessions.
To be it another way, while I’m very concerned about the technical breakdown in US stockmarkets, I’m much less concerned about the weakness being displayed in Japan – not least because the Japanese market is trading more attractive valuations, US remains horribly expensive on any historical analysis.
So all markets are not created equal, but when the proverbial hits the fan, as it did last week, all things tend to correlate towards a level of 1 on the way down. This will be an opportunity, in other words, for investors who will be missed on the Japanese rally the first time round to get back in again relatively cheaply.
There’s another reason why I’m bloody about the current heightened stockmarket volatility. I do not believe in market timing, and I certainly can not do it with any success, so it is more or less fully invested, equity exposure on the most defensive, value-oriented stocks or funds I can find.
A couple of weeks ago I had the opportunity to listen to an update from Greg Fisher (manager of the Halley Asian Prosperity Fund, the best performing equity vehicle in the entire The Price Report portfolio). Asian Prosperity Fund has returned 151.4% in GBP since inception in November 2012, the equivalent of a compound annual return of 19.9%. What’s fascinating, though, is that the overall metrics of Fisher’s fund are more or less identical to what they were.
What it is that Asia (especially Japan and Vietnam) is not expensive, and that it should be discriminating between markets that are expensive because they are extremely expensive. Asia is the train; the US is the latter. Read my letter to UK stock market investors here to get the full picture.
Until next time,
Investment Director, The Price Report