The Capon flock, for good or ill, live not too far from the UK leisure attraction Thorpe Park. Years ago, every time we headed back to southwest London via the M3 motorway, a suddenly observant child would notice the rides at this monstrous asset stripping machine and start their plaintive cries: “Dad, dad!”
A few weeks or months later, strapped into Stealth, I would pray for survival, fortitude and a greater ability to say no. Stealth is a rollercoaster that accelerates to 80mph in 1.8 seconds, climbing more than 200 feet and creating 4.7G. And then it comes down. Grown men, my passively observing parents have told me, vomited into nearby bins after disembarking, though if they had eaten the food available in the park beforehand that is entirely understandable. The worst thing of all is the moment of pause at the top of ride. You feel weightless, almost in a state of ethereal bliss, but know the plunge is coming next.
Markets may be reaching that blissful, yet nauseating peak. With European stock markets soaring, 52% of European government bonds yielding 1% or less, and investment grade credit spreads grinding relentlessly lower, it would be remarkable if investors did not seek the refuge of the nearest bin at some point in the next few months. Records are being broken everywhere you look in financial markets, but there is also teeth-grinding dissonance.
Global commodity prices are below levels seen in the Great Recession. The Baltic Dry Index of shipping costs has hit a record low of 509. But antipodean carry traders are counting their blessings. They can pick up an “exciting” 125 basis points as the New Zealand dollar trades at an all-time high against the Aussie.
The Karachi Stock Exchange 100 index is breaking new ground because, obviously, Pakistan is a really great place to invest. The S&P500, FTSE100 and Germany’s Dax equity indices are all higher than they were in the TMT bubble and even the US Nasdaq, the poster child of that episode of excess, is knocking at the door.
|Place your heads back, face forwards, |
hold on tight and brace yourself
This vertiginous rise in risk assets has coincided with Spanish government bond prices, bunds, gilts and JGBs also rising. This is a market driven by flows, a desperate search for yield, recognition that safe havens have residual value for those who care about preservation of capital and a rotation out of the themes and asset classes that did well in the aftermath of the financial crisis. So, emerging markets get battered (currencies and debt), the dollar rises, and European equities are buoyed by asset allocation shifts, policy divergence and quantitative easing.
Some of this is rational and will be fun for a while. It makes investment sense to play policy divergence and a rotation from winners to losers. The EuroStoxx index is comfortably beating the S&P500 in 2015 after many years of relative underperfomance.
It is a difficult game to win, however. Timing the shift from the FTSE250 (spring) into the FTSE100 (winter) and back again in 2014 will have made or broken many fund manager’s equity track records for the year.
The intra-day 14% move in the price of the most liquid security in the world, the 10-year US Treasury, on one day last October suggests markets and sentiment are fragile. The doubling of the yield in the 10-year JGB from 0.195% to 0.41% this year was barely noticed or commentated on. But that asymmetric risk is writ large across bond markets.
If current pricing in markets makes any sense at all, investors are highly reliant on central banks and policymakers getting everything right. That is wishful thinking. The Swiss National Bank’s abandonment of its SFr1.20 peg to the euro, led to the biggest move in a developed market currency in the post-Bretton Woods era and a number of currency funds going bust. Central bankers can be fickle friends.
Goldilocks for ever
To justify current bond and credit prices across yield curves out to 30-years would mean a Goldilocks economy for ever. But there is deflation everywhere.
Deflation cannot be good for credit as it cuts profits and margins. That makes debt harder to pay back. Though financial markets operate in silos, equity investors confront the same problem. Trying to discount the net present value of future dividends, for example, is challenging if there is persistent deflation.
If there is inflation due to monetary policy experimentation, interest rates will rise and debt service costs and defaults will go up.
Almost everything a rational investor would typically want to own is priced to perfection.
My gut feeling is that we will all have to strap in for a Stealth-like ride and be extremely brave, agile and contrarian in 2015. But, beware. The words as you get on board still induce mild acid reflux: “Place your heads back, face forwards, hold on tight and brace yourself.”
Where’s that bin gone?