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Economics

Weekly Investment Update – Should We Listen to the Bond Market?

Since the beginning of the year, 10-year US Treasury yields have risen to an almost 11-month high as markets anticipate a normalizing economy and further, massive fiscal stimulus.

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This article was originally published by Investors Corner.

Since the beginning of the year, 10-year US Treasury yields have risen by 25bp to an almost 11-month high as markets anticipate a normalising economy and further, massive fiscal stimulus.

The 10-year Treasury yield hit 1.17% on 8 February, marking its highest point in nearly a year. In the eurozone, the benchmark 10-year Bund yield now stands at around -0.45%. That is about 12bp above where it stood at the end of 2020 and a level not seen since last September. The yield on the 10-year UK Gilt jumped from 0.32% in early February to 0.48% the day after the latest Bank of England monetary policy meeting.

Theory and practice

These higher yields reflect an environment that economic textbooks tell us justify upward pressure on long-term rates: widening budget deficits, accelerating inflation, and accommodative monetary policy.

In the US, the budget resolution approved last week authorises a USD 1.9 trillion coronavirus relief bill. This very large fiscal package could be passed quickly and without much change if the Biden administration chooses to proceed by the way of the reconciliation process. A bipartisan bill, which would need at least 10 Republican Senators supporting it, would likely be much smaller, but still significant in historical terms.

Eurozone bond yields reacted to news of an acceleration in core inflation from 0.2% year-on-year in December to 1.4% in January. Primarily idiosyncratic factors are behind the surge: base effects, the adjustment of the basket of goods and services used to measure price levels, and a VAT rise in Germany. Investors will nonetheless be taking a close look at the detailed inflation numbers due out over the next few days.

Gilt yields rose after more-positive-than-expected Bank of England comments on the economic outlook and indications that a move to negative interest rates was not imminent.

Unresolved questions

There are also inflation concerns in the US with surveys are pointing to upward price pressures. Market watchers have begun looking for clues in central bankers’ comments on when asset purchases by the Federal Reserve could be tapered.

Fed chair Jerome Powell had indicated that such action would be premature in the current environment. The central bank’s message has been clear: Monetary policy support remains in place.

The ECB has been equally transparent on its stance. In a recent press interview, President Christine Lagarde repeated: “Our commitment to the euro has no limits. We will act for as long as the pandemic is causing a crisis situation in the euro area.”

The crisis is not over

The encouraging progress on vaccination campaigns (at least in some countries) has raised hopes that a return to ‘normal’ life will be possible in a few months’ time. A cyclical recovery would follow for the rest of 2021. We share this view, but would caution that investors not get too far ahead of themselves. The strong 5.5% rebound in global growth expected by the IMF, after a 3.5% contraction in 2020, does not mean that the scars of the crisis will suddenly disappear.

Take the labour market. The US unemployment rate dropped to 6.3% in January and is now at less than half the 14.8% level from last April. Before the pandemic, however, the rate was only 3.5%. Adjusting the current figure for fluctuations related to temporary layoffs and discouraged workers and the unemployment rate is closer to 8%, little changed since last spring.

Conclusions

An old investment adage says, “Don’t fight the Fed.” Indeed, we expect central banks to continue with their massive asset purchases until there is clear progress on growth and inflation.

However premature expectations for much higher inflation and other growth-related concerns may now seem, we believe a short-duration position in eurozone and US benchmark bonds could be opportune at this point. The same goes for a long position on break-even inflation.

We also remain overweight the Italian BTP bond market as the chances of Mario Draghi leading the next government appear to have increased and the risk of early elections has fallen. Investors’ search for yield should provide further support.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

 The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Nathalie Benatia. The post Weekly investment update – Should we listen to the bond market? appeared first on Investors' Corner - The official blog of BNP Paribas Asset Management.

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Government

Tesla And Hertz – Whatever Next…

Tesla And Hertz – Whatever Next…

Authored by Bill Blain via MorningPorridge.com,

“Democracy is absolutely the worst form of government, except for anything else…”

Tesla’s rise into the $1 trillion club is extraordinary – proving…

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Tesla And Hertz – Whatever Next...

Authored by Bill Blain via MorningPorridge.com,

“Democracy is absolutely the worst form of government, except for anything else…”

Tesla’s rise into the $1 trillion club is extraordinary – proving that listening to what the momentum crowd is buying, while suspending disbelief and fundamental analysis is one road to success. Hertz is a lesson in seizing the moment – its stock gains and free publicity from its new EV fleet will likely exceed the cost of the cars!

As I write this morning’s Porridge I am going to try and not sound like a bitter and twisted old man….

