Blain’s Morning Porridge – Aug 25 2020: Economy “In Irons”
“ There are three ways to make a living on Wall Street; be first, be smarter, or cheat.”
As yet another storm batters the UK, I drove she-who-is-Mrs-Blain to the station early this morning. The brave little soldier is going up to her office in London today for the first time since March!
The S&P hits another record high, but headlines this morning include the first documented case of reinfection with COVID 19. Some 5 months after suffering the virus, a Hong Kong chap has contracted a different strain of the virus while in Europe. Apparently, its “nothing to worry about”, as the fellow “might’ have had very low antibody levels from the first mild infection, and the vaccines being developed “shouldn’t” be rendered ineffective because virus mutations won’t change the way it binds to cells and triggers an immune response.
Hmm.. Trying to cut through the noise… It sounds like COVID is going to be just like flu – immunologists guessing which strain to immunise against each year. Maybe that’s a good thing – the market has so priced in Vaccine expectations it was increasingly looking a “sell-the-fact” moment when/if it actually ever happens..
Meanwhile.. Good News is Bad.
Great news in UK as Tesco announces 16,000 new jobs for its internet delivery service – which has doubled in volume during the pandemic. That’s another nail for the high-street; an example of how COVID has accelerated the evolution of retail away from high-streets and malls towards internet delivery. In the states, Lumber prices have doubled on the back of the Pandemic construction boom, holding back new builds, pushing prices higher, eat, sleep, repeat. What you win on the swings, you lose on the roundabouts…
And then there is this week’s big event to look forward to; Fed Chair Jerome Powell will use the virtual Jacksons Hole conference to announce “average inflation” targeting. Whoop Whoop Whoopedy-do… All the Fed Watchers think this is going to be profoundly significant – a historic moment as the Fed will continue with a 2% inflation target, but instead of worrying if it goes above, it will allow inflation to remain higher for longer, ie “averaging” for the periods when it’s been sub-target.
These are just words. Meaning is more important.
What it actually means is the Fed will simply ignore inflation, and won’t hike interest rates if/when the economy is overheating and inflation rises.
The market will love it.
Inflation averaging means – “don’t worry about rate hikes, or normalising rates, we are so desperate for inflation we’re going to encourage it.” It’s a way of reassuring the market there won’t be interest rates rises for ever and ever… and magics away the fear of a market taper-tantrum if inflation were to rise. It completely resets the game of Fed Watching – you don’t have to worry about interest hikes ever again.. (or at least in the medium term..)
This confirms what we’ve come to understand. In the battle against deflation the Fed, and I guess the other central banks, see markets as the major weak spot. The are managing markets to avoid a global market meltdown occurring, which would further drive chronic economic weakness across the whole global economy.
Economically, the effects of pandering to markets are proving disasterous – inflated assets bubbles and a massive debt anchor tied around our feet. The result is we are stuck “In Irons”. Let me explain.
“In Irons” is a sailing term. It’s a crisis which can occur when a sailing ship has to turn through the wind. Yachts can’t sail directly into the wind. At best they can sail upwind at an angle, say 45 degrees either side of the direction the wind is coming from. (Sailors call sailing close to the wind “close-hauled” – it’s when the boat leans over at a frightening angle.) Because you can’t sail directly into the wind, there is a 90 degree “no-go zone” centred on the direction the wind is coming from.
If a boat has to “tack” through the wind, and its going too slowly, doesn’t have enough momentum or something goes wrong as the manoever is happening, the boat can get stuck in the wind: its bows pointing directly into the wind, and the sails flapping uselessly. We say the boat is “In Irons” – as in handcuffed. It’s extremely difficult to get the boat the boat back on the wind.
It happened to us over the weekend when I was helming a friend’s beautiful 1888 Pilot Cutter in the Hamble Classics Regatta. We tacked too slowly with too little momentum, and got caught In Irons. It took ages to get out. What saved us was a swiftly running tide that pulled us back into the wind.
I reckon “In Irons” is a pretty good allusion to the current economic crisis.
The Pandemic has simply catalysed an economic crisis that’s been brewing since 2008. It’s a culmination of over-regulation in the wake of the 2008 crisis, a transfer of risk from banks to the asset management sector, distortions from artificially-low interest rates creating massive price bubbles across all financial assets, soaring debt levels, and deflation rather than inflation becoming the major threat.
It’s happened at a time of enormous technical innovation, which has rather hidden the reality of a growing deflationary threat as Western economies choke on debt and companies increasingly become debt-encumbered zombies. We haven’t learnt much from the 30 year Japanese deflationary death spiral because we’ve been so excited about the potential of internet shopping, the connected economy and smart-phones, soaring property values, and the consumption led economy.
Now that economy is wobbling and is increasingly unbalanced. It feels like large parts of the global economy are flapping uselessly in the wind. Getting the economy back on track after the sudden turn forced upon us by the Pandemic is proving much tougher than Central Banks expected. They know that QE failed to stimulate growth by much after 2008, but it did avoid a succession of embarrassing market collapses by bailing out banks (by making the bond holdings look attractive) and supporting jobs by stopping insolvent companies going bust.
The newest buzz-expression in markets is a “K-shaped recovery” – explaining why the big five Tech stocks have done so extraordinarily well, while the rest of the market are laggards. The real pain is still to come. Banks are simply not lending at present, concerned about their rising NPLs while keeping capital ratios high so they don’t upset shareholders or trigger CoCo capital instruments (which governments might just do anyway). That means SMEs too small to feast at the burgeoning new issue debt markets are likely to find themselves starved of new capital as this recession really bites. It’s therefore likely the underperformance between the Tech Haves and SME Have-Nots is going to accelerate.
The right strategy is to keep arbitraging the increasingly convoluted mess the Central Banks have created and are walking us all into. The Central Banks are trapped in promises to do “whatever it takes”, ane low interest rates forever (whatever inflation does). The problem for investors is where to find returns – the only answer to take on more and more risk for lower and lower returns.
(And buy gold for when it inevitably all goes wrong…)
Five Things Too Read This Morning
CNBC – Powell set to deliver “profoundly consequential” speech, changing how Fed views inflation
FT – Sterling traders relaxed on Brexit trade risks
FT – Who would want the top investment job at California’s pension fund?
WSJ – New Thinking on Covid Lockdowns: They’re Overly Blunt and Costly
BBerg – Germany Faces Recovery Jitters After Virus Damage Revealed
Out of time, and back to the day job..