Blain: "What Is The World Going To Look Like If Rates Ever Normalize"

Blain's morning porridge, submitted by Bill Blain of Shard Capital

“Caught in the chaos of the market square, I don’t know what, I don’t know why, but something’s wrong down there… “

As we are about to find out… Jokes aren’t so funny when you find yourself to be the butt. How is a whole country going to feel? I’ve never felt so inclined to punch the TV as when watching an oiky spotty brat boasting to camera in plummy Eton tones about how his vote for Boris will save the UK. Retching noises…

Moving on…

Fascinating article in FT this morning written by BlackRock’s head of global fixed-income, Rick Rieder: ECB can boost growth across Europe by buying stocks. Er, I how do I tell the world’s largest investor that’s about the stupidest idea I’ve heard in a long time? I completely agree Europe needs to urgently address and formulate policy to solve long-term and especially youth unemployment – but not through more distorting Monetary Experimentation by Central Banks. Yeah, 'cos that’s been a massive success.

The danger of a central bank pumping money into financial markets by buying stocks is simple – money invested in financial assets (stocks and shares) stays in financial assets. That’s the clear lesson we’ve seen over past 10 years. Trillions of QE cash has caused massive inflation in financial assets, but barely grazed the real economy. If you want a full explanation, then buy my book: The Fifth Horseman – How to Destroy the Global Economy, for the full theory.

Even Mr Rieder makes the point the US has created many $1 bln tech unicorns without having to rely to central bank largesse to create and fund them. Why can’t Europe? Clue: it’s not because the ECB isn’t buying stocks!! He is absolutely right that lower for longer interest rates have made financing tech, all kinds of small and medium sized business difficult, and is causing a new banking crisis in Europe – but Central Banks buying stocks will just increase the risks.

Who checks that money goes into building productive capacity, and isn’t funneled back to owners via stock buybacks and dividends? Because that’s how QE had widened income inequality!

Readers of the Morning Porridge will be surprised to know I am very positive on the prospects on Europe. I believe it is going to survive the current Populist plague and solve its current economic problem. And its simple: Fiscal policy. The reason Europe doesn’t work is because the Euro is a monetary construct. The current rules don’t acknowledge any fiscal dimension – that allows counter cyclical government spending to shore up economies, build infrastructure and increasing productivity (towards German levels). That is a key thing desperately required for Europe to work as it could.

It’s a slow process, and difficult when the Germans are not engaged. But Christine Lagarde, Macron, Leyen and Merkel? Talk to each other. Solve it. When Europe agrees a Fiscal Parallel to the Euro, then I am a massive buyer. I have high hopes it may happen soon. Until it does….

(Of course, any head of fixed income must be wondering what they are going to Arb next – when even Euro high yield is in negative territory, maybe its time to switch the whole portfolio into stocks, and then how wonderful if the ECB starts buying!)

Meanwhile, in a Galaxy far far away…

10 days ago I warned Boeing could be the stock that triggers a stock market slump. Tomorrow it reports Q2 earnings, and everyone is braced for lower numbers – around 47% down from last year. Its already said its $4.9 bln charge relating to the 737 Max will lower Q2 by $5.6bln.

Yesterday Fitch put Boeing’s credit rating on Downgrade watch. Their reasoning covered many of the points I made last week about its fundamental weakness: the increased regulatory oversight and uncertainty around getting the 737 Max approved to re-enter passenger service, the logistical challenge of getting the planes back in the air, and the likelihood the plane maker will have to offer airlines costly concessions to use/buy/take delivery of the B-737 Max.  They also cite the damage done to Boeing’s “reputation and brand”. I’d add cash flow drain from unpaid for planes!

What Fitch didn’t note is the problems at Boeing are long term managerial and behavioural issues – and the plane maker is doing precious little that’s visible to address these. How many Boeing execs have admitted it was their responsibility the planes were delivered with no clear warnings about the failing stall prevention system, the flight manuals were skinny on detail, or that the new engine position made it inherently unstable? Who got the lash-up design, and lack of clarity past the Federal Aviation Authority? 

Over the past decade and longer its operating mode has been tight. Saving money by paying Indian software engineers $9 an hour was just the tip of the iceberg. A history of using cheap and second hand spare parts is being uncovered. Passing off the B-737 Max as just an upgrade requiring one hour of iPad crew training to make it cheaper for airlines was another scam to help sell units. A history of poor quality, badly built planes is becoming increasingly apparent – especially from its Carolinas plant. Hammers left in the void spaces of military tankers beggars belief. Perhaps the biggest issue was how it effectively captured the Federal Aviation Authority and self-regulated itself for years.

Nor did the rating agency talk about the future – how Boeing reinvents itself from here. How does it resolve its current issues, and relaunch itself as the premier plane maker? How does it introduce a new product range – the costs and problems when it launched the B-787 Dreamliner were huge! How does it ensure its next leading launch, an upgrade of the now venerable B-777 avoid crisis and gets a clear regulatory stamp? Where do they get the money to develop new aircraft?

Just thinking out loud, but the original B-737 flew 60 years after the Wright Brothers. We should really have moved on since 1963? What does the future look like? 

What’s happening at Boeing now is Hubris – excessive arrogance in defiance of the odds. After nearly 35 years in the credit markets I’ve seen it all before. No two companies are alike – but there are lessons in watching mighty companies tumble and fall. “Look upon my works ye mighty and despair” brings back the memories of trips to win GECC mandates – then it was a trip AAA issuer.  We were treated as lepers by the company treasury team. Now its struggling to retain an investment grade rating with a miserable business.

Firms can struggle on for years or they die slow and hard. GE and Deutsche Bank are examples of the latter. Bear and Lehman went relatively fast. I wonder what the world is going to look like when/if interest rates ever normalise and literally thousands of Zombie overlevered companies look set to tumble and fall? Boeing is unlikely to go bust or default – its simply too big, too important, and had too good a product suite for that to happen. But it does need to change, and that could prove very costly.