There was a bucket load of red on the screens yesterday with the Dow taking a 200-point hit and all other major global equity markets closing on weakness. The trigger was most probably a shocking opening to the third-quarter reporting season which, in line with tradition, was kicked off by aluminium smelter Alcoa.
Alcoa’s figures weren’t at all special with a decline in both top and bottom line earnings, not what was needed by markets that were already unsure of themselves. The prospect of impending Fed tightening, of a shift to the “left” in the November Congressional elections, gently rising energy prices and now ropy earnings in a basic industry and, once again, the impact of Brexit seemed to have most markets rattled.
Although not the number one market topic yet, there are the first voices wondering whether this is where the game begins to change. Bond markets have, for the best part of 30 years, been more or less bullet proof and one of the drivers behind investment returns. I still shudder when I hear people talk about the fantastic performance of bond markets this year although I can see little merit in being long Italy for 50 years at 2.8% or even Uncle Sam at 2.50% for 30 years. It would take a lot of price appreciation to make these things look attractive and the moment the prospect of price support to back the paltry coupon income fades away, the case for bonds collapses pretty quickly.
Ten-year Bunds, now back in positive yield territory again, are nevertheless only paying 0.047%. It only takes Mario Draghi, or maybe Vladimir “Put me in” Putin to sneeze for total return to flip into negative territory. Equity pricing is also, as we have all acknowledged, held up by monetary policy and not a lot else. Now we get the shock of Alcoa’s numbers and markets suddenly look around themselves and panic about whether they are where they ought to be.
It’s astonishing how quickly sentiment can turn but it is understandable. That said, a few good corporate earnings reports over the coming days and all will be forgiven. In fact the markets remind me of the American election campaign. In the same way that many voters can’t decide which of the candidates they dislike least, so investors have to decide whether they feel more or less uncomfortable being long than they feel uncomfortable being short. Their problem is that with yields so low and dealing costs potentially chewing up a large part of their top-line returns, sitting on one’s hands and hoping for the best looks like a very attractive investment strategy.
Control
For a very long time this column has questioned the long-term sustainability of ZIRP and NIRP and the negative impact it has had on the political class’s propensity to take hard but necessary decisions. Not so many years ago the QE king, St. Mario, was roundly against using the ECB’s balance sheet to bail out prevaricating politicians. In the event they prevaricated and procrastinated long enough for Draghi to find himself holding the last ace. That has now been played while the reality that one cannot expand an economy at the same time as rebalancing fiscal flows has not gone away. Fiscal debt by a thousand cuts with all the monetary sticking plasters used up?
Yes, there is a lot of fear out there. Not the panic-button-pushing kind of fear but that of a pervading sense of nobody really being in control any longer. Maybe nobody ever was in control but the majority of us believed that somebody was – think back to the Greenspan days when he was seen as the most powerful man in the world – and that was enough to inspire confidence. That confidence is rattled. Sure, the sun still rises in the east and people go to work every day to make and sell things that others buy and consume but there is, or so it appears to me, a feeling abroad that none of this is following a master plan any longer and markets that lack confidence in what they are about are very dangerous places to be.
Ten-year US Treasury yields are now back to 1.77%, that’s just under 20bp higher than they were at the beginning of October but still, to put this in context, the best part of 30bp lower than they were this time last year and about the same below their five-year average. In other words, there is a long way for them to rise before we can talk of unusually high yields or low bond prices. On the other hand, there is also plenty of room before overall year-to-date bond returns go negative.
Meanwhile, I was asked over dinner last night whether it might be time to strap on some cheap sterling. There has been a bit of stability in the currency overnight but even dead cats bounce if they’re dropped from high enough. At this stage in the game I can see no reason why anybody would want to trade the pound from the long side.
That said, jumping all over Theresa “Kitten Heel” May’s talk of “hard Brexit” and all that jazz is, in my humble opinion, utter madness. Firstly, Article 50 hasn’t even been triggered yet and although there is plenty of paddling going on below the surface, all that is going on is pre-fight posturing. Does anybody really expect her to reveal her aims and objectives before the negotiations have even begun? I thought our industry is supposed to be populated by people of superior intelligence and, hopefully, an ability to distinguish between rhetoric and reality. Has anybody out there ever sat through an investor presentation that displayed anything other than a rosy outcome? Do me a favour!
I suspect most of yesterday’s wobbles will fade today but if they don’t and the selling goes on it might be time to look at putting on a few hedges.