The world's at your feet
July 12, 2019

Blain's Morning Porridge

"Just slip on a banana skin and the world's at your feet!"

What a funny world we live in. On the one hand, the world looks pants. The head of the US Federal Reserve told us on Wednesday he's likely to ease US interest rates because of ongoing global recessionary risk and trade threats. Yesterday, the Bank of England warned about downside risks to the global economy while the European Central Bank told us it's in "broad" agreement about "heightened uncertainty" – which is pretty strong stuff for them.

Investment banks are bearish on their expectations for the coming US earnings season warning the stock market could tank on a spate of negative earnings and signals the US economy is struggling.

We even got some real evidence. Yesterday, one of the early US firms to report, Fastenal, fell short of estimates with sales down 8 percent. It's a minor barometer for the US economy as a supply chain fastener distributor. It said profit margins were down as it tries to "offset" China tariffs.

We also have higher than expected US inflation – CPI came in at 2.1 percent - another factor Fastenal said it was having to factor into its margins. According to Reuters, 77 percent of the 114 companies that had reported up to yesterday were negative.

On the other hand, Donald Trump tweeted: "Dow just hit 27,00 for first time EVER!" Well done Donald – Americans everywhere will be thanking you for pushing up the value of their investments. Well, at least those Americans who have 401Ks and aren't trapped in low-pay gig economy jobs. And others have already pointed out the gains made under the Obama administration were actually higher and faster than under Trump.

I've been taking time this week to read through Trump's tweets. This will surprise readers, and probably offend many, but some of them are quite insightful and others are genuinely laugh-out-loud funny - if terribly non-PC and insulting. It makes me feel dirty just to admit that – does it mean I'm unreconstructed?

The point is, I don't think for a moment Donald actually thinks the Dow Jones Industrial Average of 30 large stocks represents the strength of the US economy. But he wants his voters to think it does. You don't need to send me emails to tell me how useless the Dow is. The S&P 500, a much better index, is bouncing around 3,000 - a record high!

I'm really nervous on the Dow because the biggest single component stock of the index – Boeing – is being dragged higher because in a rising market investors need to hold it. The weight of negativity on Boeing on its cashflow, regulation, litigation and management failure, is such I can see it being the harbinger of a sell-off, which could trigger systemic sentiment collapse.

Next week we've got Citi, Goldman and JP Morgan, Microsoft, Netflix, IBM and United – let's see how it goes. Maybe one of them will be the straw that breaks the market's current back?

Yes, despite all the above, I'm only mildly bearish on stocks. While I reckon some kind of sell-off is coming, it's likely to be a buying opportunity. There is still too much money in the system.

With the global economy flatlining it's difficult to see any realistic chance of interest rate normalization anytime soon. Global bonds just look too unattractive from a risk-return perspective at these levels: sovereign bonds are either negative or far too low, corporate bonds run too much illiquidity risk, and the chances of a corporate debt debacle look high.

In contrast, lots of readers have pointed out that a fair proportion of US and UK stocks have dividend yields higher than US treasuries. Do they yield enough to justify the higher risk? Most large stocks will remain liquid in a crisis that would lock corporate bond markets shut. I'm thinking where to put my chips – high-dividend stocks likely to weather a downturn well? Any suggestions?

Back in the UK, I've been putting this off too long. I need to write about UK risks. But first, I do recommend folk read the Bank of England's Financial Stability Report. Even the most hardened Brexiteer convinced the Bank is a bastion of treacherous Remoaners should pay attention.

I take what the Bank says at face value – and what it notes is: Brexit uncertainties exist - and have hit exchange rate and UK-focussed equities, and discouraged real investment by foreign investors. My question: will these be reversed once Brexit is done and dusted? (Don't ask what or how good "done and dusted is".)

