Comment and opinion for retail investors in the UK
The push me/pull you tug of war in stock market valuation judgements continues, with the pessimists seeing more central bank rate rises and recessions all over the place and the optimists predicting the end of the monetary tightening and the brakes coming off a little.
It is rare that a completely new type of investment asset becomes available to retail investors, but after the FCA has come up with rules following its consultation launched in late 2022, we may be able to access, in a limited way, LTAFs, something that is a new concept in the UK
LTAF stands for Long Term Asset Fund and at the moment only one exists, which is available to institutional investors like pension funds and has been created by Schroders.
I have already posted that I see a lot of sense in the arguments of those market commentators who say that central banks’ determination to crash the economies of the developed world into recession, even suggesting that stock markets being positive is unhelpful, is the worng strategy because it is manifestly not working and in any case it is policy reaction appropriate to different causes. We have been getting supply side driven inflation and the reaction has been appropriate to demand led.
I saw UK inflation numbers after first publishing this post and that is more evidence of supply side issues (food costs) feeding into the numbers.
A common analogy for the inflationary risks and the chosen policy strategy is of a car accelerating too fast where a bit lighter foot on the throttle might be appropriate but a panic stricken novice driver jams on the brakes very hard. The ‘novice’ driver in this case is the boss of the US Federal Reserve who is after all a lawyer by training and an investment banker with a rather patchy career prior to getting public appointments. Indeed, he could himself be blamed for feeding asset price inflation (now much frowned on by some other central bankers) in the response to Covid-19.
Modern anti-lock braking systems mean that in most situations the car won’t slide across the road when you max out the brakes with your right foot (exactly what happened to me in my first driving test emergency stop) and you get feedback in the form of pedal judder and a flashing light. Very useful when driving down steep hills on snow and ice!
It is now obvious that the failure of SVB and Signature Bank was a combination of inadequate regulation (that being the consequence of over influential lobbying in the USA) and the extremely fast and steep rises in interest rates from a base of virtually zero. You can read many more detailed explanations all over the internet.
A ‘bank run’ always gives me a reassuring feeling that my base understanding of financial markets is essentially unchallengable: what happens in markets is the consequence of self-interested human behaviour and very little else.
In the case of a bank run, a hint that a bank may be in trouble (or even Robert Peston broadcasting the suggestion that it is, as with the Northern Rock – remember that?), will panic depositors in a race to be first in the queue to get THEIR money out. As no bank can make a profit by holding all its assets in cash or near cash, it will struggle to meet withdrawal requests when they amount to more than a small percentage of its assets, so it will have to immediately sell its first reserve assets, like government securities, and the fact that it is selling and why will quickly become known, meaning the panic will widen and it may only be able to sell at fire sale prices.
Of course, many assets of a bank, like loans, mortgages or investments cannot be realised quickly and the vultures, in the form of larger competitors, will start circling immediately, looking to scavenge some cheap assets and pick up blocks of customers for nothing.
These days most private depositors in banks or equivalent deposit takers like UK Building Societies will be protected to a large extent by state deposit insurance schemes, but the bank’s shareholders, bondholders and those with very large deposits will not be (eg corporations). In 2008, the shareholders and bondholders were largely bailed out by governments because the crisis was based on underlying failings in the system and inadequate regulation and the only option was a repeat of the Great Depression.
This time, they won’t be, although all depositors are getting protection in the USA (a Main Street, not Wall Street, solution). The cost of this extended cover will be born by the other banks – they have copied the UK Financial Services Compensation Scheme!
A whole range of recent and maybe curious news items have seemed to me relevant to the short term direction of markets and maybe give us some hints, or at least warning signals, on the likely longer term trend. Here are three for you to ponder.
In the game of chicken that markets have been playing with the Fed, markets put their foot on the gas late in 2022 and bet that the Fed would put the brake on interest rate rises. The US central bank did offer some comfort by slowing a little, but as if wishing to let everyone know that its not going to be forced off the road quite yet, it has been blowing its horn to the tone of ‘we’re not finished yet’ repeatedly over recent weeks.
This week, the markets decided the amount of road ahead before a very messy collision was shrinking a little too fast and touched the brakes. Given the rate of returns on growth stocks (up to 10%) in the first 6 weeks of 2023, that is maybe not a bad thing. Bond yields also picked up again, as we would expect, but I think that is only a temporary blip.