I hope this finds you well, and you’re enjoying the bank holiday. Unless you’re in Scotland, in which case, I hope this finds you well and you had a good bank holiday three weeks ago.
Anyhow, as I’m out of the office today, I’d like to treat you to the latest from Tim Price, fund manager and editor of The Price Report.
Tim recently issued a warning to his subscribers which he thought was so important, that he wanted it to not only be sent out ahead of schedule, but that he was happy for it to go to everybody we have an email address for – even if you’re not a subscriber to his or any of our other paid services.
After you’ve read what he has to say below, I’m sure you’ll be able to appreciate why.
All the best,
Boaz Shoshan
Editor, Capital & Conflict
Things become more serious
Tim Price, The Price Report
Every household should have a copy of J.K. Galbraith’s The Great Crash 1929. Not just because it’s the most valuable memento mori of the impermanence of wealth in any financial system. But because the quality of the writing is sublime.
Galbraith is a master of dry, dark humour as well as subtle understatement. Chapter VI, “The Crash”, is a white-knuckle ride through late October 1929, featuring some of the most dramatic days in the history of the US stockmarket. It ends with the following paragraph:
Stocks, it was agreed, were again cheap and accordingly there would be a heavy rush to buy. Numerous stories from the brokerage houses, some of them possibly inspired, told of a fabulous volume of buying orders which was piling up in anticipation of the opening of the market. In a concerted advertising campaign in Monday’s papers, stock market firms urged the wisdom of picking up these bargains promptly. ‘We believe,’ said one house, ‘that the investor who purchases securities at this time with the discrimination that is always a condition of prudent investing, may do so with utmost confidence.’
The paragraph ends with a lapidary phrase,
On Monday the real disaster began.
Chapter VII is titled “Things Become More Serious”.
We are now living through a period in which things within the capital markets have become, suddenly, significantly more serious. Not to put too fine a point on it, I am now more concerned about the fragility of the European (and by extension, global) financial system than at any time since 2008. The difference being that we have already had a decade of the most extensive monetary experimentation in history, and it has all effectively been for naught.
If you don’t like my way of framing things, perhaps you will prefer that of the financial historian and one of my favourite analysts, Russell Napier, who last week wrote, in his The Solid Ground newsletter (emphasis mine):
The price of the equity of the following major European banks is now lower than when global equity markets bottomed in January 2019 – BBVA, Santander, Commerzbank, Danske, Nordea, ABN Amro, KBC Group, Deutsche Bank, ING, Societe Generale and Swedbank. Many others are close to their January lows and in many cases the January 2019 lows were the lowest prices seen since the 1990s ! The facts are that in the Eurozone bank balance sheets are contracting, key bank share prices are at all-time lows while interest rates are negative across the yield curve in most countries.
Investors can of course blissfully continue to ignore these facts and seek protection in ‘cheap’ European equities. Your analyst continues to recommend that they do not do so. We are living through the failure of the largest monetary experiment the world has ever seen – the creation of a new currency for Europe. The consequences of the failure of that experiment, now evident in Eurozone government bond yields, bodes a scale of economic disruption that is incredibly negative for Eurozone corporate earnings and equity prices.
Of course, not all market commentators are as honest or outspoken as Russell. Some, like the Financial Times, continue to pursue their partisan support for the EU project, come hell or high water. Take last week’s front-page headline, for example:
Global banks cut 30,000 jobs as investment climate darkens
“Global” banks – really? You had to read down well into the second paragraph before you stumbled on the truth that the FT was probably ashamed to concede:
Most of the cuts have come in Europe, with Deutsche [Bank] accounting for more than half the total…
To adapt a line from Margaret Thatcher’s 1979 successful election campaign on behalf of the Conservative Party: Europe isn’t working. The euro isn’t working.
And this has been evident for years. As Mrs Thatcher also observed, you can’t buck the market forever.
In the weeks and months ahead, you may need to choose your media carefully. Most of the mainstream media cannot be trusted even to provide simple facts. In some cases (one thinks particularly of Robert Peston, then at the BBC, in 2007 actively igniting the run on Northern Rock), having studiously avoided bringing you bad news for months, they may suddenly and inadvertently trigger a full-scale market panic. And then all bets are off.
I don’t waste too much time any more on mainstream media. My preferred “research” inputs are fellow fund managers, analysts and strategists, many of whom post actively on Twitter and share their materials on podcasts and YouTube.
One of them is Russell Napier, from whom we’ll hear a little more, later.
One of them is Raoul Pal, the co-founder of Real Vision, formerly head of European hedge fund sales at Goldman Sachs and portfolio manager at GLG’s Global Macro Fund. You can follow him on Twitter via @RaoulGMI.
