Slight Flaw in the Budget

Phillip Hammond delivered a reassuringly dull budget this week. The furore over the self-employed will pass or be diluted. Just what investors like to see. In fact, Hammond holds many of the traits fund managers like to see in CEO’s; ‘reassuringly dull,’ covers it nicely. Mr Hammond said that according to the OBR borrowing will be less than predicted that borrowing will be £51.7bn in 16-17, down from the predicted £68.2bn. The Chancellor has promised in fact to drop the deficit below 2% by 2021 and eliminate it completely shortly thereafter.

That would take nothing short of a miracle.

Britain’s national income has exceeded expenses expressed as a percentage of GDP for just two brief moments in the last 30 years. The first followed the stock market’s mid-80’s surge and the second was in the final stages of the Tech boom in the late 90’s. The market peaked shortly thereafter turning the surplus into a big deficit. The financial condition of the UK has been deteriorating for decades now. A 1.5% budget surplus in 2000 reversed before it reached its ’87 peak of 2% in 1988. The budget gap wasn’t closed at all in 2007 prior to the financial crisis despite booming stock and property markets. The subsequent 2008-9 deficit beat all previous records. In terms of debt to GDP, UK debt in 2010 was the third highest in the world being beaten only by Greece and Italy.

This is probably as good as it gets. The living-in-fairyland inhabitants of Westminster moan without pause about austerity. They are in for a shock. Mr Hammond’s positive read on government finances is not a ramp for take-off; it is a warning that the edge is near.

Glencore; Meltdown or Death Spiral?

While the UK markets attention has been dominated by the Rate Debate and Volkswagen, we have a rather serious problem brewing on our own doorstep. Glencore is in meltdown and with its 5 year CDS trading on Friday either side of 600bps it is a wisp away from a death spiral. That’s the point when, ‘get me out I’m not having this in my portfolio when it goes down,’ PM’s jump ship and their numbers outweigh the bargain hunters. Investors who subscribed to the recent rights issue, and wouldn’t I love to see the crib sheet and FAQ sheet written for the salesmen by corporate finance for that one, will be feeling that maybe ‘cheap,’ wasn’t quite the right word to be banded around at 125p.

Whatever valuations analysts put on Glencore, equity investors may be about to be reminded that equity is at the bottom of the capital structure. Following the announcement earlier this month of the company’s $10bn recapitalisation plan through a rights issue, dividend suspension, asset sales, capex cut and production cut; Moody’s put the company on negative watch on its Baa2 rating, (just above junk). The market is beginning to question if the $10bn recap is sufficient to guarantee the survivability of the company and the whole asset structure is consequently having convulsions.

The problem becomes acute if Glencore is downgraded to junk. At that point we have a potential Lehman / AIG scenario in the commodity space. While Glencore is the biggest listed leveraged bet on the price of copper and the Chinese economy through its mining operations, it is also one of the world’s biggest commodity trading firms. A downgrade to junk could trigger forced selling from PM’s not able to hold junk paper, collateral liquidations and market counter parties slamming the doors shut. The complex daisy chain of OTC derivative contracts have an unquantifiable market risk. At the minimum, fear of a bad thing happening is enough in this fragile environment to unsettle the broader market. Risk managers and regulators must surely have Glencore front and centre on their radar this weekend.

Goldman have suggested in a recent note that it would take only a further 5% drop in commodity prices to tip Glencore over the edge. Bernstein meanwhile apparently think it is cheap.  Sure, the company will announce asset sales, like its agri business, and the shares may enjoy big % temporary spikes. My view however, is investors have no business touching this stock unless they have a near term blue sky view for copper and Chinese growth to which it has a high sensitivity. As neither are likely to be forthcoming investors should take a wide berth. Better to catch the turn in the commodity cycle when it comes with companies who are ahead of the game rather than behind it and examine Glencore only when it recovers its rating and financial health. Better to pay more for something with longevity than to bet at the roulette table in a casino on fire, which is exactly what an investment in the company is now.

Price at the Pump

The negative divergence between the oil price and what you pay at the pump is becoming more pronounced.

Two points here. It's rather unusual for the supermarkets not to be more competitive so are they perhaps under pressure from Westminster to hold prices high to maintain tax revenue? Secondly, the oil price down here would have made an interesting start to Scottish Independance if the vote had gone the other way given the SNP's sums were predicated on a much higher oil price. The oil industry is typically very sensitive to the price; job losses and reduced capex are simply inevitable as deflation continues to pulse through western economies.

