Learn in three minutes why the dollar will continue to fall

Linchpin Associate, Michael Howell,  speaks on CNBC on why the US$ is going to continue to decline and what that means for inflation​. Watch the video here.

Are we at peak global, and do markets care?​

Trade wars are in the headlines again, as Trump and Xi exchange threats.  For investors the big question has to be whether these will lead to a reverse of globalisation.  One commentator http://petertasker.asia points out that there are parallels but also big differences with the US-Japan friction of the 1980s.  China, unlike Japan then, is an important part of the US supply chain and hiking tariffs will simply hurt US producers.  Secondly, the US has no big stick to use against China, because it doesn’t provide any form of defence shield as it did for Japan.  Thirdly, China has broader military ambitions which may create additional causes of friction. The base case has to be that Trump’s comma-head advisors head him off actually implementing his threats.  They’ve done a good job over the past 15 months but that’s no guarantee it will happen again.  I say that is the base case because it’s so clearly in everyone’s interest.  Even if this goes in a different direction, it is likely to take time to play out and increased military spending will certainly have a positive impact on some parts of the stockmarket, in Japan, the US or China.  We may indeed have reached ‘Peak Global’, but at least in the short-term trade friction is more likely to be used as the post hoc excuse for a market setback than actually be the primary cause.​

ARE Investor sentiment surveys WORTH ANYTHING?

I found myself being given some grief last week in the comments thread after an FT article by Chris Flood because I questioned whether investor sentiment surveys gave much useful information.  The debate, perhaps because of the ‘Global investors shun UK stock market' headline, was rather hijacked by the Brexit pro and anti brigades – hence the suggestion that I was the devil incarnate from I’m still not sure which side.  My perspective was simply that of an investor. It led me to ask myself the question again. I have spent over 30 years viewing investor survey sentiments as simply publicity for the sponsor, on the basis that the information tends to be stale, sample rather than aggregate, and inconsistent because investors will not all be using the same benchmark.  My comments aroused ire because I also suggested that institutions might be a little cynical in what they tell the world.   I prefer to use the risk appetite data provided by our friends at CrossBorder Capital.  It is true that it answers a slightly different question: viz are investors in aggregate overweight relative to their long term average, rather than their benchmark.  But it has the advantage of being timely, aggregate and it also gives a clear signal of investors’ overall risk appetite - ie. are they risk ‘on’ or risk ‘off’?  Particularly at extreme times like 2007-8 (greed was on top) and early 2009 (fear dominated), the fact that this was an entirely objective signal was invaluable. Right now?  I’m awaiting end February data imminently, but at end January investor holdings in UK equities were between 1 and 2 SDs above their average. From my experience last week, there is clearly a different body of opinion about investor sentiment out there, but if you wish to find out more how CrossBorder do it, please click here. ​

ESG and fixed income

I participated in a recent roundtable hosted by the LGC and chaired by Dawn Turner of the Brunel Pensions Partnership on the subject of incorporating ESG investment into fixed income investing. The ESG focus tends to be on equities but it is just as important on the Fixed Income side. The difference, as explained by Insight Investment, is that for bond investors it is a risk management tool much more than for equities. As such, it cannot just be an add-on but has to be an integral part of the due diligence process. And of course better ESG performance in fixed income may mean a lower total return for higher grade issuers because there is less credit risk. Even though bond holders don't have votes in most normal circumstances, one of the big takeaways is that they do have influence because most bond issuers will want to come back to the market for financing regularly. Excerpts from our discussion will be published in due course.​

​Global credit and money flow data from end January now available

We now have February reports on global credit and money flows available for purchase.  Provided by our friends at CrossBorder Capital Ltd, there are three separate versions.   One covers fourteen major markets and regions, the second covers Emerging Markets, and the third the Asian region from Pakistan to Japan.  The data used is end-January, and they give a heads up on where liquidity is strongest (Brazil heads the pack) and where weakest (Japan at present).   We don’t think there is any data out there that provides a quicker sight of what’s really going on in the world. The main theme today is the shift in liquidity from Developed to Emerging Markets.  Even the ECB is now tightening, while Emerging Markets policy, led by China, remains relatively loose.  More important right now is the surge in capital flows towards Emerging Markets, as investors of all sorts redeploy capital to higher growth areas.   It all suggests that Emerging Markets economies and markets will outperform Developed Markets over the next year or two.  If, as at Linchpin we expect, the trend for a weaker US$ continues, that may lead market investors to the same conclusion.  Find out more by purchasing these reports from the liquidity tab on this website.​