The banking system looks prepared and ready. The Bank reckons the UK is ready for disruption, but they say "in the absence of further action by EU authorities, some disruption to cross-border financial services is possible. Although such disruption would primarily affect EU households and businesses, it could amplify volatility and spill back to the UK in ways that cannot be fully anticipated or mitigated." Dang…

Now I know everyone is bored and just wants Brexit to end. If it's going to hurt, let's get it over with. Which gets me to my big worry: ongoing UK political instability. Let's assume Boris gets the job. He says we will exit whatever on October 31 with a new better deal or a no-deal. What are the chances of either? Pretty low.

In terms of forcing through decisions, Boris is stuck trying to swim in the same treacle as Theresa May. His options are extremely limited. I detect signals Europe is quietly offering him an olive branch – an accommodation on the Irish border in return for a soft Brexit akin to the May 3-times-rejected plan. But there is no chance the Tory right will accept such backsliding.

What is actually going to change in terms of the numbers in Parliament? He needs every single vote he can get, but already a core of Tory Remoaners have said they won't support no-deal. He needs 20 MPS at least to swing behind him to get the parliamentary vote banning a no-deal Brexit overturned.

That looks unlikely – even if a number of Tories decide they will support him in return for his patronage. The votes won't come from Labour which is swinging behind the nightmare scenario of a second referendum.

Scotland is even worse – I was up there last week. Out with a bunch of mates, every single one said they would vote for independence if Boris wins. They all voted to stay last time.

The UK problem looks unlikely to be solved by Boris getting the PM job. We either get more go-nowhere politics – and an unsolved mess on October 31, hoping the EU gives a further extension. Or we get a general election – in which case Scotland's MPs will support Labour in return for INDY 2. And an election will force Boris into bed with Nigel Farage, which is such a horrible vision I won't even begin to contemplate it…

Whatever the outcome, or noutcome, it's impossible to be enthusiastic on UK prospects for sterling or stocks in the near term. Up to a few months ago I sincerely believed UK plc would be a screaming buy when Brexit is done. I still believe that, but I just don't have any confidence if and when it ever will be..

Have a great weekend!

Bill Blain

Shard Capital





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Blain's Morning Porridge

"Just slip on a banana skin and the world's at your feet!"

What a funny world we live in. On the one hand, the world looks pants. The head of the US Federal Reserve told us on Wednesday he's likely to ease US interest rates because of ongoing global recessionary risk and trade threats. Yesterday, the Bank of England warned about downside risks to the global economy while the European Central Bank told us it's in "broad" agreement about "heightened uncertainty" – which is pretty strong stuff for them.

Investment banks are bearish on their expectations for the coming US earnings season warning the stock market could tank on a spate of negative earnings and signals the US economy is struggling.

We even got some real evidence. Yesterday, one of the early US firms to report, Fastenal, fell short of estimates with sales down 8 percent. It's a minor barometer for the US economy as a supply chain fastener distributor. It said profit margins were down as it tries to "offset" China tariffs.

We also have higher than expected US inflation – CPI came in at 2.1 percent - another factor Fastenal said it was having to factor into its margins. According to Reuters, 77 percent of the 114 companies that had reported up to yesterday were negative.

On the other hand, Donald Trump tweeted: "Dow just hit 27,00 for first time EVER!" Well done Donald – Americans everywhere will be thanking you for pushing up the value of their investments. Well, at least those Americans who have 401Ks and aren't trapped in low-pay gig economy jobs. And others have already pointed out the gains made under the Obama administration were actually higher and faster than under Trump.

I've been taking time this week to read through Trump's tweets. This will surprise readers, and probably offend many, but some of them are quite insightful and others are genuinely laugh-out-loud funny - if terribly non-PC and insulting. It makes me feel dirty just to admit that – does it mean I'm unreconstructed?

The point is, I don't think for a moment Donald actually thinks the Dow Jones Industrial Average of 30 large stocks represents the strength of the US economy. But he wants his voters to think it does. You don't need to send me emails to tell me how useless the Dow is. The S&P 500, a much better index, is bouncing around 3,000 - a record high!

