2017 is the 180th anniversary of the publication of Hans Christian Andersen’s short story “The Emperor’s New Clothes”. For those not familiar with the tale, it is the story of how two conmen convinced an Emperor to part with money for nothing – by creating a scheme whereby those who challenged prevailing wisdom were made to seem stupid. Ultimately the scheme unravelled when an innocent, a small child, laughed at the stupidity of the situation.
My problem – I’ve borrowed a bit of money and can’t really afford to repay it, so in a giant Ponzi scheme that would make Bernie Madoff blush I’m going to get people to give me more at ridiculously low levels, such low rates of interest in fact I really don’t need to worry about how much money I get.
My clever scheme – the economy is in a mess and I can sell you something that is guaranteed to make you a tiny amount of money. I know the data suggests things are actually as good as they have been for 20 years, but we all know “experts” and “facts” are so 20th century. Trust me, I can make you rich.
German 10-year bonds yield 0.25%.
German (nominal) growth is around 3.5%.
You can lend money to Germany and get 0.25% back each year.
Germany makes 3.5%.
Do that for 10 years: you get around 3% total return, Germany over 40% (did someone mention compounding?).
Now replace Germany with the UK, US (to a lesser extent) and even Japan.
But are Mark, Janet and Mario the Emperors, the conmen or the children?
Hey, if you want to buy the beta of the bond market – if you want that return-free risk – go ahead. Who am I to stop you?
One final thing to note: 2017 is the 176th anniversary of the publication of Charles Mackay’s seminal work – “Popular Delusions and the Madness of Crowds”.
Once upon a time there was a little red duck called Jeremy. He was shunned by the other ducklings on the pond who were a nice shade of light red, almost pink, unlike the strong scarlet of Jeremy’s plumage. But it wasn’t just the colour. The other ducklings – Tony, David, Ed and even that nice little Gordon – just couldn’t quite understand him; perhaps it was the accent, or perhaps the product of a poor education system? At times he seemed to be speaking a language foreign to theirs!
One day after years of teasing Jeremy, the gang woke up and found that he had grown into a rather attractive swan! They looked in astonishment at Jeremy swimming serenely along. And not only was he calm above the water, he no longer seemed to need to paddle furiously beneath the surface either.
But suddenly – to the amazement of all in view – up from behind the bushes (where she had been sharing a moment of quiet contemplation with her bestie Phil) leapt farmer Liz.
Without a moment’s hesitation she emptied both barrels of her shotgun (always kept loaded; oh how she longed for those days when foxes were fair game) straight into poor Jeremy. Red feathers everywhere.
“What the deuce did you do that for old gel?” asked Phil.
“Well” replied Liz, “My swans are supposed to be white. I saw a black one once – a portent of doom – and did nothing about it.”
“What happened?” Phil quizzed.
“There was a terrible storm about ten years ago. My house nearly fell down (in truth I couldn’t afford the mortgage but the nice man at the bank, Mervyn or Eddie I can’t remember which one, had told me not to worry about it) and half my money was washed away in the flood.”
With that, Liz turned on her heel and walked quickly back to her modest country abode. At her heels was her ever-faithful dog, Theresa, with a smile on her face (if indeed Corgis could smile).
Little did Theresa know that Liz had long had a hankering for something bigger, perhaps with a shaggier coat. Indeed, that very morning she’d been to the pet shop in Windsor and had started to look kindly on a golden Labrador answering to the name of Boris. He’d been a bit noisy, but in truth Liz worried his bark was worse than his bite. Still, if she ever needed a guard dog to ward off any more red swans, surely to goodness he’d be more use than Theresa?
A quiet weekend for me – my usual taxi-driving services not required. My 17-year-old son took himself off round a series of Universities, ostensibly checking them out ahead of deciding where to study next year. I note the perfect correlation between institutions on his list and places where he already has friends or relatives studying. No mug he – a week of free accommodation leaving the entertainment kitty fully stocked. I say ostensibly, for he long ago was offered and accepted a place for next year.
