There must be some way out of here
July 5, 2019

Blain's Morning Porridge

"There must be some way out of here, said the joker to the thief..."

Oh, what a beautiful morning… It's a Friday in July, so I may as well have an off-the-wall rant! If you are stuck in the office, send me a mail and we can bemoan we're not working from home in the back garden!

I was reading a note yesterday that we're now into the second-longest expansion in global economic history. The recovery has been slow and steady, reflecting the new normal, longer-for-longer expectations of the post-2008 crisis. Aren't we the lucky ones? Despite the current geopolitical fears and global uncertainties our supportive central banks and diligent regulators are making sure we sleep soundly at night.. (Do I really have to say it? OK. US READERS: Sarcasm Alert)

It's also US payrolls day and June's number is expected to come in around 160K compared to the disappointing 75K in May. Don't matter what it is. Whatever the number is, it won't change much. The market expects, nay, the market demands, global easing! And if it doesn't get it, it's going to sulk almost as much as Donald Trump.

For the last few months it's become increasingly clear – at least to me – that central bankers have perfected some curious time/relativity thingy to completely split financial markets from the reality of the real-world economy. What's my evidence? None at all! Except the real world is apparently deflated, nervous and worried, while financial assets are partying like there is no tomorrow and prices are going through the roof.

Stocks are hitting new record levels. Why? It can't be because they expect lower rates for longer to massively stimulate the global economy, give wage rise to consumers to hike their disposable incomes, and therefore boost earnings. Can't be? For the last ten years that policy has been a stunning ‘didn't happen'. Stocks are heading higher either because investors foolishly expect doing the same thing will achieve different results, or more likely they expect lower for longer rates will continue to fuel corporate buybacks, thus pushing stocks higher. Forget last year's correction – it just proved there is more upside potential from ongoing financial distortion!

Bond yields are hitting new record lows. Speaking to one fund yesterday, they've just had a record year because they decided back in January that normalization couldn't happen, so they bought bonds, bunds and Italy and went short gilts. Why are bonds so high? Because everyone thinks the US Federal Reserve will ease, Christine Lagarde will do exactly as Draghi would do when she becomes European Central Bank President, and even sterling may ease. Why? Because the bond market thinks the world is such a miserable and economically weak place, or because the smart bond market knows central banks will keep easing to avoid a global stock conflagration?

Back here in the real world. How bad is it? Well…growth is not so bad, employment not so miserable (except in Europe), and I even read the happiness quotient of the UK is rising. Do we really need interest rates so low and causing all kinds of distortion?

Sure, it's not perfect. If I was a pessimist I would point to everyone fretting and worrying about trade wars, protectionism, currency manipulation, political impotence, falling real incomes, corporate lending and covenants lite, chronic illiquidity, micro bonds, the gig economy, personal and student debt, Brexit, a thousand and one other things, and Deutsche Bank…(actually no one worries about Deutsche Bank. That's a story that's almost done…a sad tale I shall relate during the dog days of summer of missed opportunities, management failure, regulatory overkill and the reality that Germans make great cars, but aren't such great bankers...) The reality is…we cope.

How bad would it be if the central banks don't ease, as the equity markets demand?

That would be just horrible – they say. The massively inflated asset bubbles in bonds and stocks would be exposed and pop if the Eagles ever stop playing Take it Easy. And the music will play on. Central banks are not going to let the bubble burst because a) that would shatter confidence in the recovery (what recovery?), b) would generate a tsunami of systemic risk, c) crush sentiment (and peeve Trump), and d) expose their failings in monetary policy since the crisis, while lifting the skirts on what regulators have done to weaken the global markets. Everyone would be left looking just a lot stupid!

What will happen if the central banks keep easing? Well that will be just magic! Stocks will keep going up and bonds will tighten till every single bond on the planet is in negative yield territory. Central banks will justify it, hoping against hope that inflation and real growth will rise to wipe away the bubble valuations. But we all know, long-term artificially juicing stocks through negative rates will be a very very bad thing if this distortion doesn't stop.

What's really happened over the past ten years is central banks printed lots and lots of money and pumped it into the financial system through quantitative easing. What happened to that money? Well, most of it stayed in the system, and has been invested in financial assets – NOT the real economy.

And that is where the money continues to reside – QE has inflated the value of all financial assets by boosting bond prices via dangerously low rates and converting equity into debt (thus pushing up equity prices through buybacks). And, of course, markets have spotted and coat-tailed the effect… meaning the banks and hedge funds and owners have received lots of dividends and bonuses while workers have seen wages fall and rights reduced in the new gig economy.

Long-term it is unsustainable. But why would the party ever end? Because no one is going to get paid a pension from negative yields to infinity. And politicians and voters notice the rich getting richer while western economies flatline as the financial party goes on and on and on. Resentment is a terrible thing to behold – parliaments and the palaces of corporate princes will burn fiercely.

So, there you are, the stark binary choice. Either:

Central Banks take the medicine now and steer the global economy back to normalization, which means a sharply corrective stock market crash followed by recovery, rising rates (and a bond market wobble). Five more years of pain! Then everything back to normal.

Or

They keep fuelling the bubble, till its negative infinity rates and financial inflation mean a single Tesla share is worth more than California. And the resentment is such the real world explodes and it all ends very badly. Loads more pain for longer.

Have a wonderful weekend.

