June 16, 2017
By Bill Blain of Mint Partners
Blain’s Morning Porridge
“Sometimes I’ve believed as many as six impossible things before breakfast.. ”
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It’s tough being a Central Banker. The expectation they are doing the right thing lies heavy upon them. We’d like to believe Central Bankers are omnificent celestial beings (because we like the idea of an ordered universe), but the truth is they are as much hostage to the fickle winds of economic destiny as the rest of us. Just when they are guiding us to believe the economy is about to explode, it contracts. Just as they sort out the banks, the economy then votes for collective economic suicide. Just as they think they’ve licked inflation, commodity prices go chaotic.
The official line on Wednesday’s Federal Reserve meeting is: more hawkish than expected – 3rd hike in 6 months and talking about they will normalise the balance sheet by rolling off assets and capping reinvestment. They expect unemployment to continue improving and remain robust. They are happy with the outlook for consumption and capex.
However… Both the US and UK were poster boys for Global Growth last year. This year, they are at the bottom of the table. Estimates are tumbling… What changed? Well…. that’s worthy of a whole book – and will take in everything you’ve read in the press about confidence and politics.
One of my favourite jokes is about the Physicist, the Mathematician, and the Economist. They are stranded on the proverbial desert island and starving. A tin of beans washes up. They stare at it.
The Physicist ponders and announces: “If we light a fire beneath it, the tin will explode.”
The Mathematician jumps in: “Of course, in which case I can work out the trajectory of each bean so we can collect them..”
They both turn to the Economist and ask what he thinks..
He ponders a while, and replies: “Well, assume we had a tin-opener..”
(I have a whole book of Economist jokes… at least 3 of them are funny..)
* * *
On Wednesday, the Federal Reserve hiked rates 25 bp and told us a further hike is coming. We have to take their analysis seriously. They have the intellectual firepower and analytical base to tell us the economy is going to truckle on in a similar way. But listen how they say it. Its very much “assume” we had a tin-opener moment. Even the discussion on how the Fed is going to normalise the balance sheet was couched in terms of: “we shall normalise, provided the economy evolves broadly as anticipated.”
What does it mean for markets? Well you can buy into what the Fed is saying – which is steady growth. Or you could listen to what the macro economists are telling us about how strong the economic fundamentals are in terms of still mega-low rates and declining negative drag. Or you could listen to the political noise, and conclude (with the obvious exception of the UK) there are no political problems, therefore upside potential.
The macro outlook and the political situation are powerful arguments. Although the Fed is talking about normalising the balance sheet, no other Central banks are. Therefore cheap money continues to justify the continuing strength of the stock markets, while low rates keep bonds interesting. If there is one obvious trend at work it’s a massive re-allocation of investment capital from bonds into equities – which makes perfect sense as you can’t survive on negative real interest!
But, but and but again.
What do low rates actually mean and what have they actually achieved these last 8 years? Have ultra low rates stimulated real economic growth and capital investment? I’m not convinced. They have created massive inflation in financial assets: bonds and stocks.
How many people seriously believe the strength of the stock market is due to fundamentals of coming explosive growth? Or is the market really focused on the continuing QE cheap money fuelling the equity boom? (Any guesses on how much of the cash raised by corporates in the ultra-cheap money age has been spent building factories or infrastructure? Clue: it’s a fraction of the money they spent buying back their own stock.)
It’s at times like this when I remind readers to look at their portfolio’s and how non-correlated your assets are from the current massive financial asset bubble. For instance, if you class yourself a measured risk taker and are holding hi-yield debt (currently at close to ultimate highs) at 3% ish, why not own aircraft bonds at 7% instead? That’s just one example..
This article was posted: Friday, June 16, 2017 at 7:47 am