Bill Blain: "Nothing Has Changed: Too Much Money Is Still Chasing Too Few Assets"

Submitted by Bill Blain of Mint Partners

Too much money chasing too few assets sums up financial asset inflation and declining returns.

A Good and Prosperous New Year to us all!

It’s going to be an interesting year…… how many times have I written that before? “This time it’s different” is another over-used New-Year opener – to which I respond: “Oh no, its not!”

But first: MiFID 2. We’ve seen the first few market days under the new regime and the rules and transaction reporting requirements are in place. It’s taking a little time for the mechanics to bed down – but MiFID has not closed the market down. Get over it and get used to it. We’ve still to see the medium term consequences, for instance in relation to double counting dark pools and Systemic Internaliser (SI) effects. At that point we’re likely to see more meaningful comment about market effects and potential distortions – we will be watching carefully how this plays out. For now… we’re living with it.

What did last week tell us about the prospects for 2018? Lots of amusement value from the must read “Fire and Fury”, and Trump’s inevitable reaction. Yet, he did get his tax reform passed, and the next big programme, infrastructure, is working its way through. The US is transforming. Maybe that’s our first lesson for 2018 – “don’t be distracted by the noise!”

The first week of the 2018 saw stock markets carry on regardless! Low volatility and high expectations rule sentiment. Despite some modest US employment numbers on Friday, they continued to rise, hitting new records.
Bond Spreads continued to tighten. Nothing has apparently changed. We’ve got investors fighting to buy new high risk subordinated debt from Monte dei Paschi (which may be the world’s oldest bank, but for how much longer?), and does 6.25% for Argentina 10-year risk of 7% for 30 year risk really make sense? (Actually, I’ve got clients explaining their strategies which include buying risky European banks because the risks are overstated, and EM guys arguing that’s where the upside lies!)

Whatever – risky assets are yieldy, so folks are buying them. Aside from such blisters of risk vs return doubt, what we do know is simple: as financial asset values rise, their return decreases.

The thing is, nothing has changed. The basic problem across the financial asset markets remains too much money chasing too few assets. That’s why financial assets are costing more and returning less.

 

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We are all too familiar with US stock investors using more money to chase a smaller number of outstanding shares in a declining number of stock market names. (A smaller number because of buybacks and M&A/PE).

We’re very aware central banks are still holding vast swathes of the bond market (and the ECB’s case, still buying more.) And what are corporates doing with the vast amounts of new debt they are raising, and the cash they can now repatriate back into the US? They are buying back stock! The result is predictable - stocks and bond prices are rising.

If you are looking for inflation – that’s where it is.

The tighter returns and distortions on Financial Assets are the major reasons the smart money is looking outside financial assets (bonds and stocks) and buying real economy assets ranging from PE investors, right across to the alternative assets such as infrastructure, transport and housing I spend most of time working on these days.

Where does it all stop? Everyone is looking for the big 2018 threat. Will it be inflation? A number of learned bond investors say so. However, inflation has proved curiously shy in the wake of QE. While economies are growing, pay packets are not. Despite the Japanese government calling for 3% wage hikes, wages in Occidental economies remain constrained. We’ve also got a rising number of economists looking at the US economy and wondering just how tired the recovery has become. How much longer can it struggle upwards? There are two rising fears: a recession, and the potential for stagflation. Ouch. Stagflation would certainly be a slap in the chops for the politicians and central banks making the Gordon Brown mistake: claiming this recovery is different, that the business cycle is dead, etc… Nothing lasts forever…

Way back in 2016 Mint’s Chief Economist, Martin Malone, was one of the first to turn mega-bullish – pointing towards the prospects for Global Synchronised Growth pushing markets higher. He was spectacularly right last year – correctly calling the Japan and US markets. This year I can’t help but notice everyone has hopped on the global growth bandwagon. That makes me nervous…

Even though I’ve been wrong about Europe – where it does look like a real and sustained economic recovery is underway (much to my surprise) – I’m wondering just how resilient the global economy is. Maybe that’s where the real threats and possible dislocations lie? If Martin is right, then there is plenty of remaining upside for stocks as global GDP expands. (And since you ask, my prediction is Europe will stumble through Italian elections and Spanish/Catalan unpleasantness intact…)

On the other hand, the outlook for bonds can only be negative… spreads are way too tight and let’s see how the economic forces start to stack up in the US – and whether it’s a 3 or 4 hike year! We’ll know soon enough!

Anyway... its great to be back at my desk! Looking forward to a great year!