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Quotidian Investments Monthly Commentary – September 2017

October 3, 2017

On 20thSeptember the US Federal Reserve decided, not before time, to put quantitative easing into reverse by unwinding the huge portfolio of bonds it had built up through its efforts to safeguard and stimulate the US economy following the financial crisis of 2007 onwards.

After buying up US treasuries and mortgage-backed securities as part of its ‘easing’ programme the US central bank’s balance sheet has expanded to $4.5 trillion; around four times its size before the financial crisis.   As it now looks to move monetary policy away from what had originally been intended as a short-term emergency measure, from October and each month thereafter the Federal Reserve will start to unwind those holdings at the rate of $10bn per quarter.  We see this as a positive sign of strength and confidence in the US economic recovery.

In line with the Federal Reserve’s approach under the stewardship of Janet Yellen it has been at pains to avoid a repeat of 2013’s ‘taper tantrum’ when its surprise announcement (under Ben Bernanke) that it would start reducing the amount of bonds it bought caught financial markets on the hop and sparked a steep and vicious sell-off.

In complete contrast to the unwelcome surprises regularly delivered under Bernanke (and even moreso the disasterous Alan Greenspan before him) this latest move had been well flagged with the result that markets reacted calmly to the news. 

Greenspan, who turned obfuscation into an art form, is best remembered from his statement that “if you think you understand what I’m saying then I’m not making myself clear”! A similar quote of his along the same lines was “if I turn out to be particularly clear then you’ve probably misunderstood what I’ve said”. 

He and his deliberately obscure style was the direct cause of so many periods of extreme volatility in stock-markets as well as being directly implicated in the origins of the sub-prime loans crisis (which, in turn, was the proximate cause of the global financial crisis).  It is quaintly ironic that , at the age of 91, he is still regarded in some circles in the US as a financial guru!

In her post-meeting statement Yellen said that “the basic message here is that US economic performance has been good” and in view of this strength she signalled that there was a high likelihood of another small interest rate rise in December followed next year by the prospect of three similar modest increases. 

This latest announcement is significant as the Fed’s tightening will further increase capital inflows to the USA from Asia and the world’s economic or political trouble spots.  

On 30th September 2017 the FTSE100 closed at 7318(a fall of– 0.78% for the month) and it now stands at just +3.22%for the 2017 callendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a rise of +0.53%for the month of September and the Fund is now up+31.64% for the 2017 year to date.

As we enter October some of our technical indicators still show that it is not all sweetness and light in global markets despite the positive signals from the USA economy and the Federal Reserve.  In some areas of the globe we note:

  • increasing pressure on some already massively indebted governments
  • a lack of confidence illustrated by stagnant or falling consumer spending and by the hoarding of cash by businesses rather than re-investment of earnings into business development
  • a rising tide of potential conflicts that presently threaten Japan and Europe and which is adding further to the flood of flight capital to the United States.

 Japan is at the centre of two of those conflicts:

Firstly, it is embroiled in a long battle with China over the Senkaku Islands in the East China Sea and at the same time Japan is also in the firing line of the North Korean dictator Kim Jong-un.

The chances that China will invade Japan or that North Korea will actually bomb Tokyo are currently still infinitesimally  small but there is little or no chance that Japan can escape the economic impacts of these threats.  Its Prime Minister is trying to swiftly push through a massive defence build-up that Japan simply cannot afford.  Long before this latest North Korean crisis began the Japanese government was already struggling to deal with an economic crisis of its own making.

Japan’s government is saddled with the largest sovereign debt in the world; more than one quadrillion yen in debt (that’s a 1 followed by fifteen zeros) and it means that even if the country had a annual budget surplus of one trillion yen it would still take 1,000 years for Japan to pay off its current liabilities. 