I suppose today’s lesson today might be: “Don’t over think it.” Every morning I wake up and try to make sense of the market noise to discern the big forces acting on markets, the underlying rationales, what the numbers really mean, the potential arbitrages, and the direction of trade flow. But I wonder if I’m doing it wrong.

It’s not what I think that matters. The only thing that’s important is what the market thinks.

The market is simply a voting machine where suffrage is simply the price of a stock. If the market believes Donald Trump’s sight-unseen social media empire is worth billions, so be it. If the market believes Meme Stocks are worth trillions, so be it. Whatever the market believes.. so be it.

As so many clever economists and traders have spotted before me.. it’s the madness of crowds that matters. Over the last few years understanding Behaviours has proved far more useful than forensic accounting skills when it comes to stock picking.

I make the mistake of calling out the inconsistencies of the “drivers” like Adam Neumann, Cathie Wood, Elon Musk and the Eminence Noirs driving SPACs and funds – rather than understanding what makes them look so attractive, clever, clearsighted and intuitive to so many market participants. Promise most people you are going to make them unfeasibly rich – and they will listen.

I make the schoolboy error of asking.. how?

Life is full of regrets. If we let them define us – we truly would be miserable.

Do I regret dumping Tesla in the wake of the cave-diving comments scandal? I reckoned it was massively overpriced around $70. Ever since I have pontificated why it’s not worth a fraction of even that valuation. I don’t regret selling, but I acknowledge I’ve been wrong about the price. But not because I got the fundamentals wrong – I misread the crowd. Failing to understand the momentum was my failure. I am less wealthy than I could have been.

Tesla is worth a Trillion dollars plus. Elon Musk is the richest guy on the planet. These are facts.

Tesla, remarkably, has become a great auto-company. It makes good cars. It understands the logistics of super-charging networks. It has front-run the switch from ICE to EVs, making them mainstream, leading a massive industrial shift, and forced the rest of the sector to play catch up. It changed the perception of EVs from milk-carts to desirable luxury status symbols. It will successfully open new plants and sell more cars. It’s the number one selling car in Europe this quarter – possibly because no one else can get hold of chips!

Perversely, Tesla’s success demonstrates momentum can take a company to fundamental strength. For much of Tesla’s life, sceptics like myself predicted it would stumble and fall, brought down most-likely by apparently insurmountable production problems, its debt load, or regulation. It didn’t happen. Instead it survived, thrived and has been able to reap the momentum and build a strong balance sheet on the back of its extraordinary stock price gains. It could potentially acquire whole swathes of its rivals and supply chain.

It’s been an extraordinary climb from likely disaster to undeniable success – and the one constant has been the support of dedicated Tesla fans. Frankly, it flabbergasts me just how Elon got away with it… but he did.

At this point you are expecting a But…

But…. What would be the point?

In the mind of the crowd facts like how 10-year old Telsa only just started making profits on selling cars don’t matter. Its consistently made profits for the last 2.25 years – largely from selling regulatory credits. Prior to that… Tesla racked up losses. It has consistently failed to deliver so many promises on deliveries, automation and new models. None of these facts matter.

It’s what the market believes that matters.

So, there is no point looking at Tesla this morning and trying to explain how it’s worth a trillion – a multiple of the much larger and more profitable Toyota. Let’s not wonder  why many analysts reckon its going higher. There is no point trying to fathom why a $4.2bn order from newly out-of-bankruptcy Hertz caused the stock price to ratchet up $110 bln yesterday.

This morning analysts are predicting Tesla stock will go higher, building from the “breakthrough psychological level of $900, right through the key $1200 milestone level, and then the next level is $1500.” There was nary a mention of its PE, fundamentals, margins or such irrelevancies… just that its going higher.

Meanwhile…

The Hertz trade is fascinating – Hertz has generated tremendous publicity for its re-launch, and enough stock upside to pay for the cars! It steals a march on any other hire firm wanting to build a fleet of EVs. Hertz went bust early in the pandemic and sold its whole fleet. But, as signs of economic recovery first appeared it became the perfect recovery play. After a bidding war, it was bought out from bankruptcy and restarted with a clean sheet. It now has its very own army of meme stock proponents. Its stock price has more than doubled to $12 on the OTC market.

The fact car hire firms are vulnerable businesses in a highly competitive market, or there are now literally hundreds of new EV makers, in addition to the incumbent ICE auto-manufacturers – all now competing in the EV space for Tesla’s lunch – doesn’t matter.

For now.

Always bear in mind Blain’s Market Mantra no 1: The Market has but one objective: to inflict the maximum amount of pain on the maximum number of participants.