Bill Blain

Shard Capital





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Blain's Morning Porridge

"There must be some way out of here, said the joker to the thief..."

Oh, what a beautiful morning… It's a Friday in July, so I may as well have an off-the-wall rant! If you are stuck in the office, send me a mail and we can bemoan we're not working from home in the back garden!

I was reading a note yesterday that we're now into the second-longest expansion in global economic history. The recovery has been slow and steady, reflecting the new normal, longer-for-longer expectations of the post-2008 crisis. Aren't we the lucky ones? Despite the current geopolitical fears and global uncertainties our supportive central banks and diligent regulators are making sure we sleep soundly at night.. (Do I really have to say it? OK. US READERS: Sarcasm Alert)

It's also US payrolls day and June's number is expected to come in around 160K compared to the disappointing 75K in May. Don't matter what it is. Whatever the number is, it won't change much. The market expects, nay, the market demands, global easing! And if it doesn't get it, it's going to sulk almost as much as Donald Trump.

For the last few months it's become increasingly clear – at least to me – that central bankers have perfected some curious time/relativity thingy to completely split financial markets from the reality of the real-world economy. What's my evidence? None at all! Except the real world is apparently deflated, nervous and worried, while financial assets are partying like there is no tomorrow and prices are going through the roof.

Stocks are hitting new record levels. Why? It can't be because they expect lower rates for longer to massively stimulate the global economy, give wage rise to consumers to hike their disposable incomes, and therefore boost earnings. Can't be? For the last ten years that policy has been a stunning ‘didn't happen'. Stocks are heading higher either because investors foolishly expect doing the same thing will achieve different results, or more likely they expect lower for longer rates will continue to fuel corporate buybacks, thus pushing stocks higher. Forget last year's correction – it just proved there is more upside potential from ongoing financial distortion!

Bond yields are hitting new record lows. Speaking to one fund yesterday, they've just had a record year because they decided back in January that normalization couldn't happen, so they bought bonds, bunds and Italy and went short gilts. Why are bonds so high? Because everyone thinks the US Federal Reserve will ease, Christine Lagarde will do exactly as Draghi would do when she becomes European Central Bank President, and even sterling may ease. Why? Because the bond market thinks the world is such a miserable and economically weak place, or because the smart bond market knows central banks will keep easing to avoid a global stock conflagration?

Back here in the real world. How bad is it? Well…growth is not so bad, employment not so miserable (except in Europe), and I even read the happiness quotient of the UK is rising. Do we really need interest rates so low and causing all kinds of distortion?

Sure, it's not perfect. If I was a pessimist I would point to everyone fretting and worrying about trade wars, protectionism, currency manipulation, political impotence, falling real incomes, corporate lending and covenants lite, chronic illiquidity, micro bonds, the gig economy, personal and student debt, Brexit, a thousand and one other things, and Deutsche Bank…(actually no one worries about Deutsche Bank. That's a story that's almost done…a sad tale I shall relate during the dog days of summer of missed opportunities, management failure, regulatory overkill and the reality that Germans make great cars, but aren't such great bankers...) The reality is…we cope.

How bad would it be if the central banks don't ease, as the equity markets demand?

That would be just horrible – they say. The massively inflated asset bubbles in bonds and stocks would be exposed and pop if the Eagles ever stop playing Take it Easy. And the music will play on. Central banks are not going to let the bubble burst because a) that would shatter confidence in the recovery (what recovery?), b) would generate a tsunami of systemic risk, c) crush sentiment (and peeve Trump), and d) expose their failings in monetary policy since the crisis, while lifting the skirts on what regulators have done to weaken the global markets. Everyone would be left looking just a lot stupid!

What will happen if the central banks keep easing? Well that will be just magic! Stocks will keep going up and bonds will tighten till every single bond on the planet is in negative yield territory. Central banks will justify it, hoping against hope that inflation and real growth will rise to wipe away the bubble valuations. But we all know, long-term artificially juicing stocks through negative rates will be a very very bad thing if this distortion doesn't stop.

What's really happened over the past ten years is central banks printed lots and lots of money and pumped it into the financial system through quantitative easing. What happened to that money? Well, most of it stayed in the system, and has been invested in financial assets – NOT the real economy.

And that is where the money continues to reside – QE has inflated the value of all financial assets by boosting bond prices via dangerously low rates and converting equity into debt (thus pushing up equity prices through buybacks). And, of course, markets have spotted and coat-tailed the effect… meaning the banks and hedge funds and owners have received lots of dividends and bonuses while workers have seen wages fall and rights reduced in the new gig economy.

Long-term it is unsustainable. But why would the party ever end? Because no one is going to get paid a pension from negative yields to infinity. And politicians and voters notice the rich getting richer while western economies flatline as the financial party goes on and on and on. Resentment is a terrible thing to behold – parliaments and the palaces of corporate princes will burn fiercely.

So, there you are, the stark binary choice. Either:

Central Banks take the medicine now and steer the global economy back to normalization, which means a sharply corrective stock market crash followed by recovery, rising rates (and a bond market wobble). Five more years of pain! Then everything back to normal.

Or

They keep fuelling the bubble, till its negative infinity rates and financial inflation mean a single Tesla share is worth more than California. And the resentment is such the real world explodes and it all ends very badly. Loads more pain for longer.

Have a wonderful weekend.

Bill Blain

Shard Capital



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