Blain’s Morning Porridge – Jan 28th 2022: Consequences, Consequences, who would have guessed…
“The downright bleeding obvious is often a surprise!”
This morning: Markets are great at reacting to a single stimulus but are like a frog in a pan of warming water when it comes to consequential events. Forget “Black Swans” or “no-see-ums”, but figure out how the increasingly complex picture of unfolding events and consequences are driving markets!
The morning porridge will be intermittent next few weeks as I scramble round destinations East on a deal we’re working on. I will scribble notes whenever I get the opportunity – and please forgive me if I go a bit off-piste with some travelogue under the guise of market commentary!
This morning I am struggling to find a single topic for my usual Friday rant. There are literally so many separate threads driving markets, from recession/recovery indicators, company earnings reports, domestic politics, geopolitics, and rising dissent, that it’s difficult to focus on any one point and paint it as the dominant factor.
But, one month in, I’ve formed a pretty unshakable view on the year ahead: 2022 is going to be very different. That does not necessarily mean very bad. Different and Bad are not mutually reinforcing unless you let them be… Whatever happens in coming months, this will be a year of tremendous opportunity… but also danger.
When we think about volatility, we tend to think about steep lines on a price and volume chart, and the Vix fear index. Fast moving prices mean opportunities to extract extra value from the market – or lose more. However, we need to think more about event volatility – if that is the right expression.
Events generate consequences, which are often unforeseen and unpredictable. We tend to think of events in binary terms of “no-see-ems”, or Black Swans as they’re now called – things that come out of no-where to shock markets. Markets are far less unsettled by consequential effects – where small events occur, follow and reinforce each other. The cumulative negative effects from a cascade of small events, each of which will have spawned consequences of their own – can suddenly result in catastrophe. They can become slow moving train-wrecks, but are often retrospectively completely predictable – meaning they fail the black swan test.
In many ways markets can be a bit like the proverbial frog in a pan of water. It seems utterly unconcerned and unaware as the heat is turned up. But, threaten a frog with a sudden sharp pointy knife, and you won’t see it for slippery dust… Or maybe markets are like kids stretching a rubber band, knowing it’s going to snap, but still excitedly pulling it.
The way which markets suddenly break down is a branch of chaos theory. In a stable market the amplitude of prices moves within an apparently predictable band (to which analysts assign standard deviation, sigma, risk labels). The point where markets suddenly break out is usually unexpected. Suddenly the price will pass the chaos point. What triggers these chaotic break outs? Market over-exuberance and/or the multiplying consequences of events on prices.
What never ceases to surprise me about markets is how quickly prices can rise and fall on a single piece of company news, a single line on the annual report, a single word from a central banker, or a single (one of many) mistake by a politician. Yet, show markets a series of unfolding events and there is a stubborn reluctance to put them together in the bigger jigsaw of the economy. We understand single events better than a complex series of events – because that’s the way we’re programmed; survive the immediate fight or flight threat and face the next set of consequences.
Looking at the markets this morning and trying to figure out where its all going, I can’t think when I’ve ever seen the picture look so complex. We’ve got so many “events” happening, each of which will trigger ripples and consequences across markets – that the possibility of chaotic break-out seems very high.
Let me try to explain with a snapshot: (I could probably spend hours writing pages on each of these, and others, but I’ve a got a day-job to do):
- Over the past few days we’ve seen various firms, including Apple and Tesla, post stronger earnings despite supply chain problems. Yet the world’s second largest economy, China, remains in effective lockdown and supply chains multiply. Successful firms are finding new ways to operate – which has massive consequences for those that don’t.
- We’ve seen analysts predicting stronger US and UK recovery in months ahead (although the IMF recently knocked back estimates for both countries). House prices remain unaffordable. Inflation, increased taxes, energy bills are all set to eliminate discretionary consumer spending.
- While the UK economy slides into a backchannel in terms of trade treaties – the prime concern of the political classes is to not let Boris have his cake or eat it. The US has failed to pass critical infrastructure development funding due to political gridlock. Political failure has massive forward consequences – which will magnify ahead of this year’s mid-terms.