On 10 August Raoul tweeted the following observation:
This level in the Eurostoxx Banks Index is probably THE most important level of ANY chart pattern in the history of equity markets (hyperbole? I’m not sure). A break of this [support level] would suggest a potential total collapse of the entire EU banking sector.
Source: Bloomberg LLP
(The “SX7E” Index is a real time index of eurozone banking stocks.)
As part of this thread, Raoul went on to add:
I hope you understand that this goes beyond trading markets, investing, etc. This could be societal, pivotal and political… This may be the 4th turning. The End Game. The logical conclusion of the current system of money. The logical conclusion to the pension system…
I am fully aware this sounds alarmist and crazy. It isn’t intended to be… The question therefore is – Can it be stopped? I don’t know… but I thought it was important that I share these thoughts. I hope I’m wrong. Honestly.
(That reference to the “4th turning” is to a book, The Fourth Turning: an American prophecy, by William Strauss and Neil Howe, and the point in the cycle of life “when society passes through a great and perilous gate in history”.)
One of them is Alasdair Macleod, the head of research for Goldmoney (you can follow Alasdair on Twitter via @MacleodFinance). Notwithstanding Alasdair’s professional allegiances, here is some of what he wrote on 8 August (you can read the entire piece here):
Growing evidence of a severe global recession is sure to provoke more aggressive monetary policies from central banks. They had hoped to have the leeway to cut interest rates significantly after normalising them. That hasn’t happened. Consequently, as the recession intensifies central banks will see no alternative to deeper negative nominal rates to keep their governments and banks afloat through a combination of eliminating borrowing costs and inflating bond prices. It will be the last throw of the fiat-money dice and, if pursued, will ultimately end in the death of them. Gold and bitcoin prices are now beginning to detect deeper negative rates and the adverse consequences for fiat currencies.
My friend Paul Rodriguez and I interviewed Alasdair as part of our State of the Markets podcast on 7 July – you can listen to that interview, as well as others that are just as insightful, here.
I’d also recommend our 11 August interview with technical analyst Tim Parker of Messels – who also highlighted the deterioration in the Stoxx Banks Index.
And try to make time, if you can, to watch this presentation by Russell Napier, “Why equity bear markets happen and why one is likely now”. It’s from December 2017 and it lays out in forensic detail how the next market slide could plausibly develop. It’s not scaremongering, just solid and logical economic analysis, informed by historical example.
So what action, if any, should we take in response to the rapid deterioration in eurozone banking stability?
In the first instance, ensure that any potential liability you might have to banks in the form of cash deposits is diversified by institution. UK authorised banks and building society deposits are covered by the Financial Services Compensation Scheme to the order of £85,000 (individuals) or £170,000 (joint accounts).
It seems plausible to assume that eurozone banks are far more vulnerable to financial failure, insolvency, suspension or the risk of depositor bail-ins than their UK peers, but in an environment of a potential bank run, you simply can’t be too careful.
In terms of near-cash alternatives, the best/least worst option for UK investors is to hold short-term gilts, and the most convenient way of doing so is through a diversified short-term gilt exchange-traded fund or ETF. A handy “starter for ten” is the iShares UK Gilts 0-5 year UCITS ETF. Fact sheet available here. This tracks an index of up to five-year gilts with 13 underlying holdings in UK government bonds. The rationale for this fund is not to maximise returns per se, but rather to offer an
I recommend short-term gilts because their price volatility will be less pronounced than that of longer dated gilts, especially in the event that interest rates finally and belatedly rise. The iShares Gilt fund has a total expense ratio of just 0.07%, so it’s hardly expensive. And you don’t need to pay active management fees for what is essentially a passive ladder of short-term bonds.
Thereafter, it’s all about appetite for risk (and price volatility, for they are not the same thing), and the time horizon over which you plan to invest.
There are no European shares in The Price Report portfolio, and there aren’t likely to be any, anytime soon. This isn’t just a judgment call on the relative unattractiveness of the eurozone as an investment destination (though it is that, too), but more a reflection on the relative attractiveness of other geographies, notably Asia.
In the event of further deterioration in the European financial system, you may wish to reassess just how much equity risk you wish to hold in your portfolio, regardless of where individual companies happen to be located in the world.
Banking stocks are clearly a no-go area, especially in the eurozone. My suspicion is that any worsening in Europe’s deflationary malaise will be met, quite quickly, with further monetary stimulus that will at some point threaten messily high inflation if not something altogether worse.
That scenario would, all things equal, strongly favour gold, silver and related mining concerns. It is also plausible that the attendant volatility and strongly trending markets would form a positive backdrop for trend-following funds. It’s all about genuine diversification.
