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August
03
2020

"Massive Consequences Are Coming..."
Bill Blain

“Wait a minute. You just flash that thing, it erases her memory, and you just make up a new one?”

A new month and what new madness for markets is the question?  Non Farm Payrolls is the big one due on Friday… What will it tell us about the state of the US economy and indicate for the globe? 

More of the same I expect. We will remain constantly looking over our shoulders and wondering about market risks – disbelieving the current euphoric valuations versus the frankly miserable outlook. We’ll keep trying to guess how the global economy is changing and where the threats and opportunities lie, all-the-while working out what central banks will do next and wondering how to arbitrage their actions. AND trying to overlay our outlooks with… The Virus.. What about the Virus? 

For every economic release that seems to suggest underlying global economic resilience, it feels like there will be an “equal and opposite” force in the form of renewed social distancing, travel restrictions or even lockdowns as second waves or hot-spots threaten. Renewed restrictions feel likely to strangle any real recovery.  It’s not just me that’s wondering if this is any way to run an economy…

Headlines everywhere are about how the insidious little Virus-beast is wrecking our lives and economies. I can’t help but wonder… what if some tech genius could invent a gizmo that automatically deleted every file, clip or meme that mentions the virus or pandemic from the internet, the media and wiped our memories… would we have a problem? Where is Will Smith when you need him...

This morning the UK government is in a flap about the possibility of mandating over 50’s to “shield”. Since I passed that particular milestone a while ago, I’ve already had the heart attack (result of a botched operation), and remain somewhat “cuddly” according to my wife and morbidly obese according to my doctor.. I suppose 50 plus shielding means me… Darn.. I was so looking forward to going back to the office. 

I’m struck by investment analyst headlines warning: “markets can’t deny economic gravity indefinitely..”. Actually… they can. The reality of the last five months, since March, is that you can’t fight global central banks. QE Infinity version 2.1 distorts markets even more dramatically than the original QE 1.1 – which simply distorted markets by keeping rates artificially low.  When it all goes inevitably wrong – because it will – then QE X-Power 3.1 will see markets bailed out again.. and again. 

The problem is.. there are consequences.. Massive consequences are coming… 

Last week I wrote about how QE has created Financial Asset Stagflation - meaning savers, and particularly pension savers, are in serious trouble as returns have essentially flatlined. To reiterate a point I’ve made many times: 10-years ago a £1 million pension fund would buy you  a very comfortable retirement income. Today, it won’t even buy a train season ticket to keep working up in London. That’s a serious issue in terms of dis-incentives to save, but also a rising social issue likely to trigger dissent and unrest as unions and workers demand retirement benefits. If we’ve just paid £2 trillion to bail out the economy from Covid, how much will the unfunded pensions crisis cost the economy? 

What will that pensions and Covid spending crowd out? If we are using the nations resources to fund retirement, then how much is not being spent on desperately required reform of the NHS or Education, and how much is not being allocated to required infrastructure projects? 

This morning, let’s talk about another consequence of QE distortion – on the economy directly by distorting businesses. 

I was struck by Facebook CEO/Founder Mark Zuckerberg pointing out that only 3 of the 10 largest companies today were on the same list 10 years ago.  It shows dynamic capitalism works – but it only works where it is free to do so.  Where evolutionary capitalism doesn’t work, and new bright young entrepreneurial companies don’t replace tired old dinosaurs, the result is inevitable stagnation. If it’s not happening, it will be due to distortions – which can cover a host of competitive issues. 

We all know that replacing the invisible hand of markets with the dead hand of state control is one route to disaster. But there are plenty of others.  All distortions lead to inefficiencies – the rise of bureaucratic mindset and “satisficing” strategies where companies are free to milk revenues with little regard to cost or customer choice. 

A number of readers came back to me last week following my comments on the Airbus/Boeing duopoly – suggesting the only way to break out and reinvent air-transport is a revolution with new aviation companies. That’s unlikely to happen due to fixed cost disincentives to entry into the market, and the degree to which they are protected behind defence contracts. Yet, these two companies and the multiplier effects they have on the economy in terms of jobs and wealth creation in the aerospace sector are enormous.  

QE 2.1 is likely to prove even more distorting than QE 1.1 because its directly supporting decrepit corporates through Fed and ECB corporate bond buying. At least under the original version of QE, it was left to markets to chose with corporate bonds made sense. Today… buy anything.. Even Junk – which is back to record tight levels. That can’t be healthy. 

As the global economy continues to real from Covid-septic shocks, I suspect it’s only a matter of time before we see QE 3.1 “Max Power” propel markets even higher when Global Central Banks cut the bluff and just start buying company equity directly. There will be subsequent iterations, including purchase of commercial property, and maybe even real assets… 

Who knows where it all eventually leads.. but if you are trying to understand where today’s markets are headed, then understand the reality: it’s going to remain about desperate distortion as Central Banks keep playing whatever cards are left to stay in the game. While this crisis lasts playing markets is all about playing that distortion. Listen politely to what analysts and city-writers are saying about “over-bought markets” and “financial resets”… and follow what the central banks actually do.

At some point… the penny will drop or the dam will burst… 

 

Bill Blain is Strategist for Shard Capital, a leading investment firm. 

Bill is a well known broadcaster and commentator, with over 30-years experience working for leading investment banks and brokerages at senior levels. He's been closely involved in the growth and development of the global fixed income markets, and pioneered complex financial products including capital, asset-backed securities and private placements. Increasingly, he's been involved in Real and Alternative Assets looking to explain their complexity and create liquidity in them. 

Bill is a passionate sailor, talentless painter, plays guitar badly, is learning the bagpipes, and built a train-set in his attic.  

He is a regular speaker on HoweStreet.com, and the FinancialSurvivorNetwork radio shows. Chris was also featured on the cover of AmalgaTrader Magazine, and contributes articles to several financial hubs like MoneyShow.com.

 

 

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