I'm really nervous on the Dow because the biggest single component stock of the index – Boeing – is being dragged higher because in a rising market investors need to hold it. The weight of negativity on Boeing on its cashflow, regulation, litigation and management failure, is such I can see it being the harbinger of a sell-off, which could trigger systemic sentiment collapse.

Next week we've got Citi, Goldman and JP Morgan, Microsoft, Netflix, IBM and United – let's see how it goes. Maybe one of them will be the straw that breaks the market's current back?

Yes, despite all the above, I'm only mildly bearish on stocks. While I reckon some kind of sell-off is coming, it's likely to be a buying opportunity. There is still too much money in the system.

With the global economy flatlining it's difficult to see any realistic chance of interest rate normalization anytime soon. Global bonds just look too unattractive from a risk-return perspective at these levels: sovereign bonds are either negative or far too low, corporate bonds run too much illiquidity risk, and the chances of a corporate debt debacle look high.

In contrast, lots of readers have pointed out that a fair proportion of US and UK stocks have dividend yields higher than US treasuries. Do they yield enough to justify the higher risk? Most large stocks will remain liquid in a crisis that would lock corporate bond markets shut. I'm thinking where to put my chips – high-dividend stocks likely to weather a downturn well? Any suggestions?

Back in the UK, I've been putting this off too long. I need to write about UK risks. But first, I do recommend folk read the Bank of England's Financial Stability Report. Even the most hardened Brexiteer convinced the Bank is a bastion of treacherous Remoaners should pay attention.

I take what the Bank says at face value – and what it notes is: Brexit uncertainties exist - and have hit exchange rate and UK-focussed equities, and discouraged real investment by foreign investors. My question: will these be reversed once Brexit is done and dusted? (Don't ask what or how good "done and dusted is".)

The banking system looks prepared and ready. The Bank reckons the UK is ready for disruption, but they say "in the absence of further action by EU authorities, some disruption to cross-border financial services is possible. Although such disruption would primarily affect EU households and businesses, it could amplify volatility and spill back to the UK in ways that cannot be fully anticipated or mitigated." Dang…

Now I know everyone is bored and just wants Brexit to end. If it's going to hurt, let's get it over with. Which gets me to my big worry: ongoing UK political instability. Let's assume Boris gets the job. He says we will exit whatever on October 31 with a new better deal or a no-deal. What are the chances of either? Pretty low.

In terms of forcing through decisions, Boris is stuck trying to swim in the same treacle as Theresa May. His options are extremely limited. I detect signals Europe is quietly offering him an olive branch – an accommodation on the Irish border in return for a soft Brexit akin to the May 3-times-rejected plan. But there is no chance the Tory right will accept such backsliding.

What is actually going to change in terms of the numbers in Parliament? He needs every single vote he can get, but already a core of Tory Remoaners have said they won't support no-deal. He needs 20 MPS at least to swing behind him to get the parliamentary vote banning a no-deal Brexit overturned.

That looks unlikely – even if a number of Tories decide they will support him in return for his patronage. The votes won't come from Labour which is swinging behind the nightmare scenario of a second referendum.

Scotland is even worse – I was up there last week. Out with a bunch of mates, every single one said they would vote for independence if Boris wins. They all voted to stay last time.

The UK problem looks unlikely to be solved by Boris getting the PM job. We either get more go-nowhere politics – and an unsolved mess on October 31, hoping the EU gives a further extension. Or we get a general election – in which case Scotland's MPs will support Labour in return for INDY 2. And an election will force Boris into bed with Nigel Farage, which is such a horrible vision I won't even begin to contemplate it…

Whatever the outcome, or noutcome, it's impossible to be enthusiastic on UK prospects for sterling or stocks in the near term. Up to a few months ago I sincerely believed UK plc would be a screaming buy when Brexit is done. I still believe that, but I just don't have any confidence if and when it ever will be..

Have a great weekend!

Bill Blain

Shard Capital



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