The problems in the eurozone financial system have not come out of a clear blue sky – as the global financial crisis of 2008 appeared to, to some observers, including our own Queen. They have been building since the very start of the European project. Consider the following, from Jean-Jacques Rosa’s Euro Error, published in 1999, 20 years ago:
… in the final analysis, the responsibility for Europe’s malaise falls on the policy that was chosen and the people who were responsible for implementing it. Contrary to the litany of governments that hide from any criticism behind the “tyranny of the financial markets” and the “constraints of globalization,” supposed to deprive them of any room for manoeuvre, it should be clearly recognized that the financial policy of the State, the “macroeconomic” policy, is not dictated by the international environment. It results, in fact, from a choice that is basically political and not economic: that of the construction of a European State, intended to superimpose itself on the national states.
Instead of making it a priority to reform themselves, to restructure themselves by refocusing on their principal business as companies do, and seeking greater efficiency and therefore lower costs (that is, lower taxes), the European States have committed to a plan for external growth through political merger on a pan-European level. The Continent is no longer a simple area of free trade and cooperation among sovereign states. It has become, under the reign of the Socialists, a place for creating a super-State by merging the independent States that history had created, an undertaking that starts with the creation of a common currency. And this ambitious merger of the bodies politic is launched at the very moment when every country, all over the world, is tending rather to split and to divide in order to satisfy better their citizens’ expectations, while saving on the overhead costs of managing large bureaucracies.
The first fundamental market dislocation I experienced during my career was the ERM crisis of 1992. The UK had joined the exchange rate mechanism despite the best efforts of Mrs Thatcher to keep the country and our currency well out of it. Needless to say, she was right on the issue, even though it ultimately cost her her job.
Channel 5 has just aired a two-part documentary hosted by Michael Portillo, The Trouble with the Tories, and it’s surprisingly watchable. Needless to say, the issue of Europe features prominently, as you would expect.
The most sickening moment of the whole programme is Kenneth Clarke, wheeled out as ever to defend the European project, describing Black Wednesday – a dress rehearsal for Britain crashing out of Europe if ever there was one – as “a completely inconsequential moment”. The cognitive dissonance is terrifying.
A former chancellor fails to appreciate that membership of a common currency bloc was disastrous for the UK, and it was only our violent ejection from said bloc that lifted our economy out of recession. But not before UK interest rates had been raised to 15% and the Treasury had blown almost all of our foreign exchange reserves in the course of less than 24 hours. As a commentator said at the time, it was “as if the chancellor had spent the entire afternoon lobbing schools and hospitals into the North Sea…”
As Jean-Jacques Rosa pointed out 20 years ago, the EU is a political project, rather than the economic one we thought we joined back in the 1970s. What is now becoming increasingly visible is that Europe’s politicians and unelected technocrats at the European Central Bank (ECB) have no clue what sort of monster they have created.
Try and make time, too, to read this essay by Richard Werner, an Oxford professor in banking and finance. Edited highlight:
The overarching trend of the 20th century has been the concentration of power in the hands of the few. This has not been a healthy trend, as many millions of innocent people died during the 20th century.
Central banks have been key beneficiaries and today’s locus of this unprecedented concentration of power. At the same time, central banks lack accountability. There is no meaningful way in which central banks are held to account for their massive policy ‘mistakes’ and reckless creation of vast boom-bust cycles, massive banking crises and large-scale unemployment (with youth unemployment at over 50% in Spain and Greece).
This unaccountable, hence limitless and absolute power in the hands of the central bankers has consequences.
Lord Acton, a shrewd observer of power, concluded:
“Power tends to corrupt and absolute power corrupts absolutely.”
Lesser known is that he also seems to have been aware of the power in the hands of the bankers:
“The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.”
Some kind of reset is coming. It has to. Faced with negative rates on bank deposits across Europe, eurozone investors are understandably fleeing from yieldless and negative-yielding cash deposits and into the presumed “safety” of government bonds, almost indiscriminately.
There is a word for this behaviour. It’s called a bank run. The further into negative territory that the ECB drives interest rates, the more intensely it accelerates the run on the European banking system. Inverted yield curves and negative rates demolish banks’ lending margins – which is why the Stoxx Banks index is touching new record lows.
I’ll draw to a close this issue with just two words. Got gold?
The very last word goes to J.K. Galbraith:
Now, as throughout history, financial capacity and political perspicacity are inversely correlated. Long-run salvation by men of business has never been highly regarded if it means disturbance of orderly life and convenience in the present. So inaction will be advocated in the present even though it means deep trouble in the future. Here, at least equally with communism, lies the threat to capitalism. It is what causes men who know that things are going quite wrong to say that things are fundamentally sound.
Until next time,
Tim Price is director at Price Value Partners and manager of the VT Price Value Portfolio. He is also the author of Investing Through the Looking Glass: a rational guide to irrational financial markets.
Category: Market updates