Are bond markets about to fall over the cliff edge? william bourne thinks not yet

One of my themes over the past year has been the remarkable lack of volatility in currency, equity and bond markets.  I have tended to ascribe it to QE: there is always a cash-rich buyer to buy into a dip.   In 2018 we have seen a rise in bond yields but, to my mind, it is pretty clear that this is simply normalisation as a term premia (ie. the return premium investors require to accept duration risk) rise from the exceptionally low levels of the last two years.  At 2.85% the US ten-year bond yield may be the highest level in six years (with one small exception in 2013) but it is still a lot lower than it has been through much of its history.  This week equities have reacted by falling sharply.  Again, I would consider this as being both healthy and normal: it is a reminder to investors that markets go down as well as up and promotes healthier investment decisions.   The big question today, of course, is what happens next.  Will bond and equity markets continue to fall or will buyers come in at lower levels as they have in the past? On the one hand the market’s inflation expectations have clearly risen, partly because of the signals given by the US Federal Reserve.  Our friends at CrossBorder Capital suggest from their analysis that a 2.5% inflation level is the inflection point at which higher inflation begins to reduce equity market valuations.  The medium is a higher discount rate reducing the value of their future earnings stream. We are not quite there yet: 10 year break-even on US TIPS is currently 2.0%.  But we will be keeping a beady eye on this metric in particular. So, are markets heading over a cliff?  In the absence of a geo-political event, we doubt it at the moment, though the risks are clearly rising.  Inflation is still benign, investors are still cash-rich and bond markets are still in the process of normalising. Information on how to purchase CrossBorder’s research can be found here.​

After a 50% rise in 18 months, William Bourne looks at the future for Japanese equities

In September last year I came off the fence on the side of the bulls in Japan.  I pointed to the likelihood of another four years of Abenomics to wear down any opposition at the Ministry of Finance, the revival of the Chinese economy and a change in monetary policy to target the yuan rather than the US$. Four months later, the market is up around 50% in yen terms since mid-2016, and the very smallest companies in the JASDAQ index by much more.  It is time to review how much further Japanese equities might rise. It is clearly one of the cheaper of the developed markets, with an average TOPIX price to book of around 1.4x (half the US S&P 500 index at 2.8x), but that alone is not sufficient.  Value has had a rough near decade in the QE environment and while that trend may have ended it has not obviously reversed. There are some encouraging signs domestically.  I have written before about the gradual renormalisation of risk-taking - call it the return of animal spirits if you like.  That seems to have spread to the financial markets, with domestic investors once again raising equity weightings.  The Deputy Governor of the Bank of Japan in November 2017 called for ‘fair remuneration for financial intermediation services’, which is banking to you and me, to prevent a collapse of the financial system. I would suggest that the two largest influences, however, are outside Japan.  The first has to be China.  Japan’s relationship with China is multi-dimensional: on the one hand it is deeply connected economically as an investor and as a supplier of intermediate goods; on the other is the stand-off between the first and second regional powers, typified by the dispute over the Senkaku/Diaoyu islands.  I would argue that both are positive for Japan’s corporates: on the one hand Japan will share from the Chinese recovery; on the other defence spending is rising steeply. The second is the path of global interest rates.  This is more nuanced but if the trend to higher rates rises we can expect investors’ appetite for duration, whether in bonds or equities, to fall.  In such a case, Japan’s low valuations will be more attractive relative to other markets.  I accept that does not necessarily mean a higher market level and it may simply mean that Japanese equities fall by less than other markets.  However it almost certainly does mean a swing back to value at the same time and that is where Japanese equities score highly.  So I remain on the front foot. To find out more about Linchpin's advice and support in Japan click here.​

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.​

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