Having had time for reflection then, I remain irked by comments from the Bank of England and its Governor. Reading through the statement in detail, I share the incredulity of former MPC member Andrew Sentance at the focus on downside risks to the economy and indeed the apparent failure of the committee to model for all but the most benign Brexit scenarios. As a result the market is assuming no rate hikes until 2019 IRRESPECTIVE of economics. Paraphrasing the Pythons: other than inflation above target, growth around trend, a near 20% fall in the exchange rate boosting exports and tax receipts, stock prices at record highs, booming trading partners, record low unemployment, and an embargo on foreign workers likely to jack up average earnings, what have Brexit and record low interest rates done for us? Oh that’s right: renewed concerns at consumer indebtedness and a return to record house prices. And the Bank, along with most central banks, now admits to being worried at the level of consumer debt. A strange response this! ‘We are worried consumers are borrowing too much money, perhaps raising rates a little might curb that trend, but goodness me that might lead to a reduction in consumption and some defaults’. Now, when did I last hear that? 2008 I think. And that ended well…
Do you buy an alcoholic a bottle of whisky today so that he can avoid a hangover tomorrow, in the knowledge he’s more likely to contract cirrhosis in a couple of years’ time?
I have just wandered to my nearest Starbucks for the bargain that was its “tall, black, filter coffee”. As others have paid £4 for their daily dose of vanilla-spiced, grande, half-fat frozen frappuccino, that august American tax-paying institution has been charging me the princely sum of £1 for real coffee. Indeed, this was actually 38p cheaper than the equivalent in my employer’s “subsidised” canteen.
Well as of 7am this morning that all changed. £1.25! 25% overnight inflation. The Scot in me is still wrestling with the conundrum – is the 13p residual saving versus a short trip to my canteen worth the shoe leather?
I wonder if Mr Carney and the rest of the MPC take their coffee black and, had they visited Starbucks this morning, would their monetary policy decision yesterday have been the same?
Like many people I am confused; not necessarily at the MPC rates decision, more with the accompanying rhetoric. Apparently the main reason for not raising rates was because UK consumers would face a squeeze this year from the impact of higher inflation, all of which was attributed to a weaker sterling. Eh, you’ve lost me there chief – the MPC cut rates post BREXIT in part to push the currency LOWER so that the impact of a weaker sterling would OFFSET some of the uncertainties of leaving the EU. If Carney is really worried about the squeeze on household income, firstly in part this is a situation HE created and secondly, by RAISING rates he could help reverse it.
Let’s be honest here. Central banks globally have expanded their balance sheets to nearly $18trillion in the past decade. That’s greater than US GDP. They have created the mother of all asset bubbles across most financial asset classes and now are sh*t-scared of unwinding. That and the ongoing need to fund ever-larger government deficits means they seek ANY excuse to keep rates as low as possible for as long as possible. Meanwhile, financial assets move ever-higher, the day of reckoning pushed further into the future, but likely to be all the more painful when it does arrive. Then again Carney, Draghi and Yellen can continue to manipulate markets longer than I care to work for. Good luck timing your exit.
“Markets are highly correlated with historically low volatility. Central bank activity has created a “goldilocks scenario” where investors treat bad news as good and good news as excellent. As a result of low cost of debt, markets have been propelled to record highs. Investment grade spreads are well below historic norms, high yield defaults seem remote and Emerging Markets appear immune to historic cyclical patterns. Equity investors talk about re-ratings and multiple expansion as discount rates seem set to remain low; for most, it is not about whether to take risk or not, rather about how much risk to take!”
I didn’t write that today. I wrote it in a note to clients in 2006. At the time I was being urged to add more risk across my portfolio range. I resisted until the bail out of Bear Stearns (if you are under 25 you probably won’t remember that), which gave all of us a green light, that the US authorities would stand behind their financial institutions. And then: Lehman.
But everything is rosy, we have had 10 years of rising prices in financial assets and in the US at least regulation is (for now) much tighter. What could possibly go wrong? The Fed and ECB will each fail to tighten for a while yet, surely?
Why not ask yourself, with rising inflation, decent growth and near full employment would a Fed Chair steeped in 2007 events REALLY allow the economy to run THAT hot?
Sometimes it is right to sell everything. Just as ALL assets have risen in value since the advent of QE, so too can they fall together. Especially as monetary policy tightens.
My key thought for the rest of 2017 – “Markets are highly correlated with historically low volatility……heed the lessons of the past.”
PS: S&P 500 topped out in 2007 at 1576. Currently 2368, a nice 50% ABOVE the global financial crisis. I am often told equities climb a wall of worry. That wall must be pretty high, because they’ve been climbing it almost without a break for eight years.