David Fuller and Eoin Treacy's Comment of the Day
Category - General

    On Target: the Private Newsletter on Global Strategy from Martin Spring

    My thanks to the author for his ever-interesting report – here is the opening:

    Low-Risk Plan: ‘Shot Through the Heart’

    Those of you who have been following my opinions for a while know how much I favour a Browne Plan for those who don’t have the experience, skill or time to manage family wealth actively.

    Invented by the American strategist Harry Browne, such a plan promises steady long-term capital growth with minimal downside risk, requires no management beyond a simple annual portfolio view, and frees you from having to make any decisions about what’s happening in the markets. The concept is simple – ignoring fixed assets such as your home, you allocate a fixed proportion of your capital to each of several very different asset classes, but rebalancing periodically, moving capital from those that have gained in value into those that have fallen. You sell some expensive assets to buy more of those that have become cheaper.

    Browne recommended investing 25 per cent of your portfolio in each of just four assets -- shares, bonds, gold and cash.

    Anyone who followed such a plan in the US since 1970 would have achieved an average return of 8.35 per cent a year. In only five of those 45 years did the portfolio lose money, and always bouncing back strongly in the following year.

    The logic behind such a plan is…

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    Brad Katsuyama Q&A: I Do Not Think We Would Have Survived If It Was Just Hype

    Stock exchanges are part of the plumbing of Wall Street, and the details of how they’re run have never exactly captured the public imagination. That changed with Brad Katsuyama, 38, the co-founder and chief executive officer of IEX, who brought equity market structure to the mainstream as the hero of Michael Lewis’s book Flash Boys. Katsuyama was working as a trader at the Royal Bank of Canada, helping big investors buy stock, when he noticed it was getting increasingly difficult to do so without moving the price. As he investigated, he came to the conclusion that stock exchanges weren’t always looking out for investors’ interests and the market favored high-frequency traders at the expense of long-term investors. (In Lewis’s words, the market was “rigged.”) This led Katsuyama to start IEX, an exchange with a “speed bump” designed to slow down high-frequency traders on behalf of longer-term investors. After a grueling application process full of fierce resistance, IEX’s Investors Exchange gained approval from the U.S. Securities and Exchange Commission in June. “We just wanted a chance to compete,” says Katsuyama, who spoke with Matt Levine of Bloomberg View about the nuances of market structure shortly after the exchange went live in September.

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    I have seen the future and his name is Kevin

    Thanks to a subscriber for this note by Albert Edwards at SocGen which may be of interest to subscribers. Here is a section:

    Summers’ relaxed view on the debt build-up, particularly visible in the corporate sector, is in sharp contrast with our own view that this looks set to wreck the US economy. Summers was particularly dismissive of comparing debt to income as the former is a stock and the latter a flow concept. He thought it entirely appropriate in a world of lower interest rates that debt had reached record levels relative to income? belying, for example, the concerns expressed by the IMF this week. Should we worry about the chart below or not?

    The charts above and below have just been updated by my colleague Andrew Lapthorne (and using the S&P 1500 ex financials universe). Summers? point was we shouldn’t be too stressed about rising debt as 1) QE is driving up asset prices and higher debt does not look excessive relative to assets, and 2) rock-bottom interest rates mean the debt is easily serviceable. Now on the first point, Andrew shows that quoted company corporate debt has rocketed relative to assets to now exceed the madness last seen at the height of the 2000 TMT bubble. Indeed the problem with Summers? analysis in my view is that it is the higher debt that is being used to push up asset values (via share buybacks), just as it did during the housing bubble in 2005-7. And by pushing asset values well beyond fundamentals you build debt structures on false asset values, which only become apparent when the asset bubble bursts. And am I in any way reassured that the Fed sees no bubbles? No, I am not. These dudes will never identify an asset bubble? at least before the event!

    Andrew notes that the way corporate bond pricing models work (e.g. Moody’s KMV and Merton’s “distance to default” models) it is not just a company’s ability to pay its coupon that affects its valuation. Investors are in effect always asking, can this company repay its principal TODAY, even though the repayment is not actually due for 30 years. If asset values collapse in the event of a recession, corporate bond spreads will explode irrespective of the fact that they can easily pay the interest. But hang on a second, let’s just look at interest cover for the quoted sector, for Andrew finds that despite record low interest rates, cover has declined to levels last seen in the depths of the last recession (see chart below)! In the next recession a sharp decline in both profits and the equity market will reveal this Vortex of Debility. US corporate spreads will then explode as the economy is overwhelmed by corporate defaults and bankruptcies. And with the Fed having been the midwife of yet another financial crisis, what price do you give me for it to lose its independence?


