Broomer's Blog

Coronavirus in perspective

The expansion of the coronavirus outbreak is frightening but needs to be placed into perspective. So far, there have been 3,000 cases out of a population of 6,000,000,000 if we exclude China. There will be further cases, but the disease appears to be containable. Some nations, including poor ones, have been quick to isolate those infected and nip their outbreak in the bud. Even China, with nearly 80,000 recorded cases, appears to be winning its battle as the number of new infections falls. For the moment, we have confidence that other nations such as South Korea and Italy will take the steps necessary to isolate the disease. Sadly, we are less sure about Iran where the authorities have been in denial. The country's links to Afghanistan and Syria seem to leave a high probability that the virus will find a base in the Middle East (though the arrival of summer could stem the rate of infection). If established in the Middle East, outbreaks will continue to pop up around the world as a consequence. The human tr ...

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MRDA

I attended a presentation by a firm last week, considering asset allocation in a low yield environment. The firm in question is a US based quant shop (they style themselves as ‘systematic investors’), who employ some highly regarded market practitioners as well as banks of PhDs. They run a range of strategies including risk parity.

The presentation was elegantly crafted and engaging. Its central theme was that bonds still have a full role to play as diversifiers in balanced portfolios and that investors should continue to rely upon capital values to appreciate despite the paltry yields on offer. This argument is almost entirely reliant on the assumption that there is no lower bound to interest rates.

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Outlook December 2019

Recession risk remains heightened though the odds of one forming have dropped as the economic data shows signs of stabilising. The consumer is holding up and index of Leading Economic Indicators may be about to turn up as base effects kick in. PMIs remain soft, particularly in manufacturing but at least trajectory is less worrying. The yield curve has normalised but this provides no comfort – it always has done ahead of a US recession, which has typically lagged an inversion trough by12-18months. We can only wait with fingers crossed.

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Thoughts on Election Results

As you will be aware, the Conservative Party won the election by a large majority. Sterling has strengthened materially in the foreign exchange markets this morning and the UK stock market has risen. Investors are relieved that Corbyn and his Marxist agenda has been roundly rejected by the electorate. Markets also benefited from the overnight news that the US appears close to agreeing a 'phase one' trade agreement with China, stock markets in the Far East and in Europe have also risen this morning.

At last, the UK has a strong government with a clear mandate to get Brexit done. We expect the UK to leave the EU by 31st January, though the transitionary period will probably have to be extended beyond December 2020. We, and other investors, are now considering whether this brings sufficient certainty to justify lifting exposures to UK assets.

Trump Leaves a Foul Odour over the Korean Peninsular

I was saddened to hear the news over the weekend that the North Korean leadership had walked out of the nuclear programme talks. North Korean diplomats were left looking like statesmen in their press interview as they portrayed the US as being inflexible and not able to 'give up their old viewpoint and attitude'.

For those who have followed North Korean developments for years, the news is not a surprise. Throughout the period of 'friendship' between Trump and Jung Un Kim, North Korea has delivered nothing of worth. The "big" success was the Punggye-ri nuclear test site closure but there were indications that this decrepit base had already being scheduled for closure. Since when, the DPRK has continued with its missile testing programme, most recently, a successful launch from a submarine.

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Outlook September 2019

It is fair to say that it has been a strange summer. Greek government bond yields have traded below those of the US. Sterling has strengthened on the hopes of a Corbyn government. President Trump labels his own central banker as an enemy. The Brexit negotiations have transcended farce - as they say, even Baldrick had a plan. The British government would collapse if only the opposition would allow it. China has been labelled a currency manipulator by the US on concerns that a weak yuan gives it a trade advantage, yet the PBoC has been intervening to support its currency! If you are finding all this a bit baffling, join the club.

Economic conditions have been steadily deteriorating throughout the year and global manufacturers clearly face difficulties. Forecasts of 2019 global GDP growth have been pared back from 3.6% at beginning of the year to 3.2%. The trade war is a cause of the slowdown, although not the only one. The malaise seems to be deeper than this and may be centred on Chinese attempts to regain control of their money supply as they clamp down on their shadow banking system. Rumours of a cash shortage are emerging. Note that Chinese growth is not dependent on exports, over 70% of GDP growth alone comes from domestic consumption. US exports constitute only 4% of the economy. Tariffs are unhelpful for the Chinese, but are not the root cause of the slowdown.

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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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Outlook June 2019

Investors continue to fret about the growth outlook. The impact of the trade war is beginning to be felt and the recent escalation, caused by Trump's move to lift Chinese tariffs to 25%, compounds the issue. Even though economists predict that the economic effects of the dispute should be mild, the pain is appearing across important sectors of the S&P 500. While the first quarter US GDP print was strong at 3.2%, this may have been flattered by a low deflator reflecting the delayed response to the collapse in the oil price in Q4. Remember, the economy is still supposed to be benefitting from the effects of last year's stimulative package and this will soon start to wane. Some of the leading indicators such as the PMI/ISM have weakened (albeit from high levels) although consumer confidence remains buoyant.

Today's supply chains are complex and international, industrial businesses in places like Japan and Germany have felt the consequences of the US-China trade dispute. For instance, the German manufacturing PMI slumped to 44.1 in May, a fifth consecutive month that the index has indicated contraction. Global freight indices reflect this slowdown in trade.

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Looking Back at the Credit Crisis and the 1,2,3 Banking Model

I am in the process of transferring into the office some of my investment related books. Within the pile, I came across a couple of books which I had purposely set aside unread. Having worked at a bank during the credit crisis, I had little desire to revisit those traumatic days through Andrew Ross Sorkin's 'Too Big to Fail' and Greg Zuckerman's 'The Greatest Trade Ever'. Ten years on, I thought that I was finally composed enough to read them. Of the two, Sorkin's is the better, but Zuckerman's is a useful complement by describing the other side of the trade. Sorkin's book is a gripping read, but even now I found it as soothing as a Stephen King horror story and stressful to recount what happened.

I came away from the books with some interesting observations. The crisis was very slow moving in the early stages, many people recognised that something was seriously afoot but it took a long while for the storm to build up to its full force. Subsequent to the Bear Sterns/BNP hedge fund collapse in 2007, bids for sub-prime paper essentially evaporated. Yet prices remained high as no holders of the dodgy paper dared to sell. When the underlying fundamentals of illiquid assets change, it can take a long time to discover what the true price is. Especially when the counterparty with the power has a strong incentive to mask the news.

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