Bill Blain: "Forget 'Super Thursday', Today Is About Central Banks"

From Bill Blain of Mint Partners

Blain's Morning Porrdige, June 8, 2017

“Since 2007, 68% of stock market returns are tied to political events…”

Today is not about UK elections. It’s too late to do or say anything except anticipate and hedge the result – if you care to do so. Personally, I reckon a blowout Tory victory might not be the panacea for sterling many expect. It will simply confirm Hard Tough Fraxious In-Yer Face Brexit – and may well prove a sell-the-fact moment for the Pound.

Today is sort of about Central Banks.

Despite the noise about tighter policy, the reality is global recovery remains lethargic and thin. It’s easy to argue the new normal economic reality does not require aggressive monetary policy – low rates and low inflation for ever! Today we have the Fed and the ECB in the frame. Both are likely to defuse their respective ticking taper/tightening bombs. 

Despite strong German numbers, the ECB will look at recent disappointing European data, Mario will sagely shake his head, and any change in the current policy will be pushed back another few months.

In the States we’ve got new conservative and dovish academics rumoured on the Fed, questions as to whether Janet stays or does she go, and again, weaker numbers pushing against any change in the reinvestment of Fed coupons from its bond pile. I suspect it’s a question of sounding tough, but actually remaining softies at heart. 

Central banks are going to toe the policy line – support growth with accommodative policy. The result for markets is the massive QE distortion of financial asset prices will continue, supporting stocks for longer than we think feasible.

That kind of “what-ever-it-takes” central bank reality got me thinking about banks and the triggering of Banco Popular’s AT1 deals yesterday. The Popular AT1s were zeroed when the ECB converted them to equity and then sold the whole bank to Santander for 1 Euro. There was very little contagion across to other banking names – in fact even Spanish names were tighter. It’s simple to explain one reason why – Popular was perceived to be a one-off problem name, buyer could see the crisis coming and the ECB did the right thing by acting decisively. Applause..

Of course, that doesn’t help the holders. It’s no secret that at least one very large Credit fund was long and massively wrong Popular AT1s. Liquidity is marginal. They simply could not exit their positions as the evidence of crisis mounted. There are a number of sage analyst quotes saying a smart CoCo AT1 strategy will be to invest only in Good Bank names – avoid anything with a whiff of trouble around it.
Hm. I think CoCos/AT1 remain extremely dangerous.

When the next crisis comes, as it surely shall, I expect we shall see proof that banks exist in two realities and will perform very differently under each. Under normal conditions, central banks will be very aggressive and seek to ensure non-systemic bank failures are addressed decisively: ie trigger and then force the bank into a merger or takeover to ensure stable banking – as happened with Pop. The risk of picking the bad banks is the one investors think they can avoid through research, analysis and common sense.

However, as 2008 proved, a global financial crisis hits quickly and is systemic – names that look utterly secure one day, are scrabbling around for additional capital the next, deepening the sense of crisis. At that point, the authorities have no ability to ensure stable banking by directing failing banks into the arms of stronger ones. At that point, they can’t afford banking crisis – so I expect a new strategy will be adopted: mass triggering of CoCos and bail-in, with the state (whatever European law says) taking over banks wholesale to avoid systemic risk. Politically it might work – trigger CoCos and bail in debt to show tax-payers they aren’t paying for the crisis.

What is interesting is what parts of the capital curve do work? In the case of Popular, the Tier 2 subordinated debt was also zeroed as loss absorbing. But if the bank had outstanding Non-Preferred Senior (the recently innovated subordinated for of Capital-lite issued by French banks) these should have remained whole – they can only be bailed-in in the event of the bank’s total failure, not just in ECB resolution.
The implications of yesterday’s Popular AT1 collapse are not over yet. There is more to this than meets the eye.

And what might trigger a new banking crisis? How about a massive collapse in consumer confidence? High personal indebtedness? Folk struggling to pay their mortgages because they haven’t a pay rise in 8-yrs? Drivers walking away from car loans? Credit Cards? Unwise lending comes in many forms.

Which got me thinking about London – brought into focus by a great article I read yesterday by my old mate Larry McDonald (we were wage slaves together on board a French punishment brokerage a few years ago) on “The Bear Traps Report”. ( Larry’s been looking at a bursting bubble in Canadian Real Estate  – and as a man right at the centre of the Lehman collapse he’s seen it before. (He wrote the definite book about Lehman’s demise: “A Colossal Failure of Common Sense”.)

He made a few major points on Canada housing:

  1. Canada Housing and Demographics are misaligned – supply outstrips natural demographics. The market is overly reliant on overseas investors.
  2. Efforts to regulate the market are too late. It’s over-expanded and the buyers have fled.
  3. Trouble will not be restricted to just Canadian mortgage lenders – there are signs other players will also be impacted.
  4. Knock on effects across mortgages and consumer debt will be systemic – no matter what the regulators hope. Declining collateral will hit all lenders.

He suggests shorting the Canadian banks to profit from the coming pain! (If you want an intro to Larry, please let me know. He’s over here in Yoorp on a regular basis, and I’ll be delighted to bring him in to meet you.)

Back to London, and as I gaze out my window from Mint Towers this fine morning, all I can see are a rash of new built very expensive residential towers. Whoever thought we’d see £1million plus Penthouses on the Isle of Dogs? But we also know the Asian money that drove Nine Elms and other swanky estates has largely bailed out – losing their deposits because of fears over Brexit but also become their home authorities, especially in China, have slammed the doors on capital outflows.

While I read some UK fund managers intend to invest in “build-to-rent” properties – which will cost them vast amounts of stamp-duty - the only real difference I can see between London and Canada is demographic. Canada’s population is stagnant: 36 million of them increasing less than 0.5% per annum. London at least has a serious housing shortage and population growth… but at £1mm for a two bedroom flat near Stratford?

Just saying…. Will be interesting to see how the new government addresses it…