Blain’s Morning Porridge, Submitted by Bill Blain

“I found Rome a City of Bricks and left it a City of Marble.”

In the Headlights this morning - see www.morningporridge.com for some of the stories I’m watching:

Debt Leverage: Interesting quote I came across y’day. Which country are we talking about? A) Germany, B) Italy, C) China or D) US? 10 points for the first correct answer. (And remember points mean prizes): “local credit rating agencies have applied absurdly optimistic standards, giving top ratings to companies that rank among the most highly leveraged in the world.”

Global Markets?

Null Entrophy sums up the market’s current energy. Stocks seem to have lost their mojo. Even a major boost from the Chinese government expressing its love for the market failed to restore the mood. Indices have stalled. Funnily enough – a number of portfolio managers tell me we seem to be getting to equity price levels where dividend yields make sense for traditional economy names.

Meanwhile, I’m being told by some fixed income managers they see value in current yields in the face of potential global slowdown. Whether they are right or wrong depends on where the global economy goes and if central banks hold their tightening course. (That said, I’ve got to giggle when certain commentators are calling for central banks to ease to save stock markets – FFS! that would be an absolute abrogation of the Invisible Hand, and a far greater offense than bailing out banks… markets need creative destruction to evolve and function!)

What’s really happening? There is a very serious reassessment of trends and expectations underway in both bonds and stocks which could spell trouble all round! It feels like we are finally approaching the end-phase of the 2008 Global Financial Crisis…

IS THIS THE UNWIND? It might be time to pay-up on the costs of the many unintended consequences of the GFC..

Similar “wake-up-and-smell-the-coffee” moments triggered the Asian Crisis of 1997, the dot.com crash of 2001, and the bursting of the mortgage bubble in 2007. Strip out the froth on QE and the hopes underlying tech companies that don’t make a penny, and the other new stock market darlings that defy logic, and focus on real stocks producing real profits.. and paying them to shareholders.

In the fixed income markets, it’s a simple return to credit metrics that’s required – the aim of investing in bonds is to receive income and get your money back. Ask who is likely to repay and what’s the right risk premium for them to be paying. Every investment manager I speak with is telling me the same thing – the corporate bond markets are completely illiquid. Why?

Simple: Prices remain distorted by the long-term effects of the QE era. The blind central bank binging on corporate debt of the QE era continues to distort because prices have not yet fully adjusted downwards. (Liquidity is also stalled by technical reasons, like market making being regulated out of existence – a story for another day) The smart buyers aren’t going to buy bonds at these levels – they are waiting for the correction. Inflation hovers in the background, and who wants to buy at rates that would leave holders with a real negative return? Anyone prepared to buy at current levels is making an implicit bet central banks will step back into distort the market again by keeping rates artificially low…

Maybe the timing was providential in terms of an example, but, Netflix’s new $2 bln junk bond gives it enough money for approximately 1.3 months of box-set production. After subscriptions Its burning through it’s cash around $ 1 bln a month – but as a stock-market darling valued at $140 bln who cares about leverage…? The point is… that $140 bln is a notional amount of perceived value.. and only exists as long as the market believes….

Time to be looking elsewhere methinks…

Alternative real assets that provide proper risk adjusted returns and an element of inflation hedge – by the virtue of being real things… are certainly worth a look in these markets. It will be no surprise to readers that I’m working on a number of such deals! Call for more information.

Meanwhile...

The European Union faces a difficult one today – do they tell Italy the budget is unacceptable and fine the Italians for even proposing it? That will result in a populist uprising across the country. Or do they give Italy the nod and wink and let them get away with it – which would trigger fury in the North and Germany? I’ve put links to a whole host of stories and analysis on Italy on the www.morningporridge.com website (still work in progress), but I have a very much more simple question which I challenge anyone to answer..

Why is Italy still in the Euro? What does it gain from staying in?

I’m not convinced Italy is a basket case. Its debt is largely in domestic hands. It’s not broke. The North is extremely wealthy, while the South is mired in poverty. Yet, the country seems/is incapable of making structural reforms and adjustments that would rebalance these imbalances while improving the function of the underlying economy. Making such adjustments while trying to stick within the rules and austerity of the Euro has proved impossible, and spawned the improbably populist alliance now challenging the Euro Elites.

Next years change at the head of the ECB, and the likelihood of a new populist dominated European parliament clogging the decision making process in Brussels, clouds the issue even more. Again, I ask why should Italy remain in the Euro?

Finally, if there is one thing you should read today…. Try this in the WSJ: https://www.wsj.com/articles/the-real-reason-they-hate-trump-1540148467

It will make you think..

PS: Following my comments on Southern Rail yesterday – check out: https://youtu.be/5OR9edcMKfM