Submitted by Bill Blain of Mint Partners
“Fools ignore complexity. Pragmatists suffer it. Geniuses remove it.“
What we got in markets this fine and dandy morning? The clue might be in the weather. Blue skies over London, and the forecast is for a great weekend. Compare and contrast with the snow and storms of just 2 months ago. The outlook is fine – so why is everyone so bleak about market prospects?
Perhaps it’s the sheer complexity of all the awful bad news in geopolitics, rates, flows and all the other what-evers that drive market sentiment? Treasury yields (the 10-year US bond rate) have decisively breached 3%, spiking all the way up to 3.11% this morning - triggering terror across global stocks according to the news wires, although a glance out the window suggests stock jobbers ain’t hurling themselves lemming-like from the 19th floor… yet. Still... we live in hope.
The problem is bad news sells. When did you last read a headline about everything being just peachy? You didn’t. Sure there are worries out there. Recent economic data has been disappointing – which is hardly surprising when you consider just how much economies were disrupted by the miserable winter. It feels the global growth macro engine has stalled – but hey-ho, the sun is literally shinning this morning. We’ve seen divergence and dissonance in the synchronicity global growth vibe, but a few bum notes shouldn’t stop the concert!
The bottom line is we’re in a period of correction. Negative sentiment has been fanned because so many investors are out their comfort zones, for instance: if you bought into EM debt in search of the stellar returns that dried up in investment grade, you are probably nursing severe bruises - meaning you are bound to be negative. Meanwhile, you might miss that distressed sovereign specialist Michael Hasenstab of Franklin Templeton just took a massive $2.25 bln bet on Argentina, buying new Peso debt.. Ask yourself: what does he know that recent yield tourists into Latin America don’t? (The answer - I would hazard.. is lots.)
Then there is Italy. what’s ever not to worry about when it comes to Italian politics! 10-year Italy bond yields have risen 25% since early May, and if you really think 2.09% is the right yield, I’ll sell you as much as you want. Sure, its got everyone worried about the EU, how the ECB will react, and all that stuff about how Italy will become a rotten core of Europe with a quasi Lire destabilising the Euro. Or maybe not: Italy has been, is and will always be... Italy. Get over it. My best advice on Italian politics is worry not.. the Italians don’t seem to mind.. In fact, play the likely over-reactions...
And as for US bond yields spiking to 3.11%. Yawn… 3% bond yields are still far south of the 5% normalised rate we saw prior the Global Financial Crisis (GFC) of 2008. Slightly higher, but still historically low, interest rates will shake out a few weaker over-levered firms, put the fear of god into yield tourists, but will also stimulate other return driven sectors – not least financials!
What we are seeing is shift.
The bond spike confirms it's the end of the long-term secular 30-year bond bull market, but also the end of the post GFC experimental monetary-policy driven rally. Bond yields will go higher. Get over it. Reassess where other markets are going – take a look at oil prices, up 30% since Feb. Stocks aren’t showing direction yet – but it’s clear the VIX shock back in Feb has calmed much of the froth, and our chartists agree that while we may see a continued range pattern for a while, its as likely the next big move will be higher.
Sorry if all the above sounds a bit upbeat. I shall no-doubt return to my resolutely bearish mood by this time next week.
Meanwhile, I’ve spent the last few days traveling, including a very informative one day aviation conference arranged by Doric – the largest independent aircraft lessor. They assembled a superb roster of speakers to address many of the key aspects of aviation finance including valuations and transparency. But, perhaps the key “wake up and smell the coffee” moment was a very effective on-stage interview with the CFO of Finnair who reminded us of the complexity of all major businesses – when asked about threats, she responded with the example of new clean fuel regulations on shipping.
The new regulations will require ships to either use cleaner fuel or fix scrubbers from 2020. Presently, most ships use raw oil sludge/bunker fuel to power dirty engines. In just a few years, they’ll need refined fuel, or to spend millions retro-fitting. You can’t magic up new global refining resources overnight – and a shortage of fuel could drive Jet fuel higher as it competes for scarce capacity. The cost of fuel is a major driver of airline profits and costs.
Real Complexity – it’s a topic worth spending some time thinking about! Forget the noise about politics, and seek out the real factors driving markets.