Wondering Where House Prices Are Headed?

Foxton's Share Price - Just in case you where wondering where house prices are headed..........

Well, it didn't take the London housing market long to react to the the mendacious and short sighted idiots from the Labour and Liberal parties and their ill thought out nonsense about Mansion Taxes. 

Foxtons, the London estate agent this morning reported a "significant drop," in transactions in the second half. Now, London prices were anyway in nosebleed territory and some air needed to be released from the balloon but the actuality is, apart from the super rich bracket, transactions across the country have stopped stone dead since the Labour party conference. The market, is in practice in suspended animation until after the election. So, what does that actually mean?

Obviously, there will be a drop in stamp duty revenues. The trickle down to the rest of the housing market will cease but there will probably be price distortions sub £2m, especially in the £1-1.5m level where people will buy but will want a "margin of error," away from the £2m price point.

With fewer people moving all attendant service providers will suffer from solicitors, surveyors, removal firms, painters, decorators and so on. White van man has done very well out of the property boom; well, that's another group you've just alienated Mr Balls.

It is worth highlighting yet again to these fools who say whatever they think the particular constituency they are addressing wants to hear that people who buy a property at any price point are doing so out of already taxed income which for most, is over 50% when National Insurance is included. Even now, buying a £2m+ property elicits a minimum £140k stamp duty bill which obviously requires £280k of pre tax income, unless the buyer has a gain from his previous property.

The bottom line here is as it was when the coalition came to power. HMG doesn't have enough money and is incapable of balancing the books so they're intent on using any means at their disposal to smash, grab and spend because they lack the moral and political courage to properly reduce government spending, less of course for hitting the only people who can't defend themselves and who spend most of their time avoiding coming home in boxes from places we have no business being.

These idiots in Westminster should stop interfering and simply adjust council tax bands to reflect a modern reality. Smart money will move much more quickly than governments ever will; its the squeezed middle class, the infantry of the economy, who get hit relentlessly with headline sound bite politics. Frankly, all these deluded muppets achieve is to strengthen UKIP and they're lining themselves up for the electoral equivalent of 10,000 volts administered though bodily extremities next May. 

Thank you Bardarbunga!

Children holidaying from Britain across the azure blue shores of the Mediterranean and beyond will right now be contemplating the closing weeks of the summer holidays. As the skies darken over their little lives with the prospect of going back to Form 5B, hope and help is at hand in the form of Bardarbunga.  No, not a Harry Potter character but an angry volcano in Iceland. Oh and boy is it getting angry and potentially, it could create dark skies for real as we've previously seen, and yes, we're usually quick off the mark with the volcano thing here at Crumble HQ..

Iceland has this afternoon warned airlines that there may be an eruption at Bardabunga which is located underneath Vatnajokull, Europe’s biggest glacier.

The alert level at Bardarbunga was today raised to “orange,” indicating “heightened or escalating unrest with increased potential of eruption,” the Reykjavik-based Met Office said.

Over 250 tremors have been measured in the area since midnight. The agency said there are still no visible indications of an eruption..... yet

The volcano is 25 kilometers (15.5 miles) wide and rises about 1,900 meters above sea level. So, it’s a biggie.

You can read more here and here there is a world of resource here and here.

British kids, obviously quick of the mark, will be going to uncommonly great lengths to avoid letting their parents see news reports, listen to the radio, read the papers..... "no Dad, you need to rest and get away from the news," lest Dad gets a flap on, hires a car and drives back before all flights are cancelled and all ferries are booked.

Obviously, I don't want 15 miles of Iceland to erupt as little as does the next man, but the kids... I know what they're thinking and it very much reminds me of this scene from John Boorman's wonderful film, Hope & Glory.

Humans Need Not Apply

and while hard working students are reflecting on their examination results and potential university and career options they may wish to consider the clip above.

It's just a fact that the education system does not, yet at least, properly prepare the young for the world which they will face, not today but in three, five, ten and twenty years time. Some studies suggest that up to half of all jobs can or will be computerised or automated within 10 years. At the current accelerating rate of change, its coming down the tracks an awful lot faster than that and for many in the workforce, it's already here.

