Blain’s Morning Porridge – Jan 7th 2019

Blain’s Morning Porridge  – 7th January  2019

“Southerly 6 to gale 8, becoming cyclonic, then northerly later, 7 to severe gale 9, perhaps storm 10 later. …”

In the headlines this morning:

Friday was a classic. Despite the strength of the jobs report, the Fed says: “we might not hike..” so the stock market went ballistic on hopes of economic strength and “free-money-forever!”. Don’t argue with Powell… Or should you? Consider carefully what he might have been signalling..

Since 2008 the most effective way to get invest has been to coat-tail central banks. When they rescued the banks – buy banks. When they piled money into bonds – buy bonds. When they made money free – buy stocks. It was a dead easy trade – and with the benefit of hindsight, blindingly obvious! Why bother with nonsense like analysis? Just buy. The only nagging concern was how long would the good times could last. Rising concern the free-lunch could not last forever was illustrated by last year’s periodic outbreaks of uncertainty – the VIX crash was a pre-cursor, while Q4 seemed to confirm the era of “Follow that Central Bank” was over.

Investor uncertainty, fear and caution are not positive factors at the peak of the growth-cycle likely to facilitate a smooth-landing! They are even less positive when the Fed and others are also trying to undo the distortion effects and QE dependency of the last 11 years of monetary experimentation!  Central bankers are not stupid, and the Fed is certainly not playing to Trump’s agenda. They know 11 years of QE and accommodation has left massive distortions across markets. These need to be addressed – but how to treat them and cause least harm?

I suspect a key word for 2019 will be FLEXIBILITY.

That’s what we’re now expecting from a policy-flexible Fed. Despite Friday’s massive relief rally on Powell comment about “patience”, the new Fed flexibility is not a Fed Put on the market…. So what is it? The Fed expressing its willingness to address the current reality: that we live in a troubled world on the edge of recession and we’re about to take a step forward into the void?

Or is it more about trying to organise a less painful period of cold-Turkey? Although a number of blogs suggest the Fed is missing the overheated jobs market and domestic economy, and playing to the Trump agenda, I doubt it. Powell’s Fed is trying to do what every other Fed Head has tried (mostly unsuccessfully) to do – create a smooth landing for the US in a slowing and troubled US economy, at a time when global trade ructions are at a peak and the markets are still distorted by QE. Flexible is about the only thing they can be!

They do say any landing you walk away from is a good one.. If I wasn’t such a happy optimist, I suspect I might write something like: “walking away intact is about the best we can hope for through this year….. “

A second key word for 2019 is FUNDAMENTALS – what’s really happening. What are the fundamental truths underlying investment choices..? For instance – Apple argues its China recession that’s dragged down iPhone sales.


We suspect its nothing of the kind: its tech war betwixt China and US, its patriotism that’s driving Chinese consumers to buy Huawei, and Apple is losing the premium versus commoditisation argument. Extend that thinking to every other investment decision: what are the real effects of global slowdown, trade wars, corporate debt etc? (Yep… almost like having to do the work ourselves, rather than just follow the Fed!)

There are clear investment opportunities and consequences that stem from a Central Banks willing to slow normalisation and hold rates lower for longer. The obvious one is to stick with the programme and resume buying on accommodative central banks! Theoretically money still costs nothing. The reality is it’s getting more difficult to find as liquidity bites, and more and more market participants leave the crowded “follow the central bank” trade.

Therefore, I don’t follow the logic on a number of strategists who are calling for higher stock allocations. Free money drove the stock market rally – enabling corporate owners to swap equity into debt through stock buy-backs, and the influx of yield tourists. If the era of free money is over then that trade breaks down. If the economic cycle is slowing or about to turn, and credit spreads continue to edge higher (despite the Fed hiatus), then how attractive are overpriced, overleveraged corporates..?  Its going to happen, and what Powell is signalling is a desire to cushion the inevitable pain. Not cure it, or make it go away… just to make it more comfortable…

Meanwhile, some interesting comments in the FT about Ray Dalio’s Bridgewater “Pure Alpha” fund – up 15% last year when the average Hedge fund return was -ve 2%! Dalio makes some pertinent points: “optimism about future earnings growth has been backed into equity valuations, but we are at a potential inflection point where the economy is moving from hot to mediocre”.. or how about: “We are now seeing this classic late-cycle, strong profit growth and strong economic growth that is accompanied by falling stock prices due to the financial squeeze… that’s when the cracks in the system begin to appear and what most people never expected to happen starts happening..” 

A smooth landing is a hope. Hope is never a strategy. Be prepared for a hard landing, and pray we walk away from it..

Out of time and back to the day job!

Bill Blain

Shard Capital