I was talking to a private client stockbroker friend of mine a few days ago who was very busy writing the year-end performance reviews for his clients. We exchanged a few pleasantries about how one can’t ever get all the calls right although his portfolio of high-net-worth individuals is replete with clients who seem to struggle to grasp that single fact.
He did, however, tell me of one of his bods who insists that the annual review should skip reports on the things they got right and focus simply on the ones that went wrong. That might make sense in the relationship between the two but if, perchance, an innocent third party were to pick up and browse the report, he or she would have to conclude that my broker friend is totally incompetent and a born loser.
I make this point as we are in what seems to be a pretty persistent and seemingly resilient bull market but one that is fraught with risks. If I say “stay long”, I risk sounding like a two-bit penny stock jockey who could have been working for Jordan Belfort. If, on the other hand, I highlight all the clouds that are gathering on the horizon and which might or might not develop into a storm, then I immediately get accused of being Dr. Doom. The fact is that markets are a complex place peppered with landmines. Knowing where they are and how powerful they may be does not mean that we are going to tread on them. People who understand the fundamentals of structured credit will be able to confirm that slicing and dicing the risks does not make it go away, it simply reconfigures them in slightly less random fashion.
Although I feel quite confident that the risks to markets are currently contained, there are still plenty of issues which, if aligned, could cause trouble to investors. As President O’Bama enters the last 10 days of his White House tenure, the news channels are surely preparing their retrospectives. Had it not been for him, the Detroit Motor Show might have been taking place without the presence of Chrysler and most certainly without General Motors. Who can forget the shrill screams from the Republican right that he was turning America into a socialist country when he intervened to bail out the carcos? President-elect Trump might be out there parading as the champion of the Michigan autoworker but without O’Bama there would have been little for him to champion. The more liberal press will proudly point to the 14m jobs that have been created since Barry took over in 2009 while the less supportive side of the fifth estate will focus on the doubling of the national debt to US$20trn in just eight years of O’Bama. Do we love the 14m jobs more than we hate the US$10trn of extra debt?
Do markets go up because they are focusing on the good news or do markets focus on the good news because they are going up? The same, of course, applies in the other direction but with bad news. If we knew, we’d probably find that the answer to the question about life, the universe and everything is not necessarily 42. Sticking with the downside risk for a moment, we might be able to find a single item that triggers a market to go lower but we will never know in advance what it takes to launch the sort of chain reaction which dumped stock by 20% in two days as happened 30 years ago next September.
There is an old chartists’ wisdom that every key price level needs to have been tested three times for it to be verified. The 20,000-point Dow has yet to be tested once and yet there are voices already being heard that treat its repeated failure to reach that level at all as an evil omen. They are out there studying stool, reading tea leaves and observing flocks of birds in the vain hope that they might find out why we haven’t got there yet and are already casting runes to see if the 20,000-point Dow is going to remain as elusive as the 40,000-point Nikkei did in 1990. The “wall of cash” argument, which had driven the Nikkei to follow Daedalus and Icarus, especially Icarus, needs to be revisited. I generally belong to the crowd that argues that stock prices are supported by the lack of alternatives and that, just before the beginning of the US corporate reporting season, might yet transpire to be the wall of cash equivalent.
And then there was this morning’s Chinese December PPI release. At 5.5% it blew the consensus forecast of 4.6% out of the water and towered above the 3.3% in November. This morning the media were all over the shock increase, howling that the end of the world was nigh as all those bits we import from China – which seems to be pretty much everything other than cars – is going to shoot up in price. To quote the classic British comedy duo Morecambe and Wise “So what do you think of that?” “Rubbish!”. What is lost on the commodity import swings on the back of the rising dollar and falling yuan will be gained on the export roundabouts on the back of, you’ve got it, the rising dollar and falling yuan. What counts is the domestic inflation element affecting the value added, which is contributed within China itself and that, given the below consensus CPI number of 2.1%, is not a huge problem. Chinese equity markets seem utterly unperturbed and, in my humble opinion, quite rightly so.
Meanwhile, and very quietly, US 10-years have crept back from their post-FOMC raising of the Fed Funds target by 25bp in December level of 2.60% to 2.38%, having traded to an intra-day low of 2.33% in the aftermath of the payrolls report on Friday. This does not look like a world scared of catching the falling knife and probably flatters to deceive. The current spread between three-month T-bills and the 10-year note is 187bp, which is more or less in line with the long-term value. If the Fed tightens three or even four times this year by 25bp, then bonds still have a way to go themselves. Was it Goldman Sachs that pinned a 3% yield target on the 10-year for year end? Well, you don’t need to be a brain surgeon to come up with that forecast. A yield increase from here to there would wipe roughly 6 points off the price of a 10-year security that yields 2.38% - spot the built-in negative total return? Why would I want to own any of them? I own them not because I like them but because my investment brief won’t let me diverge further than X from my benchmark. That’s where owning something I hate is still rated as less risky than not owning it.
And it is that kind of warped thinking that will protect us from another 1987. Then it was the trading books that absorbed all the selling. A few years later it was the very retail buyers who had been skinned in 1987 who learnt to buy when the institutions were panicking. Now it is the algorithms that kick in when things suddenly trade out of line.
Economics and market dynamics have never been further apart but most of us won’t know when they have fallen in back line until it’s too late. The best we can do is to stay on the ball and to endeavour not to be part of the “most of us”.