There was a major “Oops!” out of China today as February overseas shipments not only missed the forecast increase of 7.5% but in reality weren’t even in the ballpark as the bureau for statistics reported a decline of 18.1%.
This is not a minor matter as it dovetails with a decline in the producer price index by 2% which together do little to support Premier Li Keqiang’s 7.5% GDP growth target. If this is to set the tone for the beginning of the current week, we might be in for a bit of a tricky time.
Meanwhile, the other bit of “big” news is an article published in the Bank for International Settlements’ Quarterly Review which looks at some of the danger inherent in forward guidance. I believe, no surprise there, that it has a strong point when it warns that investors will be tempted to take excessive risk if they feel that the monetary policy environment is predictable to the far horizon, thus creating the platform for future instability.
At least we know where the next blow up will be taking place.
This is the third cycle of unnaturally low interest rates which I have experienced in my career, the first being from 1992 to 1994 while the US was digesting the S&L crisis, the second being after Alan Greenspan hit the panic button in the aftermath of 9/11 which led a willy-nilly piling on of risk and the third and current one which was launched in order to help mop up the mess left by the second one.
The reversal of the first one which began with a 25bp tightening on February 4 1994 led to carnage, especially in the structured rates market which had benefited from investors’ need for yield. The second one drove the next generation of yield hogs into structured credit, the outcome of which we all know and still live day in, day out. The third and current yield hunt has largely been played out in the capital structure of corporates and banks where levels of subordination are being played with as though they were LEGO bricks. At least we know where the next blow up will be taking place.
We do not, however, know how and with what ferocity the blow-up will occur. In 2004 and in 2008 banks were still able to provide market liquidity. You might not have like the price they showed you when you were trying to get out of the door but at least there was a price available. Following Dodd-Frank and Basel III there will, with all likelihood, be no price at all.
If a market is where buyers and sellers meet, then a place without a bid is not a market. Many years back I coined the phrase that the door marked “Entrance” is many times larger than the door marked “Exit”. That “Exit” door which really could never cope when put under stress is now significantly smaller than it ever used to be.
In fact investors should now be de-risking while there still is a modicum of liquidity to be found but who amongst them will have the guts to go to the boss or to the trustees and suggest that it would be wise to exit the room where the punchbowl is kept despite the fact that it is remains well topped up and also apparently unguarded?
When credit markets go into reverse, and into reverse they will go, the CoCo or AT1 market (wittily dubbed “81” by my chum Bill Blain at Mint Securities) will probably be without a bid in any shape or form. Investors who believe that they will be able to beat the system and get out before it all goes wrong can be found by the thousand but only one of them can be the first one and the rest will quite possibly come joint-last.
Mid-30s
Alas, forward guidance tells us that rates are not going to begin moving until early- to mid-2015 so the world can rest assured that risk isn’t as yet too risky and that we can keep on piling it on. I am for the first time hearing analyst suggest that some of the new CoCos – sorry, AT1s – are looking fully priced and yet they are massively oversubscribed and all trade at an at least one point premium bid in the grey market.
The slalom for the visually impaired should be taking place in Sochi and not on Wall Street or in the City, but if holders think that when the day comes the back-stop bid will be in the mid-90s, they haven’t had the pleasure of dealing with the distressed debt funds. Mid-30s maybe. Enough now!
The BIS has made its point about the risks of forward guidance and all that I heard from the pundit community is that the BIS has got its knickers in a twist and that all we need is for the monetary authorities to gain some experience and to “fine-tune” their predictive powers. It’s not the central banks I’m worried about. It’s the investors.
As long as we continue to measure the performance of our investment managers on daily, monthly or even quarterly returns we will be faced with a culture of short term risk taking at any price and the fear of what occurs if the fund drops out of top quartile. I still wonder why I have never heard of any of funds which are in the second, third or fourth ones. Perhaps I should have learnt in 2008 that it doesn’t matter if a fund with all its investors’ wealth goes to the dogs, so long as it is firmly does so hand in hand with in its peer group. Bah, Humbug.
Leave that aside for today and focus on China’s missing exports and, to make life a bit more fun, the increasing signals that Shinzo Abe’s three arrow policy is stalling too.
Have a good week.
