Submitted by Bill Blain of Mint Partners
“The more corrupt the republic, the more numerous the laws...”
Angel Merkel is marshalling her forces for a last effort on Sunday to close out her new government. She needs to get her own party on board. According to reports, it’s going to be close whether the SDP allows her to go into detailed coalition negotiations. Some of her colleagues think the party’s identity has been sunk by Merkel’s political bargaining. Not, that the proposed coalition looks much cop anyway – 28 pages of detailed policy agreements/compromises doesn’t sound like an adaptable plan for Europe’s largest economy as it faces stormy weather on European integration, Macron and Italy pressing for the right to spend whatever it wants to spend.
According to Bloomberg even a new German election if the agreement can’t be sealed will solve nothing (except probably end Merkel’s career). While European states have sometimes survived years without government (you’d hardly notice in Belgium), the idea of rudderless Germany as the new French Sun King spreads his designs over Europe hardly sounds like stability! Yet markets don’t seem in the least bit concerned. Wake up and smell the wurst…
Back in the real world. For a market some analysts think is navel-gazing, there is lots of stuff going on. Clients are beginning to figure whether upticks in vol and VIX herald new opportunities or threats. We’re seeing new inquiry for investment ideas de-correlated from inflated financial assets – ie how to garner returns without being caught at the top of a blown stock market, or be caught on the slippery slope of a falling bond market! And, what’s the dollar story? Its not just Trump, tax madness, and lose fiscal deficit policy. Something of shift may be play in China with profound implications we don’t yet quite understand. Weaker dollar anyone?
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Truth lies in bonds. Over the past few months we’ve been calling the end of the long-term bull rally that began in the 1980s. As the 10-yr bond gets ready to climb from 2.6%, we are definitely into a new phase as global NIRP and ZIRP negative and zero interest rates polices reverse. US bond yields have doubled since the lows – driven by tighter monetary policy expectations, the Trump laissez-faire approach to the rising fiscal deficit (ie.. if you can’t explain it on the back of a cornflakes box, you are wasting my time), rising growth, tight labour, solid stock market and the fact the rest of the world is on the same page.
I was on the box yesterday, and was asked a fascinating question by the redoubtable Bloomberg Anchor Tom Keene: “if we’re facing a “bond rout”, what’s going to trigger it?” Its always easier to answer these things retrospectively.
I see three threat vectors that could see the current gentle slippage in bonds become an avalanche.
- The first is unanticipated inflation drivers catching markets unaware
- The second is overly active central banks making policy mistakes (think another dose of taper tantrum).
- The third is contagion as rising rates trigger weakness in stock markets and a raging unstoppable tide of Zombie defaults, leading to a blow out among high yield names setting off wider spreads right the way up the credit ladder.
(I love writing things like “Zombie defaults”. It almost makes the bond markets interesting. I mean highly leveraged unproductive companies that have only survived due to the ultra-low rates – when rates rise… it will be like a scene from Rise of the Living Dead involving lashings and lashing of tomato ketchup.)
The next question is where to go if the bond market is really over. Where would you rotate into? Are stocks the answer?
Yesterday I was making the point about the US Tax repatriation game being likely to fuel a massive wave of stock buybacks. With $3.1trillion being brought back home – what else would you do? However, we are getting into seriously overbought territory on the US market – with stocks getting close to the 150% to GDP level, the bursting bubble point too many of us remember from 2000. The argument is either the global economy is so changed it's able to justify higher stock prices (which could be the case as the number of companies and stocks in circulation has fallen..), or there is an immutable financial law that valuations get stretched and burst…?
And if bonds are set to tumble, stocks are overbought, that’s a problem if you are looking to invest in financial assets.
Which is why I propose real assets. I’ll be at a conference on aviation financing next week – what’s not to like about aircraft as assets when global growth is expanding wealth, demand for travel is increasing and they simply aren’t making enough new planes to service growing affluence. (Still working out what keeping the A380 production line going means – if you hold aviation bonds linked to A380s.. give me a shout.)
And there are opportunities in shipping, housing, renewable energy, and a host of other asset classes. What’s not to like about not having to worry about how loud the pop in stocks and bonds will be.
On that happy note, happy weekend.