Governments face many challenges. Two of the biggest are glacial but immovable demographic changes, meaning a smaller working population bearing the burden of supporting a growing and longer living retired population but also how to support the disenfranchised part of the working population whose utility has been replaced by an Intel chip. Theoretically, everyone could be richer and have more leisure time. That's what my Geography teacher foretold when I did my own A Levels but no, what we have for the moment is a bunch of mega billionaires competing with each to throw water over themselves while many of their fellow citizens can't afford the technology that was supposed to change and enrich their lives. It's great that Bill and friends are supporting a good cause but I think you get the point.

So kids, go and learn about chips, coding, nano tech, bio tech and avoid anything that can be done by a bot and just so you know...... that includes McDonalds so don't think that fall back will be there for long.


The Dog Days

Terrifically well crafted piece on summer markets by friend, Stephen Lewis:

The day-by-day countdown to the hundredth anniversary of the outbreak of the First World War should serve to remind us there is no firm historical foundation for the common assumption that nothing significant ever happens in the dog days of August.  The markets’ old-timers will recall it was in August 1990 that Saddam Hussein invaded Kuwait, beginning the train of events that led to the Gulf War.  More recently, it was BNP Paribas’s halting of withdrawals from three funds it managed, in August 2007, that first alerted investors to the global scale of the fall-out from the US subprime mortgage crisis.  We would be yielding to superstition if we adopted a fearful view of the next few weeks simply because they will constitute another August month.  After all, while the war in 1914 began for the UK in August, hostilities had broken out between Austria-Hungary and Serbia on 28 July. Similarly, in 2007, Bear Stearns’ revelation on 16 July that two of its subprime hedge funds had lost almost all their value was warning enough that much was amiss in the US capital markets.  Troubles rarely come out of the blue.  Usually, the signs of impending disaster are long visible before the debacle occurs.  It is tempting, during the period of denial before the final cataclysm, when markets seem calm, to believe that the negative aspects of the situation must already be fully discounted.  But there is a world of difference between a notional catastrophe and a real one, and the full dimensions of a real catastrophe are seldom imagined beforehand.

Rarely in the writer’s experience, stretching back forty-five years, have the world’s capital markets been afflicted by so pervasive a sense of unfocused foreboding.  This is not reflected in the behaviour of securities prices which continue to be well underpinned, too well maybe.  Rather, the mood is evident from the volume of comment drawing attention to a host of extreme market values seeming to betoken an unsustainable stability.  In bond markets, ultra-low yields appear to deny the chances of the economic recovery that forecasters are standardly projecting. In equities, parallels are widely drawn with the metrics that prevailed in 2000 or 2007.  But, whereas on those previous occasions when equities stood on the brink of collapse, investors had an idea from which direction the destructive flame would come, there is now no consensus on what should be most feared.  What is universally agreed is that markets would not be where they are today if central banks had not spent the past five years so energetically rigging them.  Where they might be standing if central banks had not had recourse to unconventional policies, while pushing their conventional policies beyond their historic limits, is anyone’s guess.  What makes market sentiment sensitive to this question now, as it was not a year ago, is the expressed resolve of the US Federal Reserve and Bank of England at least to reduce the degree of accommodation they will provide, without indicating when this process will begin.  The malaise runs deeper than this, though.  It is not merely a case of market uncertainty that could be dispelled by some clear ‘forward guidance’.  For beneath the surface of day-to-day transactions lies the suspicion that the global crisis and the measures the authorities have taken to prevent a recurrence have wrought permanent damage to market structures.  In short, the market mechanism may now be even less well able to cope with sudden changes in sentiment than it was pre-crisis.  If this should be revealed to be the case, the shock to business confidence when sentiment does turn in capital markets could well be deeper and more long-lasting than after the 2007-09 meltdown.

There is no shortage of threats to market stability.  They have been accumulating while central banks have applied their anaesthetic.  Politically, the state of the world is much more menacing than it was five years ago, when bond and equity valuations were lower than today.  Successive rounds of sanctions against Russia have set the seal on that country’s exclusion from ‘the international community’.  But it seems very unlikely that China will allow its BRICS fellow-member to succumb to Western pressure.  In the past, China would not have had the resources to defy the West, even had it a mind to do so, but now it does.  The Beijing authorities may shrewdly judge they will never be subject to sanctions.  Western nations have consumed ‘a peace dividend’ they may now feel they must regurgitate.  That could impose a severe handicap on their future economic performance as resources that might have supported debt reduction or capital investment are diverted to defence spending.  Then there is the growing instability in the mid-East.  Though disruption of energy supplies from that region may seem a less serious threat to the world economy in light of shale developments, there have been few signs that shale producers, most notably the USA, are willing to share their bounty with those countries dependent on imported energy.  If the US ban on crude oil exports were to persist in the face of disruption in the global crude market, Western political unity might not survive long.  Alongside these risks, we need hardly labour the point that the EU and the euro zone look far less cohesive than they did five years ago.  Fresh strains are likely to affect the euro as the region’s economy appears headed for renewed weakness.

