Broomer's Blog

From the category archives: Macro

Macro

When the Curves go Topsy Turvey

When I started out in this industry (and frankly for many years after then), I used to get very confused about yield curves, particularly when they get inverted. Thankfully, I now realise that it's quite simple.

The yield curve graphically describes what the interest rate is at various time points. So starting with bonds very close to maturity such as the 3 month gilt (or treasury bill), we can find an effective rate for a short term investment. As we extend the maturity rate, we can find the rates for 1yr, 2yr, 3yr etc bonds. Typically, curves go out as far as 30 years.

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Redefining the term ‘Investment’

If I offered to borrow money from you with no interest payments and promised to pay you back less than I borrowed in 10 years time, I guess that you would tell me where to go. I suppose you might be prepared to make such a loan to a family member or possibly a very close friend, but you certainly wouldn't consider it an investment.

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Geek Squawk: Understanding the Numbers

The quality of economic releases varies from nation to nation but the numbers can have a pronounced impact on markets. The standard of information from the UK's ONS is not bad by European standards, although it has faced criticism over recent years following its partial relocation to South Wales. As might be expected, standards in emerging markets are lower and this is something of an issue for investors as China takes on a pivotal role in the global economy.

Fortunately, the world's largest economy, the US, has a reputation for high quality economic statistics, produced both by the government and non-government organisations. Indeed, such is the dizzying wealth of reports, it is not always easy to identify the most important ones, particularly with many of today's media organisations increasingly focused on capturing eyeballs rather than imparting useful knowledge.

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Outlook January 2019

"Britain can be cancelled, top EU lawyer says" so read a headline on the CNN website. It certainly feels like it. A divided nation, a crippled Government and a Leader of the Opposition who transparently covets investors' hard earned savings. The nation is crying out for strong leadership but few of our current crop of politicians come close and Parliament merely mirrors the divisions across the nation. As the old joke advises, you really don't want to start from here. It is perhaps not a surprise therefore that this has been the worst year for UK financial markets since the Great Recession in 2008 and the FTSE 100 is back down to a level first seen in 1999. Thankfully, we have positioned our portfolios with limited exposure to equities, particularly in the UK and this has helped provide some insulation for our portfolios.

Perversely, the principal cause of the markets' woes was not UK related but more global in nature and, in particular, American. Stock markets began to feel the chill draft of the US 10 year Treasury bond topping 3.2% in late September, triggering the global market correction that began in October. At the time, it appeared to be a replay of February's valuation recalibration in response to a higher discount rate. However, many weeks later, nerves have yet to settle despite Treasury prices rallying; the 10 year note is now yielding below 2.9%. Unlike in February, the hitherto market leaders have been pummelled and the ecommerce giants seem have lost their air of invincibility. This is despite Q3 earnings leaping by 24% and President Trump's tax cuts accounting for only part of this bounty.

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Outlook Sept 2018

The FTSE All Share has drifted this year but decent money has been made from international stocks. The MSCI World has been driven higher principally by the performance of US stocks which in turn have been driven by the ecommerce stocks. The US economy is responding to Trump's spending package and earnings are benefiting. EPS growth is exceeding 20% yoy, a little less than half of which came from Trump's tax cut. Encouragingly, corporate revenues are up 9.5% over the period, well ahead of nominal growth rates. Speculative hunger appears to be significant: those who only lost half their shirts on cryptocurrencies, now have the chance to lose the rest in cannabis stocks. Piling into Facebook and Amazon is far more rational in comparison and who are we to stand in the way of such momentum. Expectations of 10% EPS growth next year sounds demanding but could be possible as a virtuous circle of confidence, spending, investment takes hold.

We were right to fear tightness in the oil market as we did at the beginning of the year. The oil industry needs continual investment to maintain supply and the freeze on development has had an inevitable consequence once the stock overhang had been dealt with. We highlighted last quarter about some of the secular changes that could worsen the inflationary outlook. Now CPIs are ticking up globally as energy prices work their way through. The effects of the trade tariffs are yet to be reflected.

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Hey Genius, You’re Worrying about the Wrong Deficit

The trade deficit dominates President Trump's attention and by some reports, he has been fixated on this subject since the late 80s when Japan seemingly threatened to take over the world. Clearly that episode did not end well for the Japanese economy, yet Trump has persisted in wailing about unfair trade practices with his main trading partners. To be fair, Trump's ultimate intention is to engineer freer trade is reasonable but is this really worth the risk of igniting a trade war to reset the balance?

Meanwhile there has been surprisingly little comment about the cost of his tax cuts. It may be more correct to consider these not as tax cuts but merely deferred taxation measures. Most of the personal cuts are earmarked to end by 2025 but even for the permanent corporate ones to be sustained, the money needs to come from somewhere. Otherwise it will necessitate cuts to expenditures. Trump reckons that the Laffer Curve will come to his rescue as the greater growth will lift tax revenues, but as this stage of the cycle this appears rather farfetched. Even using the fanciful assumptions in the White House projections, these tax cuts do not become self-funding over the next decade. While Trump believes that his policies will spur economic growth, there are good reasons to suspect that they won't.

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The more I scream, the faster they go

Investment is a difficult discipline but there lies some very simple tenets at its heart. One of these is that the more you pay for an investment, the lower the return. As we approach the final stages of this long bull market, profits are approaching a cyclical peak and investors are paying a hefty multiple for these earnings.

It is common in late stages of bull runs for 'market darlings' to emerge. These stocks seemingly are impervious to rain or shine and behave magically as both performance drivers and havens for investors during market corrections. That is, until one day, they don't, often sounding the death knell for the bull market.

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The Beauty Parade

Keynes famously used an allegory of a beauty contest to describe how markets behave in the short term. He posed the question of how you should go about betting on the outcome of a beauty contest. To be successful, you should not bet on who you think is the most beautiful contestant but those who you think the judges will consider to be the most beautiful. His point is subtle but distinct.

James Montier at GMO recently highlighted some apparent inconsistencies in the results of the Merrill Lynch Fund Manager Survey. He points out that a significant majority of fund managers now believe the US market to be overvalued,

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Crypto-currencies

The link to this article contains one of the best descriptions I have read of how the crypto currency market is structured and how it may develop. For those interested in the subject, I strongly recommend it.

I have not met with the authors nor for that matter with anyone from the Australian based Platinum Asset Management. The firm does not have any funds readily available for sale in the UK. The Platinum website has developed enormously over the years and the insights section is well named. The firm's principal, Kerr Nelson, was recommended to me by an old colleague and I have kept an eye on his views ever since.

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Filling the Bath in the Dark

NAIRU is one of those nasty looking acronym beloved by economists. Typically, the concept works very well in theory but has an unfortunate tendency to breakdown as soon as you apply it in the real world. It kinda makes sense that if there is a sufficiently large pool of unused labour in the economy, wage inflation will remain under wraps. Only once that spare capacity is used up do workers have the power to claim higher wages which are in turn passed on in higher prices.

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