Blain’s Morning Porridge – Dec 18th 2018 – What next?

Blain’s Morning Porridge  – 18th December  2018

“If you jump into your bed, quickly cover up your head, don’t lock the doors …” 

In the headlines this morning:

Sorry for lack of Porridge y’day, but yet again the trains from down south didn’t work. The emergency service switched off the power after someone jumped onto the tracks at Clapham. Tragic as it is.. must every single track be closed indefinitely into Waterloo, Europe’s busiest station?

As year-end approaches at speed – only 4 more business lunches, 2 dinners, a drinks reception, and a pub booze-up, to go till She-Who-is-Now-Mrs-Blain and I go on Holiday! – its time to work out what the overarching theme of 2019 is likely to be.

We will find out about the likely path for Fed hikes tomorrow – the language and guidance will be interesting. Or will it be global recession – something an increasing number of analysts, pundits, guessers and the yield curve are now predicting? Will it be Political risks and misjudgements? Europe or Brexit? Or could the risks be to the upside – a renewed rally in stocks now they look less fundamentally overpriced? Will it be an underestimation of the resilience of the bond markets or the pace of the global economy? Failing to spot the diamonds in the dust due to all the populist noise?

Corporate debt markets are on most people’s threat lists – which makes me pretty sure it won’t happen the way pundits expect. I’ve read a host of negative articles, including the FT noting there hasn’t been a single junk bond issue through December! Corporate debt will have to deal with 2 threats – declining confidence in the market as a result of credit fear, and that rising rates hit low coupon bonds disproportionately.

The perceived downside credit risks include over-leverage, the pernicious effects of the Great QE unwind, the threat of a liquidity crunch if bond and bank funding routes lock out simultaneously, the general decline in credit quality and, lax credit covenants and declining underwriting standards biting back, a lack of preparedness for the next recession, companies unable to react to the threats of technological change, and unaware of the shorter and shorter product life cycles.

As a result of these multiplying fears, and reduced market liquidity, I reckon it’s a potential opportunity to winnow Corporate Golden wheat from the chaff. There are zombies out there that are going to default on rising rates, and angels that will fall from the IG heavens into junk. Perversely, a good old fashioned recession – which many predict – might look like great news for many indebted corporates!

However, its more likely we get a modest shake out. Debt will no-doubt bite on a collective basis – Index ETFs, CLOs, etc, will suffer from a rise in defaults in bad companies.  But the bulk of the corporate debt market are going to keep making their principal and redemption payments… The question is who and where to play in the market?

The fact is Credit Markets are a discrete game. It is not granular. Pick winners and losers. It’s probably time for a return to good-old-traditional credit skills: doing the hard numbers to work out the names likely to repay and identifying those headed for the poor house. But, it’s also a matter of factoring the whys and how the corporate sectors are changing more rapidly than ever before. Which are the names, and sectors, heading for obsolescence? Which are likely to become the new market darlings. It’s not as simple as sell shopping malls and buy logistic centres, but recognise the companies with the management skills likely to spot, adapt and hold changing niches faster.

The pace of corporate environment change of fascinates me. Yesterday’s market leaders can slip into an evolutionary dead end at fearsome speed. We’ve seen the product cycle in tech sectors shrink from decades to months. Remember who made your first Mobile phone? And when do bright-shiny-white-things become commodities? After Apple’s corporate disinterest to help get my iPhone fixed, and being aware of some to the potential for the next generation of tech, I can pretty much bet my next phone won’t be Apple.

The other area that fascinates me in terms of opportunity is EM – battered and bruised from the stronger dollar, how much of the latent danger of un-known markets already been priced out? Lots of pundits predict it will rise. Pick your winners.

I suspect new year’s big theme will be rising Political Risk. If the globe is really headed into even a modest slowdown/recession, its going to up the populist anti. What are the risks of major policy mistakes, mis-administration and political crisis distracting markets?

Take Trump – his administration (what lasts of it) will be increasingly mired in investigations, at war with the Democrat Congress, and capable of triggering all kinds of policy shocks. His current anti-Fed stance concerns me greatly. If the Fed hints it’s going to slow down the pace of hikes next year, what is likelihood the market perceives that as a policy cave-in to placate Trump?

Take Europe – Italy is on collision course with Brussels. The Spaniards may talk tough about Gibraltar, but know the poor south’s economy requires UK tourist’ spending. The French now claim the Gilet Jaunes protests were exaggerated by the UK press in order to discourage London bankers moving to Belle Paris. With the continent sliding towards renewed recession and still with double digit unemployment, the prospects for next year’s EU Elections will be interesting. Its going to be a clear battle of Europe’s austerity poor vs authority. Sprinkle in some flashpoints like French Tax, Italian Spending, Catalonia, Hungary or Poland, and we won’t be so worried about Brexit.

And, take Brexit – Labour make a late no-confidence play. I’ve read some extraordinary stuff about how easy a no deal Brexit will be. Are we delusional? Probably. Carry On Carrying On…

Or what about a good old fashioned banking Crisis? Deutsche Bank (always on my list)? The Italian banks – again on my list. And who would ever have thought Goldman Sachs would get sucked into unsavoury dealings in Malaysia… (Sarcasm Alert…)

More helpful predictions tomorrow.. such as.. “Most days, the sun will come up…”