Blain’s Morning Porridge 6^th August 2024: Shaken not stirred markets dust themselves off… for how long?

“We live in an earthquake zone.. what can I tell you?”

Markets are shrugging off yesterday’s wobbles, but is it really over? The next few months are likely to remain volatile, fraxious and stressful – and we still don’t know what No-See-Ums are lurking in the background – but we can guess…

Bill’s Pub to Club Swim: Let me remind readers about Bill Blain’s Pub to Club Swim on September 14^th Charity event in support of Wessex Heartbeat, the cardiac care charity.. You don’t have to anything except click the link – here – and make a donation. Without Heartbeat, well, you would not be reading the Morning Porridge this morning.

Well, that was fun…. Pick ourselves up, dust off the rubble, and back to the trading room!

June was the 50^th anniversary of “Earthquake”, the culmination of a run of “disaster movies” from the 1970s. Starring Charlton Heston and Ava Gardner it features the destruction of Los Angeles when the Big One hits. It is, of course, melodramatic tosh… but back then I was glued to my seat by the “Sensurround” deep-base sound system.

It starts with a violent tremblor – which quickly passes, leaving an unnoticed fatal crack in the Mulholland Dam. Everyone dusts themselves off, and gets on with their lives – secure in the knowledge new buildings are regulated to withstand a Scale 8 quake. The local geologist concludes much, much worse is coming. The mayor, of course, won’t listen. Inevitably it all goes predicably wrong. The Big One hits at Richter Scale 9 and subsequent aftershocks destroy LA. The sun rises the next day on a scene of utter devastation… and the plucky survivors hugging one another as the rescue helicopters arrive.

……………..

Markets survived Monday’s tremblor. What comes next? Is the big “blow-off high” still to come? Turns out it was a bear day in what seems to remain as a still fundamentally bullish market.

Yep, my conclusion is the market is still in overly optimistic mood…. Which means Mr Market (remember the “market” has but one objective: “to inflict the maximum amount of pain on the maximum number of participants”) will be lining up for another attempt to crush us all.

Japan might have crashed and burned, but elsewhere no one died… Everyone walks away.. shaken but not stirred… or did they? In times of heightened market volatility there are always winners and losers – when will we find out who? No doubt there are firms nursing heavy losses. Risk officers will be trying to deleverage and sell down – into thin summer markets.

A couple of trades have been knocked squarely on the head. It will be a long-time before the mainstream buys back into the Japan trade – the dramatic, sudden strength of the yen on the back of a tiny rise in Japan’s interest rate crushed the carry-trade. The widely adopted trade arguing that Japanese corporates are reformed and represent tremendous hidden value will also have taken a dint – but may still offer substantial value, witnessed by the Nikkei soaring this morning as the bottom fishers waded in….

There remain massive friction points ahead.

Markets we will be stuck in thoroughly nervous mode; volatile on successive events, be they earnings, central bank actions, and, of course, the increasingly fraxious US election. Give it a few weeks and the watchers will get lazy. Vix will tumble, and we’ll all start to relax… (Just when you thought it was safe to get back in the water….)

Tectonics will shift and grind away… the pressures in the system mount… something else will snap…

Marvellous.. the foreseeable future will be months more living on the edge… Can my dodgy ticker stand it? Well, it will help if you donate to the Heart Charity I support: Wessex Heartbeat and, sponsor my 2 mile swim for Pub to Club in September! See the link here… https://www.justgiving.com/page/billspubtoclubswim

There are a couple issues to knock on the head:

There are calls around the market for the Fed to swiftly ease US rates – effectively a Fed Put to rescue markets. I earnestly hope it doesn’t happen – the distortions caused by interest rates deliberately set at too low a level are long-term more damaging to the economy than the cleansing effects of a swift market crash. That was proved by the multiple negative consequences of the ultra-low interest rate QE era on corporate behaviours, market relative value, financial asset inflation and widening inequality – as we saw from 2010-2022. Central banks are keen we don’t make the same mistakes again.

I read a piece featuring Warton School professor Jeremy Siegel demanding an immediate 75 basis point cut today, and that the Fed further eases to 3.5% as soon as possible, arguing the Fed should have cut earlier. It’s a fairly common call – blame the Fed. Its also bollchocks.

Normalised interest rates of around 5% have not been the disaster many expected. There has been a rise in default rates as some Zombie over-indebted firms are taken out. It has pushed up the cost of servicing massive over-blown government deficits. It has stalled the private capital markets as exits become more difficult in a higher rate environment. But, it is making for a leaner more efficient economy where investment makes sense – rather than debt fuelled stock buy-backs.

Central Banks may tweak rates lower, but are not going to recreate Zero Interest Rate Policy. Rates will remain positive – above inflation – which means 4-5% in the foreseeable future. Get used to it. If things get trully awful, then perhaps Central Banks will intervene more aggressively.

Sitting on my library shelf is “When Genius Failed”, an account of the collapse of LTCM in 1998. Many reports this morning say yesterday’s tremblor is more similar than the Crash of 1987 – I disagree – but am happy to be proved wrong. LTCM was a leverage and liquidity event. Yesterday looks like it was a wrongside of the market moment ahead of much more significant consumption crisis.

The big issue across Western Economies remains consumption – how much can consumers actually buy after their disposable incomes have been slashed by energy price inflation, higher taxation, inflation and low wages – the latter being a consequence of the increasing “financialisation”, aka greed, of corporates to pay workers less to make bosses richer. (That’s the reality of the last 20 years; bosses got insanely rich and higher paid. Workers got poorer.)

When consumers can’t consume because all their income is consumed by higher rents, paying of credit cards, taxes, and dismal jobs… that’s when to worry. That time is now. Crashing consumption is the issue we haven’t yet seen on company earnings – yet.

You can scan the financial pages for news about how Google, Amazon and Apple are being “harassed” but regulators to rein in their advertising monopolies, or how EV sales are crashing, but ultimately.. what counts is how much consumption is going on. That isn’t yet reflected in earnings – that’s when this crisis will really deepen.

Despite my comment on consumption, fundamentally economies are about supply: what is available to buy and make stuff from. There is a great misconception at the heart of economics that demand and supply exist in equilibrium. No…. smart firms only supply the things people can afford to buy, while innovators understand what people really want to buy. Entrepreneurs put these together to create firms selling stuff people want and have the money to buy. (Advertising is broadly the art of persuading people to buy stuff they don’t want and can’t afford.)

This whole consumption equation may be in for further shocks after the crash in disposable incomes we’ve already seen. As the West and China (effectively still the cheapest to produce nation) continue to diverge, the costs of consumption are likely to further rise from rising inflation and supply chain inefficiencies. Meanwhile, rising global tension becoming conflict in the Middle East could create a further energy shock.

As usual.. I fear we are watching all the wrong things. Looking at the ins and outs of stock prices without understanding the factors that should be driving them, which are the inflation threat and consumption, consumption and consumption! Time to step back and think perhaps?

Out of time, running to catch the Train up to London..

Bill Blain

CEO and Founder,

Wind Shift Capital

www.windshift.capital

Blain’s Pub to Club Swim.