Blain's morning porridge, submitted by Bill Blain
All eyes on what Powell tells Washington today, but a number of Porridge Readers called to tell me I’m wrong about summer risks! They think my expectation for a long worried nervous but stable summer before markets are bailed out by accommodative central banks in late Q3 is way too optimistic.
A number feel markets are ripe for a sudden and painful rollover in bonds and stocks – and much sooner than I think. What they did agree with was my assessment the likely trigger for a market shock will be a “no-see-em”, something so obviously hidden in plain sight it catches us completely and painfully by the short and curlies. And “Plane” sight might be a good way to put it. I’m wondering if Boeing might be the trigger! (See what I did there..?)
Hang on? We all know the next market collapse isn’t booked till October? Well maybe not. What if someone tries to start the market apocalypse early? That would shock the many market participants who think the perception of a Global Central Bank put means there is nothing to worry about. Complacency is a terrible thing.
Smart bond gurus are shouting bubble! Although US junk bonds have not tightened as much as treasuries through the last uptick, they are still at incredibly tight spreads. European sub-investment grade is rallying in the expectation a tide of new ECB investment grade purchases will lift all boats. Yet, with yields so low as to completely discourage any dealer inventory (which is too high a capital cost anyway), liquidity has never been so thin. As I say in my new book, The Fifth Horseman – How to destroy to Global Economy, (yes, I am going to plug it remorselessly), “Taking higher risk and less liquidity for lower returns is not a winning strategy.” (That is so good I’m adding it to my list of Blain’s Market Mantras.)
If the bond market is finally waking up to the bubble then we’re in trouble. All it took to fire the last crisis were concerns about sub-prime mortgages and a liquidity shut-down. What happens this time if we get a tri-fecta of junk bonds and covenant-lite CDOs, a resumed sovereign debt crisis, and overleveraged zombie corporates sinking the whole bond market? Ouch. That’s going to hurt. I confidently predict the current problems of funds that have had to gate because of illiquidity will be as nothing compared to what may come.
This morning I read Greek bonds yield less than US treasuries! Italy got €17 bln demand for a 50-year bond, basically because investors want convexity and think the ECB is going to ease. (And they want to repeat the spectacular returns garnered by the Austrian Century bond.) Italy has caught a bid because, apparently, the ECB is not going to sanction the country over its breach of GDP/Debt fiscal rules, and the appointment of Christine Lagarde as new ECB president means “do-what-ever-it-takes-for-ever” is nailed on. Even Czech bonds are in negative territory.. It all sounds far too good.
And what about Stocks – surely they will remain insanely optimistic on the back of central bank easing? That’s why they have been hitting new records. UBS is on the wires this morning warning the new US Earnings season that starts on Monday could be a big disappointment. Every 3 months, regular as a bowl of All Bran) some investment bank warns Earnings will disappoint. Maybe this time they will. UBS say “the bad news is good news” dynamic is set to end. Earnings growth expectations have slumped to 3% from 20% last year. They say “rate-cut rallies” often prove short-lived.
At the start of this morning’s Porridge I said Boeing might be the trigger that unravels the current market complacency. Why?
Many readers may not be aware Boeing is the largest component stock of the Dow Jones - 11.6% weighting in the index. That means its potential for unbalancing sentiment across the market is huge. Boeing stock is down 20.5% since it hit a high in early March, and down 17% since the second Boeing B-737 Max Air Ethiopia crash on March 10th. Since that crash, despite increasingly negative new flow and rising legal and regulatory pressure, Boeing is only down 6.5%. That’s pretty stable for a company that could be in serious trouble from a host of demand issues (ie not selling many planes,) regulation, legal (lots of people going to sue), cash, a loss of confidence, and a growing perceptions the company lost sight of safety in search of profit.
I am concerned the market is underestimating just how bad things could go for Boeing, and when it does, the whole equity market will knee-jerk aggressively, triggering pain across all stocks. I noticed yesterday the number of negative posts and comments on Boeing has risen dramatically in recent days. The crunch might be coming.
Let’s consider Boeing’s issues.
Despite the assurances from company HQ in Chicago, it looks increasingly unlikely it will get the B-737 Max back in the air this year. Boeing has just announced its H1 deliveries in 2019 are down 54%. It has only delivered 90 new aircraft this year. Yet, it is producing 42 new B-737 Max’s each month, and is having to store them on airport parking lots! It isn’t getting paid for these aircraft, but it still has supply chain commitments to meet. Boeing is haemorrhaging cash to build an aircraft no-one can fly – not a great strategy.
Why is it taking so long to get the B-737 Max back in the air? Part of the problem is fixing the problem to a level pilots, airlines and importantly, passengers are happy. Quick work arounds – Boeing’s initial response - are not acceptable. The second problem is a belated regulatory kickback by the US Federal Aviation Authority. They are running scared – under weak leadership they’d let Boeing self-regulate itself for years. Now the agency is playing catch-up and it doesn’t help Boeing has been caught out on a host of other certification issues across its whole production since the 2 Max crashes. Even though Donald Trump is now tweeting about his support for Boeing and new orders being imminent from his good friends in Qatar, the FAA is not going to rush to approve any MAX fix.
Boeing is trying to rush deliveries of other aircraft types to buyers to make up for the B-737 Max cash slack. But there have been problems with B-787 Dreamliners built at its state of the art Charleston factory – “shoddy production and weak oversight” said the New York Times. At least one airline is said to be refusing to accept aircraft built outside Seattle. The US Airforce stopped deliveries of new KC-46 Tankers for a while when they found engineers had left hammers and other tools in wing and control spaces – a clear indication of “safety standards gotten too lax” said Defense News!
Part of Boeing’s problem is its decision not to design new aircraft, but to upgrade old ones. The venerable B-737 is nearly as old as me, first flown in the early 1960s. It made commercial sense for Boeing to keep upgrading and upscaling the design because it kept the factories delivering and they could tell regulators it was just an upgrade not a new design saving billions on testing and training. It’s now clear the Boeing 737 Max was compromised to save money. 2 of them crashed killing 346 people. Someone has calculated 1 in 8 million aircraft passengers die in accidents. It’s about 1 in 300,000 on the B-737 Max. So much for Boeing and Safety.
This has massive implications for Boeing. Its next big upgrade is the B-777X, an “upgrade” of the old B-777. It will be lighter and more efficient for operators, and a new experience for passengers. But, there is now no-way it’s going to get a fast-track path to airline service as a “upgrade”. It’s going to be tested, stressed and pilots trained. Forget next year deliveries. We are looking at years down the road before any of us fly it. Boeing must rue the day they didn’t go with completely new design – which would have been hugely expensive and killed the stock performance of recent years, but would have left Boeing dominating the larger aircraft space and reaping the kinds of returns it could have made on the Dreamliner. It would have been a far more valuable company long-term.
Now the B-787 Dreamliner is tarnished with the botched Boeing brush. The winner is the relatively new Airbus 350 which can do exactly what the Dreamliner does in terms of efficiency and passenger experience. It can also do the B-777’s job. Airbus wins by default.. but what does a beaten Boeing mean for markets?
Crashing minor chords.