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    Email of the day on medical innovation

    Here's an intriguing finding - silkworms  can produce silk with graphene embedded, which gives material with electrical conductivity! With further development, materials with these properties moves us closer to the day when we may be wearing 'ordinary' clothing which gathers and transmits information in real time about our health. So all of us can then have a longitudinal personal health record assessed constantly by AI systems which feedback instantly any concerns being noted. No need to visit a doctor for diagnosis, AI will be much faster and much more accurate. Comparison of our personal health longitudinal record with the collected human database will give much more accurate diagnosis and prediction than is possible today. 

    This vision is one of the reasons I noted in an email a few days ago that healthcare will generate the biggest of big data, and why we need blockchain technology to secure it. 


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    Email of the day on the influence of mega-caps on the performance of the S&P 500:

    Given that (apparently) the FANGS account for about 50% of the total gains in the S&P500 over the last 2 years, it would be interesting to see what a chart of the S&P500 minus the FANGS would look like. Does such a chart exist?

    My gut feel is that the chart would look more like the Dow Jones Industrial Index


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    If Europe Insists On a Hard Brexit, So Be It.

    Personally, I have been in favour of a "soft Brexit" that preserves unfettered access to the single market and passporting rights for the City, but not at any political cost - and certainly not if it means submitting to the European Court, which so cynically struck down our treaty opt-out on the Charter in a grab for sweeping jurisdiction.

    But what has caused me to harden my view - somewhat - is the open intimidation by a number of EU political leaders. "There must be a threat," said French president Francois Hollande. "There must be a price... otherwise other countries or other parties will want to leave the European Union."

    These are remarkable comments in all kinds of ways, not least in that the leader of a democratic state is threatening a neighbouring democracy and military ally. What he is also admitting - à son insu - is that the union is held together only by fear. He might as well write its epitaph.

    Mr Hollande and German Chancellor Angela Merkel invariably fall back on the four freedoms -movement, goods, services, and capital  -enshrined in EU treaty law, as if they were sacrosanct.

    These freedoms are nothing but pious shibboleths. They often do not exist, and where they do exist they are routinely honoured in the breach. Services make up 70pc of the EU economy yet account for just 22pc of internal EU trade. All attempts to open services up to cross-border commerce have been defeated, to the detriment of Britain.

    The sorry saga of the Services Directive in 2006 tells all you need to know about how the EU works. "The French and Germans gutted it," said Professor Alan Riley from the Institute for Statecraft.

    The 'country of origin rule' that would have allowed firms to operate anywhere in the EU under their own domestic law was dropped, casualty of the "Polish plumber" scare. The directive did not cover health care, transport, legal services, professions, tax experts, and the like. Germany protected its guilds.

    Online and digital trade across borders remains minimal, riddled with barriers. Britain's All-Party Parliamentary Group for European Reform concluded that "there is no single market in services in any meaningful sense."

    As Brussels correspondent I covered the parallel fiasco of the takeover directive. This too was sabotaged by France and Germany,  after fourteen wasted years. They reinstated poison pills and a host of tricks in an explicit attempt to stop 'Anglo-Saxon predators' taking over their companies, even as their own companies were free to stalk British prey.

    "It was disgusting," one Commission official told me at the time. Frits Bolkestein, the quixotic single market chief, was despondent.  "It is tragic to see how Europe's broader interests can be frustrated by certain narrow interests," he said.

    So much for the freedoms of capital and services. Nor has the free movement of people been strictly upheld. France and Germany - unlike Britain - blocked access to their labour markets and welfare systems for East Europeans for seven years after they joined the EU in 2004. It was political decision.

    The four freedoms are really just aspirational guidelines, enforced when expedient, neglected at other times. The rigid exhortations from Paris, Berlin, and Brussels that there can be no free trade with Britain unless there is unrestricted migration - even after leaving the EU - is politics masquerading as principle. If they want to find a compromise solution, they can do so easily.