The most dangerous forces, though, may be those generated within the markets themselves.  As in the past, market excesses may bring disorderly correction.  Arguably, the very levels of market prices represent excess.  But in judging where excesses lie, it has always been most useful to examine where market activity has been growing most rapidly.  Thus, it seems unlikely that trouble will arise, at least in the first instance, from bank lending to non-financial corporate customers because, for years past, demand for such loans has been weak and the banks have been careful in granting credit.  The BIS, in its annual report, identified the massive substitution of bond finance for bank borrowing and the growth of non-bank asset management funds in recent years as potentially problematic.   It also warned against the concentration of risk in some ETFs.

Hull City Council; Thinking & Doing

Not sure about the graphic though.....

Hull City Council have announced a scheme to create their own crypto currency with which citizens may be paid for doing jobs that benefit the community and which may then be used to pay for local services such as public transport, food banks or even council tax. At last, a council that is thinking and doing.

Notwithstanding it may be an April Foll story, (although the story was circulating yesterday), this is a great piece of mutually supporting creative planning. Designed to tackle local poverty, without knowing it they've just drawn the blueprint for what a Big Society really is. They probably also don't realise that I proposed a similar Community Credit scheme three years ago in a piece called, oddly enough, "Creating the Big Society," But hey, this isn't about trying to catch some airtime for a good idea that someone's else has also come up with! The important thing is that they're doing something about it.

The elegant enhancement in my scheme though is that citizens could also be fined credits / Hull Coins / widgets for minor offences and be forced to earn them through community work, or use those already earned, to pay the fines off. 

Anyway, I take my hat off to Hull, salute their innovation and applaud the can-do and will-do attitude. As an aside, what a great thing to do to bring a community together some 100 years after the same community stepped forward to help their countrymen and raised four Pals Battalions, the 10th Easy Yorks (Hull Commercials), 11th East Yorks (Hull Tradesmen), the 12th East Yorks (the Hull Sportsmen) and the 13th East Yorks, (T'Others) .......... only in Yorkshire.

Hull Volunteers

Bonus Season Dawns

This year's bonus pool

This year's bonus pool

QE powered markets have been motoring to new highs with all the abandon of teenage lovers. I've been promulgating the view for some time that markets are not pricing in the risk of a demand shock, of any scale, but it has had little resonance until recently. Yet a growing number of commentators are beginning to echo the thought and with a deal more intellectual weight. Upside from here is totally dependent on increasing economic confidence and momentum. Without demand that’s not going to coalesce. The pace of human worker replacement by machines is accelerating, the US consumer is still on the rack even before interest rates move, a reduction in Chinese GDP is self evident, Europe remains the mother of all time bombs and the UK is being flattered by selective house price moves and the auto manufacturing business in the West Midlands. There is an end to all this but a deflationary disruption in demand along the way will eventually rock equities. 

So why are stock markets doing so well? One answer might be from a client who said, “I think governments everywhere are strangling their economies with regulation & taxes. It’s easier to put your money into the stock market than it is to build a business or a house on land that you own so equity markets go up and the real economy stagnates.”

Indeed, how many people do you know from the City or elsewhere  who have retired to invest and or trade under their own steam rather than drag themselves out of bed at 5am in the morning? As we roll into bonus season for the banks another challenge is facing managers on trading floors. The near doubling and more of basic salaries in investment banks, rolled out 4-5 years ago to circumvent an expected clamp down on bonus’s after the crisis, has created other unintended but quite predictable consequences.

Unallocated and allocated costs have soared, (especially as other headcount like compliance has mushroomed). One head of a desk told me the “per head,” number to have a member of staff on his trading floor and I nearly fell over; it was more than twice the number we used when last I worked in a bank and even then my bank was at the top end of peer group. Despite this, most operations have been profitable. However, with structural change being imposed on the bond market by Dodd-Frank and the underwriting of markets by QE on the wane, there will be some tough decisions to make when the tide goes out.

