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Quotidian Investments Monthly Commentary – September 2016

October 5, 2016

Global stock markets were relatively quiet from mid-July through to the end of August.  In fact, the S&P 500 went for 43 trading days without moving more than 1% in either direction.  However, that period of relative calm was decisively broken in the early part of September as the S&P 500 plunged 2.50% on Friday 9th, rebounded 1.50% on Monday 12thand then again plunged another 1.50% Tuesday 13th. 

There was no actual economic reason for this renewed turmoil.  Wall Street just loves to engineer investment volatility and sometimes take it to uncomfortable extremes.  Market makers like to keep the fear factor at the forefront of non-professional investor’s thinking and thus provoke the unwary into selling when they should hold fast (and let buying opportunities pass when they should be filling their boots). In this latest burst of volatility all major asset classes saw declines.  As ever, Wall Street bangs the drum and global markets march to the same tune.

In theory, stock and bond prices move in opposite directions from each other; when share prices decline bonds rally upwards and vice versa.  Too often for comfort that old truism does not persist in today’s markets. One of the consequences of the financial crisis has been that much conventional economic thinking has been turned on its head.  Thus we see that supposedly non-correlated asset classes frequently now all move in the same direction whereas in times past they counter-balanced.

In practice it has always been true that stock, bond, commodity and currency markets are influenced by the actions of central banks.  In recent years, however, that influence has reached new extremes as a direct result of endless political tinkering and central bank intervention. This has created an unhelpful addiction to financial stimulus which, in turn, has the effect of illogically distorting asset prices across all the main asset classes.  It can be compared to giving £10 to a drunkard; you know what he’s going to do with it but you just don’t know which wall he’s going to use! These frequent and unpredictable bouts of volatility will only stop when politicians stop interfering and simply allow markets to price assets on the basis of economic reality.

A few months ago the Bank of Japan (BoJ) decided that it would take the ultimate monetary policy action (and a step into the unknown) by taking short-term rates into negative territory.  Seemingly the thinking (if one can call it that as opposed to guesswork) was that Japanese banks would thus be forced to lend out money rather than see the value of that asset depreciate on their own books.  However, like many market manipulators before them, the BoJ did not anticipate the unintended consequences of their action.  Negative short-term rates drove rates on longer-term bonds into negative territory too and so banks (who make most of their profits by borrowing short and lending long) saw their profits evaporate.  With diminishing profits, banks’ lending standards perversely became even more stringent; they thus lent even less than before and ended up with the greatest hoard of cash in Japanese history.  This, of course, was exactly the opposite of what the BoJ had intended.

On September 21stthe BoJ essentially admitted defeat when it announced that it will no longer practice standard quantitative easing (QE) but instead would focus on yield targeting.  It still intends to buy Japanese bonds and stocks but will now ensure that the yield on the benchmark 10-year Japanese Government Bonds remains above zero.  In short, the BoJ asserted that there was “no limit” to their willingness to keep 10-year rates above zero.  We’ve heard that sort of rhetoric before but invariably it’s a typical politician’s empty promise.

Through its actions the BoJ is effectively nationalizing the Japanese stock-market. From figures compiled by Bloomberg, by the end of 2017 the BoJ will be the largest shareholder in 55 of Japan’s largest companies.

Meanwhile, both the Bank of England and the European Central Bank have announced massive asset and corporate bond buying programmes too and seem to be following the same road as the BoJ.

Observing that situation with a cynical eye, conventional pricing mechanisms are in danger of being swept away by this tsunami of newly printed money and, with governments becoming the largest shareholder in such a substantial number of major businesses, the scope for market manipulation is becoming a cause for concern. 

On 30thSeptember the FTSE 100 closed at 6899.33(a rise of+1.15%for the month and +10.53%for the 2016 year to date).  However, the mid-cap and small-cap indexes have not done as well thus far this year. By comparison, the Quotidian Fund’s valuation at the same date shows an uplift for the month of September of +1.17%and for the year to date the Fund is now –7.82%.  We continue to claw back the ground temporarily ceded during two substantial global market downturns earlier in the year and, with three months of the year remaining, I remain confident that we will be nicelyinto profit for 2016 by the year end.

We have been following with wry amusement various ongoing arguments between the USA and the European Union, which have accompanied their 10 year negotiations in search of agreement on a trade deal. These have come to a head during September.

To gain perspective, it is worth comparing and contrasting the historical background to the trading and business styles of each of these blocs. 

The US approach to international trade can best be understood through the philosophy expressed some years ago by John Connally when he was their Treasury Secretary.  He said that “All foreigners are out to screw us and it’s our job to screw them first”. 

From the other corner, the EU is and always has been protectionist, anti-capitalist and anti-business (think Jeremy Corbyn on performance enhancing steroids).  The latest salvos give one an even better insight into the workings, beliefs and motives of the EU.

