InterestingLeigh – Oh, you should never, never doubt what nobody is sure about
Leigh Himsworth, head of UK equities at City Financial & manager of the City Financial UK Select Opportunities Fund
I thought I would begin with a quote from Willy Wonka given the release of a new play; for those living outside London, I’m talking theatre.
The magnitude of reversal since the market peak towards the end of May has been savage with markets losing nearly 9% to the end of June. The scale of sell-off in some overseas markets has reached bear market proportions. This for me, is worth dwelling on for a moment. Markets have had a nervous reaction to the possibility of a rise in bond yields, this time only caused by the US merely mentioning turning off the monetary tap! Given the scale of excess liquidity in the system, not loaned out through QE, we will undoubtedly face many more such scares en route to ‘normalisation’. This path will be bloody, and it is worth noting that few economists or academics have written about the mechanics of reversing QE. My own view is that bond yields have to rise markedly or inflation will rise markedly — neither prospect is particularly appealing. In the near term, this has created one of those perverse times in investment circles where good news is bad and bad is good! That’s a Willy Wonka phrase if ever there was one.
I have unashamedly pinched a comment from one of the more intelligent strategists at Peel Hunt, who I think has hit the nail on the head with:
‘We are less confident that screening for "stocks that do well when bond yields are rising" is the right approach. Those higher yields are a 'normalisation' as the extraordinary support from central banks is being wound down, rather than a precursor of growth. From an asset allocation standpoint, we have to acknowledge that an argument in favour of equities that rested heavily on a relative yield comparison to government bonds is severely weakened when those bonds (in the case of gilts) are yielding almost 100bp more than they were at the start of May. Expect to hear less of the 'great rotation' thesis until some calm is restored.’
I fear that there is growing panic in monetary circles as the folks in the driving seat have realised they only have forward gears. It has taken three massive bites at QE to stabilise the bond market over five years, can we honestly believe that the return to normality can be so easy? As an interpretation of the words of a statement have caused such a reaction, can we believe that the authorities are in control of: the end of QE, recovery in the economy, currency moves and inflation?
As I have attempted to point out a number of times before in these pages, monetary policy is a very blunt tool. Exhibit 3, below shows the scale of rise in the US monetary base that has actually seen a reduction in the level of credit over the past few years — yes there is supply but there is NO DEMAND!
The chart above, exhibit 2, I find quite almost frightening on the basis that this shows how much excess is in the banking system that will need to be removed if we actually see loan demand return and the multiplier effect kick off.
In such times of flux where investors are unclear how to react to economic news, there is a risk that investors fall into the trap of becoming speculators rather than investors, attempting to second guess the news and other investors’ reaction. It is vital in such times that we have the ability to stand back and take stock of the underlying picture and invest as much as possible based on fact and focus on what is identifiable — good companies with sensible business plans with forecasts based on a tough outlook!
A little nonsense now and then is relished by the wisest men (Willy Wonka)