A decade after Lehman Brothers failed, what do managers think about banks?
On Monday 15th September 2008, I remember walking into the office, not knowing quite what to expect....
If we had said at the beginning of 2016 that the UK would vote for Brexit, the US would vote for Trump and that Leicester City would win the Premiership, you might not have taken the bet – a pity as a £10 accumulator would have netted millions!
One thing we can “look forward to” in 2017 is more political uncertainty. We have no idea what a Trump administration will spring upon us, while in Europe there are elections in the Netherlands, France and Germany to contend with. The European banking system is also a matter of concern.
One bright light on the political front is the agreement by the oil producing countries to cut production. This has spurred the price back above the $50 level, but for the last 18 months this has proved to be a formidable barrier. It will be good news for the shale companies, but less good for oil importers like Japan.
Equity markets continue to ride the Trump bull and in the US and UK we are at or very close to new all-time highs. Bond markets also had a relatively good December following a rather stark November, which may have been the starting gun for further declines in prices and increases in yields. The bright spot in the commodities complex continues to be oil and gold may just be starting a new rally phase.
In the UK, we have yet to trigger Article 50, six months after the referendum. Wage growth has been marginally above stated inflation for over two years, but price inflation is picking up on the back of sterling weakness—higher import costs, notably for fuel—and the gap is closing rapidly. The lower pound has now been exacerbated by dollar strength and the current wave of consumer optimism may have been sated by the Christmas binge in spending.
The US election result was largely unexpected and it is too early to draw any sensible conclusions. The December rate rise was greeted with barely a moment’s reflection before the equity markets continued the Santa Claus rally. The Dow failed to breach 20,000 but the proximity is such that new all-time highs are on the cards. With equity prices at these levels, there is inevitable risk to the downside and I remain cautious.
The Italian referendum has fast faded from the news, although their vote on whether or not to remain part of the European Union may be yet to come. Meanwhile, the French elections may prove to be a defining moment for the “union”. Expect to hear much in the press about François Fillon and Marine Le Pen. Fillon is currently the bookies’ favourite; no guarantee of success as we have seen in 2016!
The European Central Bank is now the largest single owner of European government and corporate debt. Unlike the Swiss and Japanese central banks, it has not yet resorted to buying equities but, given the ongoing failure of bond buying to boost economic growth, that may well be their next plan.
The third up month in a row for the Nikkei, which is hardly surprising given that the Bank of Japan (BoJ) now owns more than half of the total issued Japanese equity exchange traded funds (ETFs).
As an aside, buying ETFs or any other index-linked equity product is often the sign of the end of an uptrend. The largest capitalisation stocks, which have the greatest effect on the index calculation, get bought up regardless of valuation and active managers are derided for not following suit. I recall a conversation with Neil Woodford in early 2000 when he was berated for not buying Vodafone (then the largest stock by market cap in the FTSE) at over £4 during the TMT (technology, media and telecoms) bubble. 16 years later and it still hasn’t recovered to half that price … so Japan investors should exercise caution.
Dollar strength and the threat of Trump mercantilism have weighed heavily on these markets, but the trend is still up at this stage. Longer term the growth potential relative to western markets is significant, but in any “emergent” market, tomorrow’s winners won’t be those of today. A market where active managers are a must.
In India, efforts to cut reduce endemic bribery and corruption by withdrawing higher denomination bank notes—500 and 1000 rupees—have negatively impacted the economic growth. Cash is very hard to find, which is a serious problem in what is largely a cash economy, as their printing presses can’t cope with demand for smaller denomination 100 rupee bills. To “improve” the problem, they intend to get more cash into the system quicker by printing 2000 rupee notes instead! Madness!
It remains to be seen if the oil producers’ agreement to cut output lasts long enough to be effective. The price is edging tentatively towards $60. Trump’s foreign policy will be watched closely by crude market participants.
Gold meanwhile has been knocked back again by the dumping of large numbers of contracts on the market outside normal hours – selling the odd billion dollars’ worth of bullion in such a way seems more like manipulation does it not? At the same time demand for physical gold, especially in India given the banknote situation, is very strong. There is a big disconnect here.
Bond world does seem to be smelling the coffee, with yield rises across all markets. December saw something of a respite but, if yields continue to rise, losses will be mounting for existing holders, who have always considered bonds to be the safe haven. Where does that “funk” money go then, with cash offering such derisory and often negative returns? As equities now yield more than bonds, they are, allegedly, the risk-off asset. Really? Despite its failings in the interest rate department, cash does have significant attractions.
As Warren Buffet said, “cash combined with courage in a time of crisis is priceless”.