Tokyo’s existing debt is nearly two-and-a-half times the size of the entire Japanese economy and far larger than the over-indebtedness that pushed Greece, Ireland, Italy, Spain and Portugal to the brink of collapse.  Worse still, Japan’s debt is still trending upwards partly because of its servicing costs but largely because the government is committed to social welfare spending, which already accounts for one-third of its 106-trillion-yen budget and is rising automatically by about one trillion yen every year. 

In Europe the sovereign debt crisis we first saw a few years ago in Greece and the other PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) was only the tip of the iceberg. 

  • Despite repeated bailouts, 22 of the present 28 EU member states (including Spain, France, Italy and the UK) are deeper in debt now than ever before.
  • In Spain and France, it would take virtually every penny generated by their economies in an entire year to equal their national debts.
  • Portugal owes 29% more than its economy produces in a year. In Italy it is 33% more.
  • The Greek government, still in dreadful shape even after six huge bailouts, owes 76% more than its economy produces.
  • In contrast to the US decision to taper quantitative easing and phase it out, the European Central Bank still have their printing presses in full swing creating 60bn euros per month from thin air.This extreme and protracted central bank intervention was what Dragi meant when he promised to ‘do whatever it took’ to save the Euro and, indeed, it is the only thing saving the Eurozone from implosion under the weight of its own indebtedness.
Despite all this, in his most recent ‘State of the Union’ address Jean-Claude Juncker (with all the arrogance, complacency and financial incompetence we have come to expect from him and his ilk) proudly stated that the EU has the wind in its sails once again and is heading towards a glorious future.  Sadly, the only thing in Europe suffering from an excess of wind is Juncker himself.

At the same time as presenting this vision of the EU as a land of milk and honey, Juncker was busy behind the scenes trying to frustrate and repress a referendum in Catalonia to determine whether the majoriy of Catalans would prefer to secede from Spain and form an independent state.  Unlike the economic background to the Scottish referendum, Catalonia is the wealthiest and most productive region of Spain and if it were allowed its independence then that would risk destroying the supposed integrity of the Euro (and, thereby, the EU project itself).

Predictably, the very same ‘Project Fear’ tactics used in the lead-up to the UK Referendum have been in evidence and taken to even further extremes. Despite the fact that a referendum was originally agreed to by Madrid (albeit under a different Prime Minister), it has now been declared to be illegal and attempts have been made to prevent polling stations from opening.  It would be difficult to find a better example to illustrate what freedom of expression and choice really means Juncker-style in a centralised, anti-democratic federal paradise that exists only in the minds of EU technocrats, the politically myopic and the economically naïve.

History shows that politicians can ignore and frustrate majority public opinion for decades, but not forever.  Hubris is invariably followed by nemesis (even if there is sometimes a long time-lag between them).  At some point in the future the piper will have to be paid and it would somehow be quite fitting if he came from Hamelin.

From an investment perspective, for the time being all of this will simply add to the flight of capital towards the USA, which is still seen as the safest of financial havens.

A reliable investment mantra in years gone by was that if money supply was tight (that is, if it was difficult and expensive to borrow money) then the stockmarket would head south. Conversely, if money supply was loose (if it was cheap and easy to borrow) then stockmarkets would rise.  Of course, those were in the days of exchange controls to limit movement of capital and when markets were comparatively naïve and parochial.

Nowadays, stockmarkets are global and more sophisticated.  Huge sums of money can be transferred around the world in the blink of an eye and at the press of a button and, in continuation of the trend we’ve witnessed for the past few years, this flight capital will continue to flow into the US stock markets and support what, in times past, would have been seen as over-extended valuations.

At present we remain just 10% invested in equities with the balance of the Fund invested in cash. A proportion of that cash balance is held in US dollars and has been a welcome source of recent gains as sterling has appreciated against the dollar.

When we believe that the time is right to re-enter equity markets we will remain shy of the problem areas of the global markets outlined above and seek to re-establish a portfolio comprising a focused and relatively small number of carefully selected growth stocks that we trust.

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