Tyler Durden Tue, 10/26/2021 - 08:00

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Economics

Technically Speaking: The Bull & Bear Market Case – Part 2

Last week’s "Technically Speaking" covered the first part of the bull and bear market case as we head into the end of the year. As we noted, investors face a conundrum between year-end seasonality and the Fed starting to taper its bond-buying program….

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Last week’s “Technically Speakingcovered the first part of the bull and bear market case as we head into the end of the year. As we noted, investors face a conundrum between year-end seasonality and the Fed starting to taper its bond-buying program.

I received lots of comments about the article from individuals pointing out their perspectives on the market. In addition, there were enough excellent comments to derive a follow-up to last week’s post.

The dichotomy of views is broad. Numerous articles recently discussed how the bull rally would emulate that of the 1920s. Others discuss the biggest crash ever is coming. The problem is wading through the noise to discern the underlying risk at any given point.

It’s challenging to do. Such is why so many advisors charge clients a fee for “buy and hold” strategies. Since there is a lack of knowledge or experience to manage risk, they tell clients they can’t do any better than deal with the eventual losses.

That isn’t investing. That is a capitulation to laziness, a lack of research, and a lack of defined investment discipline and strategy. While such approaches seem to work while markets are rising, financial goals get permanently destroyed when markets eventually decline.

If such was not the case, then why, after two of the largest bull markets in history, are 80% of Americans woefully unprepared for retirement?

While the promise of a continued bull market is very enticing, it is essential to remember that all markets ultimately complete a “full cycle.” Therefore, if your portfolio, and eventually your retirement, depends on the thesis of an indefinite bull market, you should at least consider the following charts.

The Bullish Case

1) Sentiment

Despite the recent correction in the market, bullish sentiment has quickly returned to the market. As a result, the CNN Fear & Greed Index is back to “greed” levels after the latest rally. However, the index gets heavily influenced by the movement of the market.

Our “Fear/Greed” index gets based on how investors allocate to the market without any influence from market price changes. While our index declined with the recent correction, investors have quickly piled into equity risk over the last week.

What is clear, judging by the surge in SPACs like Digital Media (DWAC) last week, investors have been quick to jump back into some of the most speculative assets recently without regard to the underlying risk. But, of course, such is also a sign of a high degree of “complacency.”

2) Complacency

At the moment, there are plenty of concerns, but investor psychology remains hugely bullish. Most concerns are well known, and, as such, the market discounts them concerning forward expectations, valuations, and earnings projections. However, what causes a sudden “mean reverting event” is an exogenous, unexpected event that surprises investors. In 2020, that was the pandemic-related “shutdown” of the economy.

Currently, as shown by the collapse in the volatility index over the last couple of weeks, investors are highly confident that a “correction” will not occur.

“The Volatility Index (VIX) closed at a new 18-month low as the S&P 500 closed at a new multi-year high on Thursday, 10/21/21. If you were wondering, the 18-month low in the VIX Index represents the first occurrence since November 2017.” – Sentiment Trader

It is worth remembering the market had three 10-20% corrections in 2018 as low volatility begets high volatility.

Stocks Earnings Risk 10-22-21, Stocks Surge As Earnings Roll-In, But Is Risk Gone? 10-22-21

3) Earnings Expectations

Currently, significant support of the bullish advance remains the rather exuberant expectations of earnings heading into the end of the year. With estimates very high, forward valuations are dropping as market prices remain at the same level currently as in August.

As long as expectations get met, the bullish advance can continue. Furthermore, as noted last week, with the buyback window opening November 1st, that support for asset prices will continue into year-end.

So with this very bullish backdrop for equities short-term, what is there to be worried about?

The Bearish Case

1) It’s Been A Long Time

As noted this past weekend, the S&P 500 index has gone 345-days without violating the 200-dma. Such is the sixth-longest streak going back to 1960.

Stocks Earnings Risk 10-22-21, Stocks Surge As Earnings Roll-In, But Is Risk Gone? 10-22-21

While investors are currently starting to believe that a test of the 200-dma won’t happen, there are several points to be mindful of.

  1. Corrections to the 200-dma, or more, happen on a regular basis.
  2. Long-stretches above the 200-dma are not uncommon, but all eventually resolve in a mean-reversion.
  3. Extremely long periods above the 200-dma have often preceded larger drawdowns.

The most crucial point to note is that in ALL CASES, the market eventually tested or violated the 200-dma. Such is just a function of math. For an “average” to exist, the market must trade both above and below that “average price” at some point.

