Across Europe this morning market players will be chewing their fingernails in anticipation of what the ECB president Mario Draghi the patron saint of risk asset buyers, will have to say in his post-ECB Governing Council meeting press briefing.
Let’s start by blithely assuming that there will be no immediate change to monetary policy at the headline level and as far as markets are concerned - that’s a given.
The big guessing game is all about future policy, about the gradual withdrawal of physical stimulus but most of all about the timing. At the ECB conference at Sintra, Portugal on June 27, Draghi threw the markets a curve ball in giving absolute proof that there is no such thing as a one-handed economist. It was Theodore Roosevelt to whom the line is ascribed that one should speak softly and carry a big stick and that is what St Mario likes to do. His rhetoric of “We can’t tell you exactly what we’ll do and we most certainly won’t tell you when we’ll do it but we will do something and we’ll do it in the future” isn’t really of much help. He is painting the dots and the markets are doing the joining up.
The best line that I read on the subject came from a paper published by Nordea immediately after the Sintra speech. “We expect the gradual adjustments in Draghi’s communication to continue next week….” We’re no longer talking about adjustments to monetary policy but to the language used by Sr Draghi. Do I get the feeling that all of our PhDs, our CFAs and MBAs have forgotten how to see the forest for trees? The path taken by US asset prices since the Fed first began to wind down the asset purchase programme serve as living proof that they need not go into meltdown the moment the first signs of stimulus withdrawal appear on the docket.
In fact, were one to look at stock and bond price charts and were one to try to pinpoint where on the chart the Fed’s tightening decision is reflected, I suspect that all we would all draw blanks. Asset price dynamics and Fed monetary policy seem to be nigh-on totally divorced from one another. The yield on the 2-year note bottomed in May 2013 at 0.20%; since then, with a few disruptions, it has pretty consistently been on the rise. The longer term trend channel would have fair value at 1.20% and not 1.36% although the 2-year yield did break out of the channel just after the November elections and it has since then not re-entered. A new rising channel has been established that runs parallel to the old one, just with its lower band taking over from the previous higher band.
European traders and investors would do well to look at this and to assume that the response of markets here will be very similar. In other words, forget wasting the afternoon trying to weigh what Draghi has to say today against what he said at Sintra – words are cheap - and trade the markets on their merits. At the time of the “taper tantrum” in May 2013, the Dow was trading at just below 15,500. Last night it closed at 21,640.75, up over 40% or with an annualised return of 8.50%. At the same time 10-year Treasuries were at 1.93%. Today, over four years on and four 25bp tightening moves later they are at 2.26%.
As I have observed repeatedly over the years, investment managers are paid to get the markets right and not the economics.
Back-flipping
Draghi’s rhetorical gymnastics might be as cryptic as the predictions of the Oracle of Delphi but we have to, pardon the terminology, cut through the crap and use our own brains to work out where markets are going and why. Bunds are now at 0.55% so unless one has been trading in and out of them while getting all of the entry and exit points right, they have been a negative total return investment this year. On January 1, that was as predictable as night follows day and yet folks are buying them. Sod benchmarks and indices – who can justify his or her existence by buying into investments which one knows are going to do nothing but lose money?
The FT ran an elaborate article this morning titled “Seven charts that show how the developed world is losing its edge”. A nice piece and well worth a read but it fails, in my opinion, to capture the most important and also the most toxic of weaknesses, namely the belief that everyone can benefit from the upside while nobody is exposed when it goes the opposite way. Benchmarking may protect the poor, hard done-by asset managers from the vagaries of market direction but the pensioners, the widows and the orphans still lose their money when it’s invested in assets that are going down. I digress.
Anybody who expects Draghi to give away any more than a vague “sometime in the future we will be withdrawing stimulus” is probably smoking something. The weighing up of every word he says and in which order has gone beyond being a sport and does the markets no credit.
Trading places
Meanwhile the Sino-American negotiations on rebalancing the trade deficit have ended – for the while at least – in failure. It’s not easy to redress the balance when one country makes things the other one wants to and needs to buy but not the other way around. I still think the best example of the Yanks not getting it was in the late 1980s when Washington took on Tokyo over the imbalance in the car trade. The fact that Detroit neither made many cars which would fit onto the much narrower Japanese roads nor produced anything in right-hand drive appeared to have escaped them. The key to export success is to produce something that is cheaper or better or, ideally, both. It must also be something that is geared to the market into which it is being exported and without simply assuming that because it’s popular at home that the rest of the world will love it too.
Much of the focus will have been on chicken and beef but as we know from the abortive TTIP debate, American standards with respect to stuffing their animals full of pharmaceuticals are different and not to everyone’s liking. What did I just say about adapting to the export markets? The steel issue is very different and the application of anti-dumping sanctions is more than overdue. The Chinese economy might appear to be a rolling behemoth but there are some very delicate socio-political balancing acts that the Beijing government has to execute. Europe and the US both know from their own bitter experience with the volume car industry just how hard it is to take out overcapacity and the Chinese face similar problems. I spent the larger part of my last 25 years in the City working for American banks and I have a few stories to tell on just how little most of my US-based colleagues either understood or wanted to understand the way that people in other countries tick.
Then, right in the middle of all this, the drip-drip of Russia and its role in the 2016 elections rears its ugly head again. Is the New York Times on the way to becoming to Trump what the Washington Post was to Nixon, or is this a storm in a teacup stirred up by a cabal of journalists who feel their moral powers have been undermined by the Twitterati? I have friends on both sides of that debate and shall reserve judgment.
So index closing records are closing at about the same rate as articles are now appearing telling us that there’s no asset price bubble. I believe there is something resembling an asset price bubble developing but I still don’t think it’s about to burst. Stay long. The key will not be how high the markets are when it bursts but how far they will fall when it does. Now there’s something to exercise the mind while the kids are at summer camp.