Blain’s Morning Porridge – July 4th 2019
“I know of no country in which there is so little independence of mind and real freedom of discussion as in America.”
In the headlines this morning: https://morningporridge.com/stuff-im-watching
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Happy birthday America! This morning’s intro-quote is over 170 years old – and I could only use it on a day when all good Americans will be on holiday. Extra points to anyone who can name the author sans Google.
Interesting markets y’day. European bonds were off to the races, perceiving new ECB head Christine Legarde as a QE lower-for-longer dove who will continue to ease, ease and ease like Draghi. Bunds at -0.40%! Even Italian 2-year notes dipped below zero percent as the EU dropped threats to take action against the deficit. Some day we shall shake our heads in disbelief at that price…
In the States, the Dow hit a new high, and Trump tweeted it as a personal triumph. He is not so stupid as to mistake the stock market as a proxy for economic health – but he is making idiots of the American people by telling them it is. To keep up the illusion, he’s nominated new names to the Fed likely to toe his dovish line. Much comment on the private networks y’day about Trump’s latest nominations to the board – Judy Shelton being a particularly intriguing choice as Fed critic and gold standard advocate. For the Fed to lose credibility doesn’t just need Powell to surrender – packing the board will be just as effective.
The bottom line is financial assets remain absolutely distorted by QE asset inflation. While its been great news for the market, the real economy remains deflated. That’s what Jerome Powell and Christine Lagarde should be thinking about as they play with the monetary policy toolbox.
Meanwhile, back in the real world, the chance of achieving real returns are getting more and more difficult. I had the same conversation with 3 different fund managers yesterday. They all went along the lines of:
Bill: “Hi! What’s up, what you looking at..?”
Fund Manger: “Well I’ve got to buy assets, but yields are too low, spreads are too tight and market so thin. Any ideas?”
B: “Excellent, we need to talk about some of my alternative investments- what about something you can fully due diligence with a proper risk/return profile 8% return and secured on solid performing aircraft assets used by decent credit airlines? Or, how about a 10% convertible based on monetising proven technology with a definite Green angle?”
FM: “Sound great, but are you reading the headlines? We can’t even think about buying illiquid assets these days…”
For the bulk of public funds, pension and insurance managers – the real money market – the doors on risk assets have been slammed shut. The well-publicised Illiquid asset problems at GAM, Woodford and H2O has triggered all kinds of market over-reaction. All around the market Funds that have been carefully investing “patient capital” in smart alternative real assets are being told by their management to hold back from further investments, and pile into liquidity instead. Why? Because a couple of funds got it wrong? Because senior management fear regulatory backlash and client fury if they are caught making similar mistakes.
It doesn’t help that there is so much corporate dross around. Here in the UK the papers are full of stories of Funding Circle’s mounting financial woes, and comparing it to Lendy (which went bust after it’s naïve lending strategy imploded.) While the FT reports one successful student accommodation provider buying another from a major Canadian investor, it also carries the sad tale of another that funded itself from retail promising a 10% return on properties – the receivers are now chasing the individual investors for ground rents and service charges on empty student rooms. Don’t get me started about “mini-bonds” and London Capital and Finance – they give the bond market a bad name.
It’s a two-way street. There are bad investments and there are bad investors. If you are invested in risky buy higher yielding instruments – be very aware of the risks, which includes being locked in if the market turns. Don’t try to pretend otherwise. Also be aware that when markets lock – as they did for financials during the crisis – nearly every bond asset ended up performing as expect and repaid. Sure a few struggled, but generally investors that had invested well and diligently got their money and interest back when markets reopened.
Unfortunately, it’s equally clear regulators are terribly excited about an opportunity to throw themselves into the market and chuck some more rules into the equation. Their plan will no doubt be even stricter investment parameters dictating how liquid portfolios should be – without considering the consequences. Basically, regulators will regulate to protect investors from their decisions to invest.. You can’t regulate against stupidity – which is basically the root cause of 90% of fund collapses!
I can’t comment on the reasons funds found themselves in trouble by investing in deeply illiquid assets. Perhaps it’s the attraction of an above market coupon, or the promise of stellar returns, or not seeing past an apparent guarantee. But every case of an investor buying an asset and then discovering it is not what they thought they were buying is an example of failed due diligence and bad decisions. It happens. I’ve seen some very clever investors buy some incredibly stupid things and walk away smarter people.
All of which means investors are wracking their brains to work out how to generate any returns. If they buy liquidity – then they get effectively zero returns, and will be utterly reliant on Global Central Banks continuing to ease rates to boost bond and stock prices… further hiking financial asset inflation. If you were smart enough to have bought Treasuries or European bonds back in January, you would now be sitting on huge gains as yield tightened.
But the brutal reality is no one is going to get their pension paid if European bonds carry negative yields and Treasuries just a smidge more. If you buy Treasuries, then you pretty much know they will remain a liquid investment in all circumstances. But, are regulators now going to class corporate bonds and anything outside the FTSE or DOW as illiquid? Because that is what will happen when a market crunch comes. Markets will lock, and just about every corporate bond on the planet will likely be locked.
Which will be the moment for smart money to post ridiculously low bids and start scooping bargains, secure in the knowledge the market is never as bad as it looks. It happened in 2007/9 and it will happen again.
Even better are the opportunities currently available in the alternatives space – since so many funds are now running scared on liquidity, it’s an opportunity for smart money to step in and buy. Although we advise clients alternatives will be highly illiquid, we are also talking to many accounts and generating secondary interest in even the most complex asset classes – which means there are buyers out there waiting to buy at the right price.
Now… what shall I do for the rest of this Independence Day? Who is up for lunch?