Blain: If Yields Rise Any Higher, The Melt-Up Will Quickly Reverse
Blain’s morning porridge, submitted by Bill Blain of Shard Capital
“The vegetation is of iron, dead tanks, gun barrels split like celery, the metal brambles have no flowers or berries.. ”
Stock markets are staging a Melt-up! China and the US have agreed to roll back sanctions. Whoopee! Everything is fine and dandy. No… it’s not. Might be time to hedge with some puts.
As stocks soared, bonds suffered. Earlier this week I asked a number of clients for their predictions on markets in 2020 – one them replied: “ I am expecting to see a massive correction in the bond markets. 10 yr UST moving above 3%, 10 yr Bunds above 1%. Credit spreads blowing out and Stock markets falling 20 to 30%. The trigger? Perhaps a deal between Xi and Trump?” A coconut is on its way to that chap for his bond comment.
This morning we have most European bonds back in positive yield territory. (I note with some amusement Greece yields less than Italy!) 10-year Treasuries flirted with 2% yesterday – now at 1.90%.
There is massive danger in a reeling bond market. If we see rising yields morph into a serious bond market meltdown, the melt-up in stocks could split and go rancid very quickly. Rising rates have massive negative implications for corporate credit and without the juice of further central bank easing – stock markets could well lose heart.
On the back of a “trade agreement”, the short-term reactive consensus is everything about global growth and the economy favors stocks through earnings growth potential. I’d argue we are entering a more positive economic environment – even recent European numbers have been marginally less depressing than usual. But that means market participants have to be even more careful to understand what the picture is describing. This is still a “Danger, Danger, Danger Will Robinson” Market
Any China/US “roll back the tariffs” agreement is merely an accommodation – it’s not a peace treaty. Nothing is essentially resolved in the big picture or the details like IP or Huawei. In terms of the effects on global growth:
- A trade war standstill and unwinding recent tariffs doesn’t even take us back to where we were in 2015. It does mean there is plenty of room for a growth spurt/catch-up which might flatter the real outlook on growth.
- There is a strong chance the tariff stand-down doesn’t go further. Xi does not trust Trump. The loss of Kentucky and Virginia to the Democrats this week was an interesting signal. Trump knows he has to deliver economic strength, booming stock markets and sell pork and corn to ensure he wins Nov 2020. Xi knows that. Xi can pull levers.
- Global growth prospects are not simply about Trade Wars. The Global economy is complex and changing.
The real global growth narrative is far more nuanced than just trade wars:
- Factor in policy mistakes like central banking monetary policy since 2008 – low rates fuelled financial asset inflation, but not real investment, while political mistakes like austerity-spending imposed massive slowdown. End that repression, and a recovery in consumer wages and spending back to pre-crisis levels could fuel a spending boom. That’s a short-term positive.
- China growth dragged global growth in its wake. As China slows as its economy turns to consumption, the world slows with it.
- There is no growth driver to replace the scale of China – get used to slower for longer growth.
- Global Supply chains are changing – as China exports have fallen, Vietnam’s have exploded. Changing supply chains will take years to resolve – and will require corporate investment – which could struggle as companies struggle with leverage after years of debt-fueled buy-back bingeing.
While the current record stock market levels will be great news for investment managers trying to close out the year on a positive, the underlying picture is far more complex. As always, look to the bond markets for the real danger.
In Bond Markets there is truth. This is a story you need to read: Prime Time: debt investors should heed the lessons of Casino. The story is a warning about Fallen Angels – companies that tumble from BBB into junk. Without covenants, there is nothing to stop Fallen Angels “priming” existing bondholders by layering new debt ahead of them, effectively subordinating them. Ouch. I’ve warned a couple of times that even a modest rise in bond yields could trigger a new bond crisis.
Imagine what happens if even just a few BBB corporates crash out of investment grade into junk. They would be like the first few few pebbles tumbling down a steep slope. Investors would be keen to exit these names, but find liquidity is difficult in a bear-phase bond market. These few pebbles become a cascade of rocks as investors try to pre-empt other names that might become Fallen Angels. Very quickly the rush to exit BBB names becomes a full Credit Market landslip as the whole Mountain-side of near-junk Corporate debt tumbles into the Ocean below – triggering a Tsunami of destruction across Markets. Ouch, indeed.
BBB debt has been the fasting growing part of the Corporate Bond market, and now accounts for 38% of total debt, according to one report from a major investment firm. They concluded: “The growth of the size of BBB rated debt outstanding is not simply a broad-based symptom of a suffering investment-grade market… Active management of fixed-income investments can help avoid the bad actors and focus on issuers that have the balance-sheet strength to withstand a potential economic downturn.
Sadly, that’s not the way markets work. When the panic starts, everyone gets caught in the stampede for the exit. I fear a bond market liquidity event will just be the start..
