Tuesday, never the best day of the week from a momentum perspective, disappointed. Although in the middle of the US earnings season, stock market volumes were pitiful and most major indices ended within 1% of their respective Monday closes.
The Dow was up 0.14% and the S&P was down by 0.14% although the VIX, known for some reason as the “fear index”, was pushed through 12.00 to close at 11.97, its lowest since its slip down to 11.47 in September 2014.
The VIX –its full name is The Chicago Board Options Exchange Volatility Index – is supposed to reflect future volatility on the S&P but with all the geopolitical risk filling the ether, it is hard to get one’s head around what it’s doing at such low levels. Sure, the main indices are fiddling around in the vicinity of their all-time highs but it is not easy to see why trading at lofty levels should be reflected in a concomitant assumption that risk is low.
Meanwhile, I was rather touched yesterday when, among the unusually high number of responses to my column, I received the following from a gentleman who in 1987 sold out brokerage business of which he was a partner for what was then a silly amount of money and left the City. In a number of roles, the person in question had been instrumental in developing and defining the modern traded money markets as we know them today but who was happy to take his rewards and to ride off into the sunset, thus becoming a “private investor”. He wrote to me “When I see market distortions like this I expect that there will be an eventual denouement and a return to something like sanity. Is there any way out of this seemingly blind alley into which central banks are leading us without some sort of cataclysmic step function readjustment?”
Well, my friend, the snotty nosed equity geeks seem to be of the opinion that all is well in the garden and that the monetary authorities will continue to hand out free put options.
Tightening
I’m not sure whether The Wall Street Journal’s Jon Hilsenrath is the measure of all things but he comes about as close as anyone and he seems to reckon that Fed raising rates might be back on the agenda and that the September FOMC meeting is as good a time as any for Janet Yellen and her merry men to consider progressing with the nascent tightening cycle. Nascent tightening cycle? Since the Fed cut the funds rate to 0-0.25% on December 16 2008, we have had one, just one little wee tightening to the current 0.25-0.50% target range on December 16 last year. I know this exercise has been done before but, December aside, the last previous tightening took place in March 2006 when rates were raised to 5%.
What most people aren’t aware of is that said tightening to 5% was the last of 16, yes 16, consecutive 25 basis point rate rises that had begun on June 30 2004. During that same two-year period, 10-year yields rose only from around 4.60% to 5.20%. During that same period, the S&P rose from roughly 1,150 points to rightly 1,250 points and the VIX averaged 13.39. Comparable? Yes and no. No because Wall Street is now carrying much less leverage, yes because that leverage is now held on central bank balance sheets instead. The risk has not gone away, it is simply owned by somebody else and that somebody is the collective of central banks. Quis custodiet ipsos custodes?
The question which my retired friend is asking therefore is what happens when the central banks start to deleverage? The BoJ is already buying equities and I have heard the question asked with respect to the ECB when they might follow suit. They have already swept up the corporate bond market to an extent that is killing investors. Not only are underlying rates no longer visible with a magnifying glass – a microscope is probably called for – but they have caused a compression of credit spreads way through default probability adjusted values.
Strong ARM tactics
Knowing, however, that the price of an asset is wrong is usually not a particularly good line of defence. Wisdom has it that nobody has ever been fired for being long of a falling market but they have been for being short in a rising one. My niece who has about as much to do with finance as I do with ballet dancing wrote to me yesterday, highly excited that she and her husband owned stock in ARM Holdings. I don’t. Why would I? – It was already stupidly expensive before the Softbank bid. Whereas some suggest selling out on the basis that Softbank might suffer a shareholder revolt against the 43% premium (forget that myth), there are others who are trying to talk up the chances of Samsung joining the fray.
ARM only employed 4,064 people when it last reported on March 31 so the company’s assets, one could say, get in the lift at 5pm and go home. I well remember when Bank of America bought Montgomery Securities for a much more modest US$1.2bn. The day after the sale, the bulk of the key staff resigned and moved down the street to set up on their own. It was said at the time that Ken Lewis had paid US$1.2bn for 400 desks, 800 screens and a brass plaque. ARM may own a lot of IP but, given the speed of development, that will go stale pretty quickly if key people in the machine room leave. Under the new market abuse regulations I can of course now say no more without it being taken as investment advice but I’m sure that all the seasoned professional investors who read this column and who are CFA charter holders as well as having MBAs and PhDs from some of the world’s top institutions of higher education would A) not take my daily polemic as investment advice and B) even if they did, will still do what they think is right and for which they get paid some pretty chunky money.
I rarely agree with President Francois “Qui? Moi?” Hollande but I do when he said in Lisbon that “one can’t inflict sanctions on a country that has worked to improve its budget, its competitiveness” and that the eurozone needs “solidarity and hope”. Sol Capital is based in Portugal and as it happens I shall be popping out there for a few meetings on Monday and Tuesday. That little country’s potential is staggering. It might be a bit “garlic belt” and all that but it is extremely well positioned to significantly benefit from the fall of first North Africa and now Turkey as tourist destinations.
Given the legacy problems of sovereign over-indebtedness it still looks to be an uncertain investment – 10-year bonds are not trading at 310bp over Germany for fun – but the long term potential, at the right price, is certainly worth a second look.