Moreover, the CEO of another operation said to me, “Bonuses’ are not what they were and anyway, only a modest percentage is paid out in year 1. That though is stifling ambition because they feel they just have to turn up and do a good job to bank the pay cheque.” Even at Goldman they are ramping up basics even more in response to EU bonus caps. These are the business economics of the madhouse. It won’t end well and yet again the City is lining itself up for another great reckoning.


rear view mirror.jpg

Talking of madhouse business principles, in these days of volatility suppression I’m reminded of another bugbear from my days in a bank. Trading books often have to take provisions against their positions. These provisions will be calculated against a number of metrics, mainly volatility but will include average daily volumes in the name, the average bid/offer spread and so on, and they are usually reweighted weekly. Unsurprisingly, when a bad thing happens volatility spikes and after a big fall for example, traders can expect risk control to wander over and say, “don’t forget, your provisions will rise on Friday.” Similarly, after a prolonged period of flatlining volatility, as we see now, provisions will be released back to the trading books and from their perspective, they’ve recovered hard earned P/L and can now walk the floor looking windswept and interesting rather than gaunt and persecuted.  We see then, that after a bad thing the risk geeks decide that it would be sensible to take out an insurance policy in the form of provisioning but when we’re at all time highs with stretched valuations and low volatility they chuck the insurance policy in the bin.

Is that smart?

Energy Bills; Who's Fault Did You Say Minister?

Ed Davey, the Energy Secretary, speaks today and apparently will again verbally eviscerate the power companies.  

Just a couple of points to note Mr Davey before you mount the current political hobby horse,

Energy bills are obscenely high, we know that and we've known what's been coming for years.. We also know that a complete intellectual and political vacuum in the field of strategic power planning for twenty five years by successive governments is mostly to blame. The entire political complex is culpable thinking as you did, that you could wave through planning permissions for windmills that don't generate enough electricity to power a train set and that don't work in the cold or high winds in order to tick the green voting box; idiots. The only winners in the windmill game have been property developers, (many of whom have never even seen the land on which these monstrosities have been dumped), and wealthy farmers. All subsidised through the power companies by the beaten up citizen. You're an utter disgrace, the lot of you.

Moreover, creating uncertainty in a sector of shares in which most pension funds are invested for stability and yield is irresponsible and damages the income many of those you purport to want to help by creating an uncertain economic environment for those companies.

Power companies are not perfect but they should not be demonised. We've already seen BP in the oil sector left to the US judicial wolves over the past two years with no political top cover and the current rhetoric does Westminster absolutely no credit. 

Were it only power generation and it's cost then we might be able to muddle through. Actually, Westminster's default reaction to any problem is to go on the offensive and blame everyone else, never themselves. We will see this in other departments in years to come and defence will probably be at the front of the queue when 22 years of sequential defence cuts suddenly mean we are unable to protect our interests.

Switch On and Switch Off

Finally, there is of course an expectation that everyone has a right to a fully centrally heated house all the time. Not so. The elderly and babies need and require minimum temperatures; everyone else can take a leaf out of the Crumble Towers book of winter living; put a fleece on and turn that bloody light out. 

I suspect Michael Gove is probably the only one in government with the stones to say it given he is the only strategic thinker with moral courage in it. 

London; Another Country

The Lloyds Bank England and Wales regional PMI numbers released today reinforce, if any evidence were needed, that London is indeed another country. 

Interestingly,  Savills also had this to say about London property,  "London faces an oversupply of high value homes". While we know that 80% of demand is from foreign buyers, 2/3 are for investment and with more supply destined to come on stream "any further supply might not find demand from tenants." I suppose that not all Asian and expat buyers are insensitive to income returns. If they were all cash rich, the property market of Hong Kong would not have halved and doubled a couple of times in the past 15 years!

The point here however, is not to start another discussion about the bubble that is London property prices but to highlight that the "surprise," growth we keep reading about is in fact very patchy and is more likely a direct result of QE which has been building asset bubbles without raising real incomes across the country in any fair and reasonable way that might be described as beneficial to the whole.

In fact, most families appear to be going backwards and we're building up an even bigger shock in the pipeline and when the bubbles burst the easy money will have been made and fast disappeared, and the remainder of the population will again pick up the tab. Many people are now forecasting that growth will ratchet up into 2014; I wouldn't be so quick to believe that.

Unbelievably, I'm about as right wing as they come but the short term inept and bungling clowns we have running things are turning even me into a socialist and for that, I do despise them.