2) Lack Of Liquidity

Since the pandemic-driven shutdown, there has been a flood of liquidity into the financial system. In the short term, that liquidity supports economic growth, the surge in retail sales, and the explosive recovery in corporate earnings. That liquidity is also flowing into record corporate stock buybacks, retail investing, and a surge in private equity. With all that liquidity sloshing around, it is of no surprise we have seen a near-record surge in the annualized rate of change of the S&P 500 index.

Stocks Earnings Risk 10-22-21, Stocks Surge As Earnings Roll-In, But Is Risk Gone? 10-22-21

“However, as stated, there is a dark side to that liquidity. With the Democrats struggling to pass an infrastructure bill, a looming debt ceiling, and the Fed beginning to “taper” their bond purchases, that liquidity will start to reverse later this year. As shown below, if we look at the annual rate of change in the S&P 500 compared to our “measure of liquidity” (which is M2 less GDP), it suggests stocks could be in trouble heading into next year.”

Stocks Earnings Risk 10-22-21, Stocks Surge As Earnings Roll-In, But Is Risk Gone? 10-22-21

While not a perfect correlation, it is high enough to pay attention to at least. With global central banks cutting back on liquidity, the Government providing less, and inflationary pressures taking care of the rest, it is worth considering increasing risk-management practices.

3) Bad Breadth & Volume

In the very short term, despite the bullish market rally, the technical backdrop remains exceptionally weak. However, to expand on a point from last week, breadth remains dismal, with only 60% of stocks above their respective 50-dma even though the index is at all-time highs.

Stocks Earnings Risk 10-22-21, Stocks Surge As Earnings Roll-In, But Is Risk Gone? 10-22-21

Moreover, while our “money flow buy signal” reversed to previous highs, volume dissipated sharply during the advance. Such suggests that “commitment” to the market rally remains lacking, and liquidity is thin.

Stocks Earnings Risk 10-22-21, Stocks Surge As Earnings Roll-In, But Is Risk Gone? 10-22-21

Plenty Of Risk, Limited Reward

While anything is possible in the near term, complacency has returned to the market very quickly. As noted, while investors are very bullish, there are numerous reasons to remain mindful of the risks.

  • Earnings and profit growth estimates are too high
  • Stagflation is becoming more prevalent
  • Inflation indexes are continuing to rise
  • Economic data is surprising to the downside
  • Supply chain issues are more persistent than originally believed.
  • Inventory problems continue unabated
  • Valuations are high by all measures
  • Interest rates are rising

Furthermore, as noted above, there is limited upside as the annual rate of change in the market declines.

So what do you do?

As discussed last week, we believe additional equity exposure gets warranted due to the bullish case. However, the longer-term dynamics are bearish. 

For now, we remain optimistic about the markets due to liquidity, seasonality, and bullish sentiment. However, we remain concerned about the broader macro risks, which keep us cautionary. Therefore, it is crucial to stay unemotional and focus on managing your portfolio.

Such is why focusing on “risk controls” in the short-term, and avoiding subsequent significant draw-downs, will allow the long-term returns to take care of themselves. The following are the “control boundaries” under which we operate.

Everyone approaches money management differently. Our process isn’t perfect, but it works more often than not.

The important message is to have a process that can mitigate the risk of loss in your portfolio.

Does this mean you will never lose money? Of course, not.

The goal is not to lose so much money you can’t recover from it.

The post Technically Speaking: The Bull & Bear Market Case – Part 2 appeared first on RIA.

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Spread & Containment

UK Faces ‘Plan B’ Peril: COVID Multiplies The Economic Threat

UK Faces ‘Plan B’ Peril: COVID Multiplies The Economic Threat

Authored by Bill Blain via MorningPorridge.com,

“T’was the best of times, t’was the worst of times …”

The risks of Plan B and a further Covid Lockdown are multiplying….

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UK Faces 'Plan B' Peril: COVID Multiplies The Economic Threat

Authored by Bill Blain via MorningPorridge.com,

“T’was the best of times, t’was the worst of times …”

The risks of Plan B and a further Covid Lockdown are multiplying. It will clearly impact markets, but the real economic effects of Covid combined with energy costs, supply chains and bleak company earnings forecasts may be pushing us towards stagflation anyway.

"How to address the biggest economic shock in 300 years?” asked UK Chancellor Rishi Sunak while doing his pre-budget politicking last week. Whatever you believe or don’t believe about Covid, Sunak is quite right to consider it at the centre of the on-going economic crisis. Markets should factor that reality accordingly – which boils down to a very simple question: how much will Covid force Central Banks and Governments to act to stabilise the global economy?