    It is an odd spectacle. On the one hand the EU is so insecure that it talks of punishing Britain to deter other escapees; on the other it exhibits an imperial reflex, demanding submission entirely on its own terms, seemingly unable to accept or even to imagine a reciprocal trading relationship based on sovereign equality.

    Mr Hollande wishes to bring about the hardest possible Brexit. If this proves to be the EU position - and it may not be, since it is lunacy and he for one will soon be irrelevant - it does at least clarify the issue.

    A hard Brexit was never my preference. While the economic benefits of the EU customs union are greatly overstated, it would be no small matter to unwind the nexus of cross-border supply chains that has evolved over decades.

    But if that is the only choice, so be it.

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    Soaring Gilt Yields are a Bigger Problem than the Pound Slide

    Forget about sterling; the real action is in the bond market, which has suddenly caught fire.

    Yields on 10-year gilts have almost doubled to 1pc; they were just 0.52pc on 12 August.

    Investors are reeling, and for good reason.

    So what is happening?

    For years now, gilt yields have been going down, and further down, in common with fixed income markets in all developed countries.

    The cost of long-term borrowing has fallen to ridiculously low levels; in many cases, people have been paying in real terms for the privilege of lending to the Government.

    There are cons as well as pros to this.

    We’ve seen the emergence of a giant bonds bubble, a false market in gilts fuelled by quantitative easing and the belief that central banks are now the gilt buyer of first resort; asset prices have surged, bolstered by lower discount rates; pension funds have become almost unviable; and an excessively bearish view of long-term economic growth has taken hold, with forecasters confusing artificially low bond yields with the market’s assessment of long-term GDP growth.

    The main advantage of cheap money is that it has slashed the cost of government as well as private sector borrowing.

    Fixed rate mortgages have tumbled, and companies have been able to borrow more cheaply, which means that the hurdle rate for capital projects has fallen, boosting corporate investment.

    Yet the trend in the UK has suddenly turned, for now at least. In the last week alone, yields have jumped from 0.73pc last Monday to 1pc today, going hand in hand with sterling’s drop from $1.30 to $1.24.

    Some institutional investors are licking their wounds: since 12 August, the 10 year gilt price is down 3.7pc, the 20 year gilt by 6.6pc and the thirty year gilt by 9pc, according to Hargreaves Lansdown.

    So much for a supposedly safe, non-volatile asset. On top of all of this, the gap - or spread - between gilt yields and the yields on German government has increased, rising to almost a whole percentage point. Philip Hammond’s borrowing will be more expensive and his deficit greater; by contrast, pension fund deficits have fallen sharply in recent days.

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    Four Ways the UK Can Take Advantage of a Weaker Pound

    First, let’s focus on core export industries where price makes a difference

    We sell a lot of pharmaceuticals, but they are not price sensitive. Ten per cent here or there does not make a lot of difference to which medicine you prescribe.

    But our largest single export by value is now cars – we sell $46bn (£37bn) of those abroad every year.

    With a cheaper pound, the likes of Jaguar and Land Rover should make real progress against BMW and Lexus – indeed, the German manufacturers must be feeling a little queasy at the thought of tariffs in retaliation for our audacity in leaving the EU on top of the currency movement.

    Likewise, our biggest net export by value is Scotch whisky. That is now going to be a lot cheaper against brandy or bourbon or any other high-end spirit. We should help distillers to expand and conquer new markets. If people get a taste for British cars and drinks again, that will last a long time.

    Next, let’s encourage a fresh wave of inward investment

    It looks like we are going to lose the advantages of being in the single market, which was a powerful incentive for global companies to base themselves here.

    But, heck, we just became far, far cheaper, and, to make it even better, we have the lowest corporation tax of any major economy as well.

    If overseas companies want to set up in this country, or buy our companies, then great. The more the better. In the last decade foreign investors have rebuilt half of London – let’s get them to rebuild Manchester and Leeds as well. And if at least three FTSE companies haven’t been sold in the next year, we should count that as a failure.

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    Email of the day

    On dealing with EU countries once out of the EU:

    Dear David, In commenting on Roger Bootle's article yesterday, you wrote "Once out of the EU, the UK can propose sensible trade terms with individual European nations..." As I understand it, once the UK leaves the EU it will only be able to negotiate trade agreements with the EU Commission and not with individual EU countries. Under EU treaties, it is the Commission that has exclusive authority to negotiate trade deal on behalf of its members as a whole. Were you referring to all the other European countries in your comments?

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