Directionless Markets – the biggest threat and an opportunity for instability.

Blain’s Morning Porridge – March 6^th 2023: Directionless Markets – the biggest threat and an opportunity for instability.

“The goal is not to get to the bottom of the run, but to get to the bottom as often as you can while having as much fun as possible.”

This morning – There is nothing as dangerous for markets as directionless markets and a deep threat board. Place your chips accordingly…

Apologies to those of you who missed their daily Morning Porridge last week. I was skiing in the Italian Alps – and it was glam! I come back refreshed, fitter (but substantially heavier after a diet consisting entirely of meat, cheese, more cheese, potatoes, wine and beer), sun-burnt, and happy. We were blessed by a number of overnight snow falls, and beautiful long days on the hill. My knee needs some manipulation, my legs ache, but I’m generally unbroken!

It’s a cliché how being up in the mountains is simply wonderful – but it did me give me some time to think about “stuff”. Stuff fascinates me. Some folk want to know how engines or sports function. I want to know how markets and economies (“stuff”) work. Most days I force myself awake, rush out my morning porridge comment, then chase around markets. Up in the Alps last week I had time for a bit of thinking. I came to some worrying conclusions about markets, risks and how we perceive them.

The flight back was scary, and not because it was a Boeing 737 Max (which Tui tried to hide with passenger safety cards on the back of every seat claiming the Seattle-death-trap was actually a B-737-800!!! I asked the steward why and he didn’t respond…)

Looking out the window, the Alps looked scarily devoid of snow. I’d been skiing in La Thuile, a small resort just south of Mt Blanc known as Italy’s Siberia. Our snow was great on the slopes, but the village at 1400 meters was pretty much clear. Most days I didn’t ski down the hill to finish because of the claggy snow at the bottom. By the end of the week it was getting nasty. I doubt many resorts will remain open through March.

I’ve been going to La Thuile for years and made some good friends – they tell me it’s not just temperature that’s the problem, but a dearth of snow/precipitation. Since early Jan they’ve had the longest dry spell on record. Something is changing – and although we kid ourselves we know what climate change is – it’s going to get increasingly complex and challenging.

Some resorts may vanish. The mountains are becoming more dangerous. Less snow means the glaciers retreat quicker, causing ground beneath them to rise, causing the rocks above to destabilise – which melting ice assists. Less ice cover means temperatures rise more quickly (the albedo effect).

The consequences of climate change are not just about clear energy, but much wider aspects like water and economic consequences. But.. challenge is opportunity.

Whatever… next year I’m spending more time on the slopes! It’s good for the soul…

Meanwhile, back in the markets….

Today will be a catchup day for me. But my gut feeling is this is a most dangerous moment for markets. There is no particular trend or belief driving prices. The equity bounce has gone. Bonds look tired. All the major themes are out there, clearly in play; inflationary expectations, interest rates, company valuations, the sustainability of national debt loads, geopolitics and global threats, but there is no particular momentum behind any of them. That will change in a flash – but how or when we simply don’t know.

Part of problem – as perceived by myself while sitting on a ski-lift last week – is every part of the global economy is not really meshed together. The way in which the US will successfully use the Inflation Reduction Act to subsidise climate change innovation and growth is in marked contrast to the thick-as-mince austerity of UK plans. The resilience of the US economy in the wake of the Ukraine energy shock is not matched by the inefficiencies of the European economies re the Euro and Brussels. The goals of China and Russia are very different to the West (NSS!)! Try putting all these blocks together and its clear the global economy is a challenge! (I’m not even going to mention UK politics… oh dear…)

The second issue is liquidity. Returns are out there – but only if you are prepared to embrace the prospect of being stuck with risk long-term. (That’s the trade-off in the Alternative Assets: you can garner seriously good returns relative to low risk, but its likely you will be unable to exit your investments unless you have a seriously good broker – and you know my email!)

I’ve been thinking about upping my gold allocation. The first headline that grabbed my eye this morning was a comment about staying long cash in directionless markets… When cash in an inflationary environment is a good call.. then be afraid..

If I was looking for clues – and I will be – it will be in the credit markets. In bonds there is truth. Where are the signs of stress, or ease? A major aspect of credit markets isn’t just the ability of companies to repay their debt and interest in a timely manner – but how liquid is the market. Who is going to buy corporate debt if things turn…. nasty? Nasty is defined (in my experience) as the moment companies start looking vulnerable and illiquidity locks the market. At that point, hit the bid harder and faster than the proverbial red-headed step child.. although you are probably too late at that stage.

I have a gut feel the credit market is too tight. It is underestimating the cumulative risks facing markets….

The Nasty Moment could come on the back of rising concerns on higher for longer rates, tumbling consumer spending, and falling earnings impacting corporate balance sheets. Conventional bond wisdom says in such an environment, rising corporate bond yields should compensate for the higher perceived risk, meaning credit remains relatively attractive… BUT!

That’s not the way it works. Directionless markets – like this one – are overly sensitive to small signals. Something like a major debt shock, a no-see-um in a bank credit book perhaps, or maybe rating agencies warning about rising defaults or the unsustainability of bonds secured on consumer spending – like autos. Or maybe it will be a major fund manger gating drawdowns on credit or other private investment funds…

In a fervid trading environment where investors feel increasingly vulnerable to what they just don’t know…. fears about higher for longer inflation, economic hard landings and chronic one-way liquidity in credit markets could become a flash flood, potentially triggering crisis across markets as fear leaps between investment sectors… That’s pretty much what happens in every market crisis… fear becomes the vector for fear… and its often credit that triggers the shock.

Nasty.. or maybe I’m just being overcautious.. Whatever, but it’s time to go open my emails and see what I missed last week! Full service from tomorrow…

Five things to read this morning:

FT                    Former top Credit Suisse shareholder Harris Associates sells out of bank

FT                    Beware the European optimism trap

BBerg              UK Less Attractive Than US, EU for Investment, Shell Chief Says

WSJ                 Why Some Investors Are Still Waiting For Discounts on Corporate Debt

BBerg              Forget Peak Oil: A Thirst for Barrels Puts $100 in View

Out of time, and back to the day job….

Bill Blain

Strategist – Shard Capital