This week pay attention to the UK Budget on Wednesday on how Chancellor Sunak addresses the ongoing critical-care needs of the UK by stepping away from his previous “policy-mistake” sounding mention of austerity spending cuts and tax-rises to make noises about increased “levelling out” spending. Hanging over everything will be the question – how much more economic pain could Covid inflict?

It’s a tough question.  A new lockdown would be economic suicide. The UK government plans to ride it out – but the history of the last 19 months says they won’t hesitate to make a U-Turn and institute Plan B if they think their credibility is on the line if the numbers of infections surge and the health service looks swamped. That’s a potential trade: should you sell UK stocks now on the likelihood the government will panic? (And buy-them back almost immediately as the Bank of England stops the noise about a rate cut and QE taper.)

But… another question is how much will rising infection numbers cause the economy to contract anyway? How much has confidence already been dented?

Here in Blighty, It’s a tale of two headlines:

Daily Mirror: Fears of new lockdown Christmas as scientists warn tougher Covid measures needed NOW.

Daily Telegraph: Coronavirus cases to slump this winter, say scientists.

The papers looks like it boils down to a political split – which may reflect the UK’s national pride in our venerable National Health Service. How much we are prepared to sacrifice to protect the sacred cow of the NHS has become a badge. The left-leaning, Labour supporting Daily Mirror is peddling one set of scientific views, while the daily journal of the Conservative Party, the Torygraph, finds another set of white-coats to quote.

What does the threat of Plan B or further lockdowns mean for the UK economy? A quick glance round the motorway service stations we stopped in yesterday shows many more people wearing masks, and I’ll be interested in how many people start working from again as the perceived threat level rises.

I wonder how rationally people consider the pandemic. The vector for the rise in infections is schoolchildren being children – their interactions will diminish this week due to mid-term holidays. Back in September, a British Medical Journal report (How is vaccination affecting hospital admissions and deaths?) said 84% of hospital admissions before July had not been vaccinated, although rates of vaccinated infections were rising – their conclusion was simple: unvaccinated people are 3 times as likely to go to hospital and 3 times more likely to die. There is a broad consensus the efficacy of vaccines wanes after 5-6 months – hence booster shots.

Maybe the best way to move forward is the Swedish solution of taking personal responsibility to rising infection numbers? However, research in the Guardian earlier this year suggests that strict-lockdown Denmark and easy-going Sweden experienced similar levels of economic dislocation, but Sweden suffered a death rate 5 times higher than Denmark! It’s down to behaviour – Sweden kept the schools, offices, shops and pubs open, but people got careful, stopped going out and kept the kids at home anyway.

As the supply chain crisis continues, and energy prices go through the roof, we already know it’s going to be a tough holiday season – retailers warning of toy shortages and price hikes on scarce Turkeys. It impacts consumer behaviour – we all want to spend, but if we can’t because of rising prices and falling incomes, and it feels dangerous to do so – then what effect does that have on spending patterns? It’s got to be negative.

We’re seeing the supply chain effects beginning to hit corporate results – an increasing number of firms have been giving lacklustre holiday earnings guidance. Intel took a spanking last week on the back of expectations of a downbeat outlook. Snap got pummelled on the back of a disappointing Q3 number. This week is big for Big Tech earnings – and names from Apple to Amazon could be pummelled by supply chain shortages and the problems these cause meeting holiday demand.

Headlines about a downbeat Apple sales forecast have consequences – not just in making global consumers a little more depressed about the future.

The very first thing junior economists learn about is multiplier effects – on consequences as lay-people call them. A company finds it can’t get it full allocation of Christmas units to sell so it cuts advertising, cuts stuff overtime and starts planning to cut investment in new plants, warehouses and future spending. Repeat over the whole economy, and with everyone with less in their pockets… as “transitory” inflation feels increasingly permanent, and you’ve got a perfect recipe for stagflation.

I often get accused of being a misery-guts and far too negative about the state of the global economy. My own market mantras include the classic: “Things are never as bad as you fear, but never as good as you hope”.

Think about that for a moment. Covid caused the greatest economic downspike in 300 years, but the actions of swift government interventions to prop up commerce and fuel consumer spending kept the global economy functional, but wobbly. The markets quickly began to anticipate recovery and upside – yet these remain vulnerable to the news and perceptions around this Coronavirus.

Covid fears are multiplying again. Renewed Covid instability on the back of lockdown news from China, Europe, Australasia, wherever, will continue to roil markets. Supply chains remain fractured and the consequences of the virus effects on the global economy will continue.

Get used to it…

Tyler Durden Tue, 10/26/2021 - 03:30

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