Blain’s Morning Porridge Aug 29 2023: The last third of the year begins – human nature is among the risks
“To “err” is human, to “arr” is pirate”
Don’t underestimate the effects of the natural cycle of the year on markets – the pressure to perform in the face of increasingly uncertain news flow is driven by a sense of opportunities and an awareness of time – which for 2023 are running short.
Markets are dynamic, in constant motion and turmoil, driven by the tides and affairs of men. I’ve written many times about how FOMO (fear of missing out) is the most powerful force in prices. As we try to make a buck, we worry about rates, economic activity, avarice, opportunity, what is good and who is bad, all while navi-guessing how these forces will direct prices and what happens next.
But markets also follow cycles – we talk about short-term trade cycles, medium-term business cycles, and long-term economic cycles. Being Scottish, Celtic, (and with a least one witch on the family tree), I suspect markets are also influenced by the natural cycle of the market year, based on a host of behavioural factors that stem from factors such as when the sun rises, our holidays and our motivations.
Let me try to explain…. Bear with for a paragraph or two…
Somethings are permanent. On Monday morning I was woken early doors by something in the garden. I peered out, but my attention was immediately grabbed by the magnificent night sky. Directly to the East were the “Pleiades”, perhaps the most beautiful star cluster. It’s also known as the Seven Sisters for the number of visible stars, but I grabbed my binoculars (yep, always keep some near the window) and started counting the hundreds of tiny jewels hidden within it. Then I noticed Bellatrix, the top right star of Orion above the horizon. The rising of the Constellation of Orion is a sure sign Autumn is coming.
Some things in life are certain. Others are not. From here to December the market pace traditionally picks up with a deluge of fundings and transactions. The next few days after Monday’s bank holiday are the last of summer before markets reopen fully for the final third of the year. What is the mood of the market into this busy period?
Not so great I fear.
Here in the UK we were promised a marvellous summer… climate change was supposed to mean blue skies here in the UK. Instead, what we got was the Jet-Steam looped underneath us; bringing wet, dark, driech, stormy weather, more than a few gales and lashings of depressing rain. Extreme climate events seem to dominate the news flow, and we now expect El Nino to impact food prices substantially. Numbers from Germany show the real reason Europe has withstood the impact of higher gas prices has been slowing the economy – not so much accessing new supplies. So much for summer.
Trying to do business through the summer is never easy. It’s like swimming through a congealing Eton Mess.
Let me explain what happens: You have a great trade idea in mid-June. You discuss it with a client, who agrees it’s too good to miss. But the credit manager is on holiday till next week, so it has to wait till then. The credit guy loves the deal, but the risk management guy who looks at this sector is out for another 10 days, and then the ESG team have a backlog of deals awaiting approval and come back with difficult questions a month later. Eventually every desk agrees it’s a crackerjack transaction, so with all the boxes ticked it’s all set to go to credit committee, but during the summer it only meets once a month, and the initial fund manager you showed the deal to is on holiday herself, so won’t be submitting the proposal till… well… next week. And the opportunity is gone…
Come September… everyone is back on their desks. They have all noticed it’s getting dark earlier, and the sun was just coming up as they stood waiting for the London train this morning. They are all very aware it’s the last few months to make numbers for the year, to impress the boss, to build their bonus. They look around and see signs of economic risk and confusion, signs of slowdown and recession, rates set to remain higher for longer, and the chances of a big win are receding. The gamblers among them are tempted to press the risk-on button.
This may be why September and October markets are so dangerous – especially after a difficult, disappointing year. Most of the really, really bad things happen in the final third of the year. Just saying… don’t under-estimate the “other” factors that influence market behaviour…
Back in the real world, the things markets are supposed to worry about – what have we got?
At the Jackson Hole gabfest Jerome Powell laid out as unclearly as possible the reality for US rates. The US economy remains vibrant, is “not cooling as expected”, so interest rates are staying longer till inflation is right back down to 2% – forget about a 3% interest rate fudge and declaring the war won.
Stock markets are more buoyant than the poor August suggested – in the US they are driven by expectations of the AI everything boost, the likelihood of lower rates sooner rather than later, a soft-economic landing, strong jobs and growth. Elsewhere we’re looking at issues such as changing corporate behaviours in Japan, growth in China, and frankly “can things get any worse” in the UK. All these “positives” are positive, but also vulnerable to sentiment knock-back.
High interest rates take time to filter through to the real economy. US and European corporates face a massive refinancing hump through 2025/2026 – the binge borrowing at ultra-cheap rates they undertook during QE and through Covid to fund stock-buy-backs will come due. They will be forced to refinance at interest-rates that will cripple them. Their hope was rates would have significantly eased by then. If they remain elevated – as Powell suggests – then ultra-high rates will accelerate the demise of Zombie companies. A rising wave of defaults is unlikely to fuel positive market sentiment… especially when funding for the Private Equity roadkill distressed bottom feeders who seek to prey on broken companies has apparently dried up.
I found myself on Radio 4 Today’s programme on Monday morning (I suspect the BBC can’t find anyone else willing to get up too early on a bank holiday to mumble-swerve about markets..) I found myself talking about UK zombie companies – Pizza-Hut UK which is struggling with high debt (a result of its time in PE hands) and Wilko – a company I simply can’t fathom.
A few weeks ago I broke the hunk of wood I’d fashioned into a Wellie-boot remover, so I looked on line for a cheap replacement. Lots of things available on Amazon and elsewhere, and then I spotted Wilko. The website said it was available online to collect at their local shop and 5 miles down the road. I bought it and drove to collect it.
It was grotty – the shelves dirty and half-empty, a sure sign of retail credit problems in any business. I had to queue to collect it, only to be told the order wasn’t ready.. but I could go get it myself from the shelf. I looked for it. No sign of it anywhere. A staff member told me it wasn’t in stock. Then I spotted it in a very unobvious place. I had to queue again to take it out the shop. As I drove home I regretted not just taking the Amazon option. I feel sincerely sorry for the 12,000 staff who will be made redundant by the management mistakes and the lack of marketing vison that has left Wilko terminally ill as a commercial concern. It is also burdened by unpayable debt, yet a PE firm is bidding to ransack what’s left..
What if things really do get worse and the pressures likely to upset the soft-landing many US investors expect, but European markets hope for, are overturned? What if China plunges into recession, (or something worse)? (I’ve attached links to a host of China stories below.) China could drag down commodities and spell disaster for Australia, while undermining the rest of Asia. Or what if things destabilise in Eastern Europe as the pledges for support for Ukraine come under pressure due to funding constraints in Europe and the threat of isolationism in the US? What if a wobble in commercial property, auto-loans or mortgages turns critical?
On one hand, Central Banks have shown they have the tools to address outright market failure in terms of QE and rates – but, as we have seen such intervention has massive consequences. The still unanswered question is: do CBs have the ability to unwind the consequences of market distortion and sort out the destabilising forces of inflation? That’s the real issue we still need to worry about.
This is going to be an interesting week to see how the market aligns itself as new data emerges..
Five Things To Read This Morning
FT Markets are not signalling doom and gloom for China’s economy
WSJ Communist Party Priorities Complicate Plans to Revive China’s Economy
Bberg As Rates Near Their Peak, the Pain Begins for Europe’s Borrowers
Torygraph China facing Japan Style Stagnation As Nation Gets Old Before It Gets Rich
FT High hopes, rocky realities: Europe’s new banks struggle to grow up
Out of time and back to the day job..
Bill Blain
Strategist Shard Capital