As everyone agonizes about what the UK election might do to Sterling and UK assets, we are beginning to see the Tory Press launch a new Project Fear. Predictably, the papers are full of horror stories about how billionaires will immediately leave the country in fear their wealth will be seized, while rich foreigners will turn their backs on Gulag Britain causing the property market to collapse. The upper classes will be beside themselves worrying about how Tarquin and Jemima will be educated as Eton is turned into a young offenders’ institution. The middle classes will fret about how they can survive if tax-hikes see their just-coping salaries given to 73 differently gendered single parenting support groups. Within a few weeks the dole queues will be miles long, and the printing presses will break from printing too much money to pay for it all. And it will be our fault for voting for them!
The only happy people will be the Union Bosses of RMT who will simply declare all trains stopped till they get 100% pay rises.. and even then it will be at the option of the train soviet… Etc, etc. (Actually, the strikes planned for SouthWest Rail through December could prove a staggering own goal for Labour. The rail companies want to reassign guards to a train-manager role collecting tickets and helping customers. The Unions object – claiming it compromises safety. It doesn’t. No one is losing a job. But the RMT want to inflict misery on millions. Why? To show they can and they feel empowered to do so. It’s likely to result in a massive shift to the Tories across the SouthWest Rail region.)
A Labour victory will be the end of the World, scream the right-wing press.
Relax – No it won’t. Remember Blain’s Mantra Number 4: “Things are never going to be as bad as you fear they might be.”
This morning lots of Tory supporters will be gloating about the dispatch of Deputy Labour Leader Tom Watson, and praising retiring former Labour MPS Ian Austin, Tom Harris and John Woodcock for urging the electorate to vote for the Conservatives on the basis Jeremy Corbyn would be a disaster. All these defections prove is that Labour is as riven internally as the Conservatives. The Labour “moderates” are peeved to find themselves in the cold.
The Conservatives have swung to the right, and Labour has spun to the Left. That leaves the middle moderate ground undefended by either party. That’s dangerous.. what if the Liberals were to fill it??? (Seriously… if the Liberals win I might not leave the country, but I will go into the most monstrous sulk…)
For the record: I’m a lifelong Labour supporter – and sincerely believe in a fairer, just society. I just won’t be voting for Labour this time – I’m making a tactical choice because it’s better to get Brexit done and over with – because if it’s not strangled soon, its divisiveness will come to define the UK and destroy us. I would struggle to vote Labour because Corbyn, McDonnell, Momentum et al have hijacked my party too far to the left. They are opportunists. In a few years time.. they will be gone. Just like the Militant lunatics in the 80s.
If any party really wants my vote – then:
- Deliver a fair economy
- Get rid of student fees, make education a right not a paid-for lifetime of indentured slavery,
- Repurpose the NHS for the modern age – not close or privatise it, but address the very real problem of internal bureaucratic inertia. (Every political party is terrified to say it: the NHS needs reform.)
- Give us a realistic and achievable road map to zero emissions by 2050,
- Present us with a rational national programme to create jobs and growth for the fourth industrial age! Plan and innovate Climate Cures tech, AI, Robotics, VR, nanotech, 3D printing to build a vibrant future for the UK, and explain how in in terms of the infrastructure we need and the training required to make it happen.
I have sent my CV to Mr Johnson and Mr Corbyn. I can probably take Wednesday afternoon’s off work to sort it all out for either of them.. (I have not posted it to Jo Swinton. Liberals don’t count as a party… just an annoying whine.)
France and Europe…
I was having a pint with a Remainer chum last night and he was whittering on about how the EU is a marvellous thing that has united Europe and avoided war for 75 years. Marvellous stuff, timely in view its Remembrance Week and when we’re all wearing Poppies. But, I told him he is looking in the wrong direction. The threats of European conflict are all external.
Even though her Government is teetering on the edge of a coalition meltdown, Angela Merkel has hit back at Emanuele Macron’s recent sideswipes at NATO.
Macron clearly thinks a distracted Germany means Europe is a ripe fruit to be picked as he prepares to assume undisputed leadership. He attacked the lack of support Trump is giving NATO, warning the American’s have “turned their backs on Europe”, and the Treaty Organisation “can only work if the guarantor of lost resort functions as such”. Clearly, M. Macron is setting up France, in the absence of the US and soon the UK, as the new military leader of Europe. It will soon be the only nuclear power in the EU. What Napoleon never achieved, maybe the Force de Frappe can?
This would be the same France that flounced out of its NATO responsibilities in the 1950s and 60s? De Gaulle took umbrage because Les Anglos weren’t giving France an equal place at the top table and were suggesting the rearmament of Germany. In 1966 De Gaulle ordered all non-French NATO troops out – to which the Americans pointedly asked: “Does that include the bodies of American soldiers in French cemeteries?”
France stayed out till 2009. Nobody noticed.