At the end of August the EU attempted, through the sly medium of instructing Ireland to collect the sum demanded, to impose an eye-watering ‘fine’ on Apple for what was alleged and painted as tax avoidance.  The device used to construct this artificial judgment, though, was an assertion that Apple had received financial assistance in the form of low rates of taxation from Ireland and that this ‘state aid’ was forbidden under EU ‘rules’.  This interpretation of accepted international tax law is interesting to say the least.

Quaintly, government support given to banks throughout Europe (and particularly in the UK) to ensure their very survival during the global financial crisis was not deemed to have been ‘state aid’. 

Within days of that ‘judgment’ the USA declared that negotiations on a trade deal with the EU were over.

This was followed rather swiftly by the US Department of Justice imposing a $14 billion fine on Deutsche Bank on the grounds of mis-selling (packaging and selling toxic debt monetized in the guise of AAA grade assets). As you will have seen in recent news bulletins, Deutsche Bank is in grave financial difficulties and close to failure and its share price has plummeted accordingly.  How enigmatic that the amount of each of these fines is strangely similar. 

It is also interesting to note that the US has chosen its target well.  Deutsche Bank is close to collapse; will the Germans allow it to go bust or will they step in with financial support (although they were not prepared to help Italian banks in this way)?  Would that be “illegal state aid”?  If a German bank, of all things, were to go bust what would that say about that famed German financial rigour (as used to impose discipline on Greek and Italian banks!) and what would it do for the future of the euro itself.  Hats off to the US official who thought out that particular tactic!

In the background to all that, for the past 5 years the EU has being doing its best to find an excuse to fine Google over claims that it has become too dominant in its field of business which. of course, is deemed to be ‘unfair’ in the other-worldly eyes of the EU.  Apparently, being too good at what you do (and therefore beating the competition hands down) falls foul of EU anti-competition rules.  To inflame matters further, a US investigation in 2013 cleared Google of misusing its dominant position (well they would, wouldn’t they) in the way that the EU were representing. 

All good clean fun.  In its move against Apple I can only conclude that the EU was trying to get its retaliation in first!  The idea that the EU could overturn or even challenge the USA’s global financial hegemony is an alarm call for the men in white coats to pay an urgent visit to Brussels.

It all goes to show that the pantomime season has started early this year!

EU Rules and Reality 
The EU’s unbendable and unbreakable ‘rules’ (and how they are ignored when expediency suits our bureaucratic dictators).

The truth is that these ‘rules’ are simply words that sound good and are meant to intimidate.  However, they are subject to whatever political interpretation suits the Brussels mafia at any given point in time.

For example, the ‘sacred’ stability and growth pact which, when the euro was first introduced, was meant to limit each EU country’s budget deficit to 2 percent.  As soon as the real world interfered with the EU’s Malice in Blunderland economic illiteracy, this pact became unworkable and was quickly and quietly removed.

Likewise, the ‘no bail-out’ clause intended to protect members from bankrolling other nations was quietly torn up as soon as the Euro started to collapse.  It could well become the same with the ‘single market’ and ‘open borders’.

Quite simply, the modus operandi of the EU is that all their apparently implacable ‘rules’ are broken with impunity if political expediency requires them to be broken in order to maintain the charade.

The next potentially market-moving event is the US Presidential election which is now only a month away.  Both candidates are equally unpalatable and are neck-and-neck in the opinion polls (which, of course, have proved to be so reliable in recent elections and referendums!). 

I have no doubt that stockmarkets will react negatively whichever of Clinton or Trump prevails but I believe this will be just a short term effect.  We have known for three months or so that the choice falls between just these two unimpressive candidates and so the final outcome will not be a long-term surprise to financial markets.

If Clinton wins she will in effect be a non-executive figurehead only and have no real legislative power.  The US legislature (Congress, comprising The Senate and the House of Representatives) is firmly dominated by the Republican Party which will subdue and overwhelm any of Clinton’s wilder inclinations and expenditure.  She is profoundly disliked and distrusted by over 60% of Americans most of whom would dearly like a change away from the socialist policies pursued by the Obama administration over his two terms in office and which are so foreign to American culture.  In many parts of the United States it is now possible to ‘earn’ more on welfare than it is to work which is a shocking betrayal of the aspirations inherent in the ‘American dream’.  The fact that Clinton is still in the race is a telling commentary on the persona of her Republican rival.

Trump is beyond parody.  Is he as crass as he appears or is he dumbing down and making wild and idiotic statements in order to appeal to red-necked Americans, the very people who would normally vote for the Democratic party?  Time will reveal all.  If he should prevail and be sworn in as President then Congress will no doubt also supress Trump’s idiotic and exuberant buffoonery.

It beggars belief that, on the face of it, these two are apparently the best alternatives America has to offer. 

Once the election outcome is known and when the dust has settled, I am sure markets will quickly refocus on economic rather than political news.

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