- We’ve got the Bank of England and the Fed both expected to tighten. After 12 years of over-easy money and cheap capital, the consequences on markets are obvious in terms of inflated financial assets – but there are equally dangerous consequences from unwinding over-abundant capital in the ways companies have reacted to it – most visibly in profitless tech sectors and speculative bubbles like crypto.
- We’ve got a real or imagined threat of war in Ukraine from which a billion potential consequences will flow.. Even if nothing happens (my call) the growing tension in Ukraine, rising tension on Taiwan, while Russia and China apparently come together, could spell distraction disaster for US policy, Biden and the dollar.
- Marcelo Claure of Softbank walking out after he didn’t get a $1 bln bonus from Masayoshi-Son.
Curiously, I have suspicion it’s all going to go badly wrong in the UK first as we approach a political chaotic break. Nothing surprises me in the news anymore. How did we ever get here? Let me explain.
Later today I will pay taxes to HMRC. Worst day of the year.
If you are a large supranational you might decide to make a token payment, and instruct your Panama based lawyers to come to an arrangement with your tame tax inspector. You might suggest you cover the inconvenience with, say £1 in ever £1000 the HRMC has assessed your taxes due from UK earnings. The HMRC will be pragmatic – and accept the deal, even give you a certificate of tax compliance or some such paper you can wave at protesters to conclusively demonstrate you are not a tax dodger. The HMRC doesn’t have the time or money to waste chasing down expensively lawyered-up corporates.
They chase the low hanging fruit instead.
If you are a barely solvent middle class family juggling escalating bills and fees, it’s about this time you get hit with an additional surcharge or payment, or a demand for money on account. There is no appeal – pay or expect to suffer. Young professionals working in London (I am de-facto banker to two of them), have been surviving on stale bread since last Wednesday, wondering how they are going to pay next month’s gas bill, and how they can afford their flat after their earnings are slashed when taxes and national insurance hikes kick in. They are living anything but “Their Best Lives” the glossy mags and social media show everyone else is having…
And if you are a struggling single parent trying eke out any kind of life on your wholly inadequate benefits, it’s about this time of year the HRMC sends you a letter saying a clerical error means you’ve been overpaid £100 per month for the last 18 months, and you have 3 days to repay the entire £1800 with interest – if not the bailiffs will attend and throw you and your brood out into the snow. There is no appeal and even though the bulk of such demands that taken up by MPs are subsequently dropped, the HMRC follow a proud tradition of tax-gatherers through history – pick on the weak.
And then you might pick up the papers and read how the much the PPE companies that secured Fast-track VIP government contracts (because they were friends of Tory MPs), have made from the pandemic.
Or maybe you will read about how the bounce-back loan programme became a fraudsters dream – £47 bln of credit given to 1.6mm applicants – of which £20 bln is never going to be repaid. We’re all familiar with stories like the small businessman next door who suddenly bought a Porsche, or the family that got the new holiday home in Rock. Lord Agnew, the counter-fraud minister, resigned, citing “desperately inadequate” efforts to stop tax-payers money being effectively stolen.
Or maybe it will be the news well fancied Tory Leadership contender Nadhim Zahawi was apparently instrumental in speeding Greensill loans to the crooked Sanjeev Gupta’s steel businesses last summer, after former PM David Cameron had trousered millions working for Greensill? Or that Lynn Truss spent £500k flying herself to Australia or back..? Or maybe it will be the local authority officers on the Isle of Wight taking bungs from Big Pharma to push drugs on the Island? And, I haven’t even mentioned Party Gate.
The point is that news is cumulative. I suspect the Tory strategists are betting we don’t see that. I’m betting the Brits are approaching that chaotic breaking point when it comes to political patience. If there was an election tomorrow, I have some pretty harsh questions for my Tory MP… and I won’t be making the mistake of voting for Boris again – back to Labour for me. I suspect many more of my neighbours will just vote Liberal instead.
And I can’t think of anything worse….
Five Things To Read This Morning
Have a great weekend! Back to the day job!
Strategist – Shard Capital