Despite headlines about US bond yields, William Bourne, albeit reluctantly, is staying ‘risk on’​

Investors have begun 2018 much as 2017 ended – with a high appetite for risk (call that complacency if you will) and a willingness to ignore politics in the hunt for return of any kind.  Hence arises the conundrum we have regularly referred to – ie. that market volatility remains stubbornly low while political risk appears to be high.     Global liquidity at end December, as measured by our colleagues at CrossBorder, was 51 on a scale of 100.  This provides some justification since it is not at a level which predicts any kind of financial crisis.  However, when there is a consensus, one has to ask the question: what could possibly go wrong? Well, there are the obvious geo-political risks but they would have to be of a cataclysmic scale to burst investors’ complacency.  In the Linchpin view of the world, all market setbacks involve some form of financial crisis where one entity can’t pay its debts to another.  Think back to the UK in the 1970s, Latin America in the 1980s, Russia in 1998, Enron in 2002 or banks in 2008.  We can only see a few plausible candidates here, principally in the US and China. Today’s headlines feature a technical break of the US two year bond yield downward trendline, with comments that they are for, the first time in ten years, close to 2008 levels.  If this does signal an end of the bull market in bonds and a normalisation of the ‘price’ of money, that has the potential to impact investor complacency, simply because of the level of debt in the western economy.    Investors should also keep an eye on the US$ since cross-border flows out of the US are accelerating.  If currency weakness is gentle, investor confidence will probably be maintained; however a sudden lurch could be sufficient (as in 1987) to burst confidence, and lead to a further rise in bond yields and downward repricing of equities. China is another possible candidate, though the level of state control in the financial system means that any financial crisis would be the result of deliberate state intervention rather than market forces.  We are more optimistic about China than the consensus in the short term but are also aware that at some point the People’s Bank of China will need to turn off the monetary taps, as it did in 2015, to control excessive domestic credit growth.  This is not a 2018 story but if it is done in a clumsy way, so that there are major defaults, the domino effect may take over. All that said, despite the jitters in US bond markets, we are not predicting an imminent correction, simply because the gross level of cross-border flows remains healthy (currently 66 on a scale of 1 to 100) at the end of December.  It is when they turn sharply down that we should be afraid.  So we will be watching them closely in 2018 and until then will retain a reluctant ‘risk-on’ mindset. Information on how to purchase CrossBorder's research can be found here.​


At Linchpin we have for a number of years written an annual update on the long term outlook for inflation by monitoring shifts in a varied range of inflation indicators.  12 months ago, we suggested that after many years with deflation firmly in charge, the forces pulling each direction were roughly equal.  Today the consensus seems to have tipped towards inflation: we would agree that inflation is inevitably on the rise but argue that the global level will stay low for a few years yet.  Click here to read the full update.

William Bourne attends 22nd LAPF Annual Conference

On 6th to 8th December 2017, William attended the 22nd LAPF Annual Conference in Bournemouth.

William Bourne comments in Room 151 article on London civ global infrastructure initiative and brexit risk

To read more please visit Room 151.

The end of austerity - but not yet?

The Chancellor’s budget has a clear theme of extra spending.  I was waiting until the end for the hammer-blow of more taxation somewhere to make up for all the goodies but it never came.  As it happens, I believe his approach is the right thing to do when gilt yields are so low, but I do note from the Treasury’s detailed documents that the fiscal loosening doesn’t really kick in till 2019-20 and there’s actually a small fiscal tightening compared to March 2017’s forecasts in the next two years.   It will all be very convenient if this Government lasts the full five years but could backfire if it falls after, say, two. I’d applaud a number of the micro measures the Chancellor is proposing: to allow councils to charge 100% premium on the council tax for unoccupied properties and to remove the transitional arrangements for taxing carried interest (designed to ensure that tax is paid on the full economic benefit of a partnership’s activities) immediately, to take two tiny examples.  As always, however, the Budget is long on headlines and I am cynical about how much of them will really make it into legislation, particularly given the weakness of this Government. I will highlight a couple of the details I found interesting: he is making £1bn available for local authorities to finance local infrastructure at a rate of Gilts +60bps.  I wish he would make more use of this - effectively allowing them to borrow.  On the other hand, there is a mention of a new long term strategy for the asset management industry, ensuring it continues to ‘thrive and deliver the best possible outcome for investors and the UK economy.’  That could be taken as code for making them pay for some of the infrastructure improvements he wants to bring about. All in all, I would give the Budget a thumbs-up, though with the caveat that all these detailed measures may never happen.  Ending austerity must be the right thing to do, with the BREXIT risk looming, and the Chancellor was absolutely right to talk up Britain’s strengths rather than falling prey to the gloom everywhere.

