Depending on where you were coming from, Friday’s sharp rebound in risk asset prices served to prove either the underlying health of markets or, if you wanted, the very opposite. Dead-cat bounce or re-evaluation?
I shall stick my neck out and suggest the latter. Yes, I think the worst of the wobble is over. That does not mean that prices and valuations might not fall further but I do suspect that whatever does happen will do so in a more measured fashion. What my own social conversations over the weekend and the press have in common is the observation that, investment-wise, alternatives are hard to find.
Bonds are rich. So is credit. Equities valuations are, in absolute terms, stretched. Real estate has had a good rally but it has the Chinese property bubble breathing down its neck. Commodities look like the proverbial falling knife. Gold is both volatile and going nowhere in a hurry. Cash pays no return and in some cases even less than that. The monetary authorities are warning us not to get too excited too soon about growth and now the IMF has put the icing on that particular cake. In other words, there is a severe lack in the choice of alternatives so the easiest way out is to return to the existing model, irrespective. A flawed model is better than no model at all.
Was it not Warren Buffett who coined the phrase that it is better to be approximately right than precisely wrong. Thus the bottom fishers were out on Friday and, driven by fear of getting caught short, the mainstream hopped into the pond too and almost all risk asset markets rallied around them on fairly grown-up volumes. Please don’t get me wrong; the Dax is still 950 points down on the month which is about 9½% and the S&P is off by 125 points which is closer to 6½% but this is still all very much within the realm of being a healthy retracement. The Dax has returned something in the region 8½% annually over the past five years which a chunky number by anybody’s standards, not least of all with the average 10-year Bund yield over the same period having been no more than 2.07%.
There are plenty of calculations which prove that the total return on bonds outstrips that of equities but the measure is fatuous. As there is no fixed methodology for either capital or coupon reinvestment, anything can be proven for bond returns. Yield to maturity has always been a myth as the algorithm assumes that coupons can be invested at the initial rate. So if 10-year rates are say 4% at the date of purchase, then the nine-year rate has to be 4% in a year’s time and the eight-year rate 4% a year on and so on and so forth until the 9th coupon is paid and reinvested at 4% for a year.
Dream on! Not only that but with minimum increments now often set at 100,000+1, the minimum initial investment would need to be 5,000,000 of whatever currency in order to receive a coupon payment of 100,000 units which can be reinvested in the market. Now try the same on a bond with 1¼% coupon.
Is this a case of investor protection or is it screwing the little guy who can only invest in bonds by paying fees to mutual funds? He can punt around in unpronounceable tech IPOs until the cows come home while frittering away his kids’ inheritance but he can’t buy a piece of Deutsche Bank’s 4/19 senior unsecured floating rate note which only comes in €100,000 units. Ummm? Can anyone explain that logic to me please? Equities = risk; bonds = safe. I digress.
By now we should have all worked out that the risks to growth are the same this week as they were last week and that those are the same as they were the week before. Hence, the key US release this week, in my mind, is on Wednesday when we get the rather unheralded US Manufacturing PMI. So far there is little that indicates that the US is slowing to any significant extent, other than maybe by way of the shockingly poor Empire State Manufacturing Survey of last week, and one outlier a recession doth not make. However, the risks of China exporting deflation are on the increase and with that even I with my strong views on when rates should be going up have to concede that the Fed’s slated tightening might not happen in March or April and might well need to be priced for June instead.
Finally, on the warnings uttered by Jose Manuel Barroso to David “Call me Dave” Cameron over the weekend with respect to British membership of the EU. Had the former been watching and listening to the latter during the totally screwed up Scottish referendum debate, he might have grasped that sometimes discretion is the greater part of valour. He, along with his cohorts, would do better to hail the putative referendum as a laudable exercise in democracy and in doing so make the sceptics feel more comfortable within the European structure. He is certainly right that many of the terms of reference used in the UK are far from the mark but loudly honking about it isn’t going to make it better. A propos referenda; I trust the Scots have noted that the price of Brent has dropped by an ⅛ since the referendum a month ago. I wonder whether the new SNP First Minister in waiting, Nicola Sturgeon, will be blaming that on one of those Anglo-centric Westminster conspiracies?