William Bourne comments on the latest LGPS cashflow data in Room 151

To read the article please visit Room 151.

Investors, watch the People's Bank of China!

At 31 trillion renminbi the People’s Bank of China (PBOC) is now the largest central bank in the world by some margin.  It also operates differently to other banks in one crucial respect - it sets domestic banks overnight reserve targets rather than operating through reserve maintenance windows which allow some flexibility.  This gives it more direct control over domestic credit, as can be seen by the fact that over the last 40 years the credit multiplier (ie. the ratio between the total pool of credit, including shadow banks, and the PBOC’s balance sheet) has remained almost unchanged at about five times.  In contrast, both the US and the Eurozone’s equivalent numbers have varied by about 400%, demonstrating that the Federal and the Reserve and the ECB have more limited control over their economies. An important consequence of this is that interest rates and bond yields, which we have always seen as the ‘price’ of money’ rather than a policy tool anyway, do not give any signals about the PBOC’s policy stance.  The clearest signal of domestic monetary policy is given simply by the size of the balance sheet. In 2015, there was a 15% tightening, both in order to ensure the Chinese currency was included in the IMF’s SDR basket and also as part of an anti-corruption drive.  This resulted in a sharp contraction in the economic growth rate, capital outflows, and sharp falls in equity markets both in China and other Emerging Markets.    Today the balance sheet is growing at a 12% annualised rate.  In our view, this is clear evidence of easier monetary policy, which will in turn lead to a faster growing Chinese economy.  As well as Chinese markets, other Emerging Markets and Japan and commodity prices can be expected to benefit.   Some commentators are misled by rising bond yields, currently 4%, believing this is a signal of tighter monetary policy and a faltering economy.  In contrast, we see this simply as a higher ‘price’ of money as economic confidence returns and appetite for safe assets declines. It is not all good news: if the PBOC has more control over its domestic economy than western banks, it has the ability to turn the taps off as well as on.  The next major financial crisis may well emanate from this source.  That is why we say all investors need to watch the Chinese central bank. Our data comes from our friends at CrossBorder Capital, who have published a more detailed analysis on this subject and have for many years kept a careful eye on Chinese monetary policy.  If you would like to purchase their report, please email us on ​

What are the prospects for gold?

Gold has not been particularly fashionable as an investment since the heady days of 2013 when the price reached nearly US$2,000 per ounce.  The undoubted heightening of political risk (think superpower jostling, demographic challenges, European constitutional uncertainty and terrorism) might lead one to expect the price to approach that level again.  It has risen about 25% from its low in late 2015, but either investors are not worried by events or they do not see gold as the ‘go to’ safe haven. We like to think of gold as being a measure of the overall demand for fiat money, almost the inverse of its price.  The price of paper money increases if investors are confident enough to want to invest more (ie. demand rises) and goes down if central banks print more (ie. supply rises).  Demand for gold - whether bullion, jewellery or whatever - is simply the other side of that economic equation. It is gratifying that the data from our friends at CrossBorder Capital backs this up.  They measure the price of gold inverted against net demand for paper money and there is a strong correlation between the two.  No surprises that is the case during QE2; however the measure has picked up most of the major changes since the 1980s.   Today the data signals limited upside for gold, which should not be much of a surprise given that at least some of the central banks are beginning to withdraw QE.  Of course, there is always a case for holding gold as insurance against a major geo-political crisis but we would suggest there is likely to be an opportunity cost attached. For more on Linchpin IFM and asset allocation please click here.​