Stranger In A Strange Land


Many will simply shake their head while muttering, 'the world has gone mad.' I know I did. We are where we are though. Westminster is trying to figure out how to make a seized up situation work while the rest of the country is going about its business with an air of, 'well that showed them.' The chickens though, whole squadrons of them, will at some point in the future be coming home to roost. In the piece that follows, my friend Tim Price of PriceValue Partners offers his take on events, past, present and future.

“If you have been voting for politicians who promise to give you goodies at someone else’s expense, then you have no right to complain when they take your money and give it to someone else, including themselves.” - Thomas Sowell.

It is difficult to know where to begin. That 262 British parliamentary seats fell to a party led by a self-confessed Socialist is bad enough. That said leader lacks the support of 172 of his own MPs is troubling. But that someone who has publicly supported the IRA, Hizbollah and Hamas could attract 12.9 million votes while the United Kingdom is under attack by terrorists simply beggars belief. Sir Richard Dearlove, the former head of MI6, the British Secret Intelligence Service, points out that Jeremy Corbyn – who seeks the office of Prime Minister – would not be cleared to join either his former agency, or GCHQ, or MI5; and indeed would, 2 in the past, have been actively investigated by the latter. It is said that you get the politicians you deserve. So what on earth did we do to deserve this ?

Letter to the Financial Times, 8 June 2017, the day of the UK General Election.

Letter to the Financial Times, 8 June 2017, the day of the UK General Election.

Nor are we making a narrow party political point. As Clive Crook points out for Bloomberg, while Jeremy Corbyn offered the UK electorate the sort of swivel-eyed Trotskyism that ought to have died out in the 1970s along with flares and safari jackets, Theresa May was making her own lurch towards the left:

..instead of championing a solidly pro-market centrism, May adopted a semi-skimmed leftism heavy on industrial-policy meddling and other piecemeal dirigisme.

So a plague on both your houses.

Many investors today were forged in the crucible of the Global Financial Crisis. This was, no two ways about it, a crisis originating in debt. The plain numbers are stark. Simon Mikhailovich of Tocqueville Bullion Reserve reminds us of those numbers with a sobering tweet:

A bit of math. With the global debt / GDP ratio at 320% and the cost of average debt service at 2%, it takes 6.4% growth per annum just to service the debt. Not happening.

Our politics have gone mad, and our markets have gone mad with them. As Ronni Stoeferle and Mark Valek point out in their latest, magisterial study of the yellow metal, In Gold We Trust,

We live in an age of advanced monetary surrealism. In Q1 2017 alone, the largest central banks created the equivalent of almost $1,000 billion worth of central bank money ex nihilo. Naturally the fresh currency was not used to fund philanthropic projects but to purchase financial securities*. Although this ongoing liquidity supernova has temporarily created an uneasy calm in financial markets, we are strongly convinced that the real costs of this monetary madness will reveal themselves down the line.

*With that amount of money, one could purchase 20 Big Macs for every person on the planet. Notably in Switzerland – according to the Big Mac Index – the most expensive jurisdiction worldwide. Alternatively, one could also buy one 1/10th oz. gold coin for every person on the planet. We would recommend the latter.

Faced with universally expensive bonds and predominantly expensive stocks, there seems to be little point in low cost index tracking – at present, at least. This is an investment ‘strategy’ that Jim Mellon describes as “pass the parcel for investment morons”. The only sensible and credible responses to the investment challenge of our times can be to diversify broadly, and then invest selectively, and defensively. (Longstanding readers, along with our clients, will know that we put particular emphasis on Benjamin Graham-style value stocks, systematic trend-following funds, and gold.)

This is also a crisis of education. How, aside from craven bribery, could so many young Britons flock to the sirens of socialism ? How did so many millions manage to avoid any grasp of history (or choose to ignore it) ? Eamonn Butler of the Adam Smith Institute, however, is not defeatist. He quotes from the master, Hayek: 

We must make the building of a free society once more an intellectual adventure, a deed of courage. What we lack is.. a truly liberal radicalism which does not spare the susceptibilities of the mighty.. and which does not confine itself to what appears today as politically possible. We need intellectual leaders who are willing to work for an ideal.. They must be.. willing to stick to principles and to fight for their full realisation, however remote.

There is otherwise the very real likelihood of nasty intergenerational conflict. The Baby Boomers already ate most of the pies. The millennials and Generation Z are right to be angry. But last week this anger manifested itself in the form of some Corbyn supporters burning newspapers. To anyone with a sense of history, the UK today feels like a very strange, and disturbing, place.

“Sell everything and run for your lives”

Headline of the week comes from who else but Albert Edwards at SocGen in his Global Strategy Weekly with his "‘Basket trade’ suggests “Sell everything and run for your lives”........... taken from a letter last weekend to the FT from a Mr Matt long who writes,

Sir: The next financial apocalypse is imminent. I know this to be true because the (FT Weekend) House and Home section is now assuming the epic proportions last seen before the great crash. Twenty four pages chock full of adverts for mansions and wicker tea trays for $1,000. You’re all mad.
Sell everything and run for your lives.
Matt Long, Seilh, France.

I rather like Mr Long's approach but fear that he is more accurate in his assessment than perhaps he knows and certainly than most of my colleagues in the City either appreciate or will admit to.

Brown Claims What?


Bloomberg reports this morning,

 "By Blanche Gatt

     May 17 (Bloomberg) -- Former U.K. Prime Minister Gordon Brown has told friends that he has global support for his candidacy for the post of managing director of the International Monetary Fund that could prevail over Prime Minister David Cameron’s opposition, the Financial Times reported, citing unidentified colleagues."
Well, he does of course have global support if global means North, South East and West Kirkcaldy, although Mrs McMinty at number 11 thinks he's a nutter.................

Barclays; Anyone See an Iceberg?

The hand wringing class warrior liberals, led by Rusty Cable and the Boy Clegg, joined by innumerable Tories who are torn by a deep seated sense of self need and corrosive envy of their contemporaries in the City cannot help but focus on "Bankers Bonuses."

As we have discussed here before, this is the wrong target for legislators and regulators to be aiming at. They need to be closely examining the origin of the "profits," on which the bonus payments are based. In fact, not much has changed since the crisis, which has thrown ordinary decent people into penury, and precious little has been done to stop a reoccurance of a bad thing happening. Some might say the system is even less robust now than before.

Not to worry though, I'm here to help them ask the right questions.

When I joined the City the compensation system was very simple. Everyone was paid a reasonable basic salary and in good years the bonus pool was distributed by partners. In bad years  the bonus pool was reduced or cut to zero. Typically, the partners went unpaid and perhaps, might have put something together to give the junior staff a modest lift. That culture is dead, gone and buried. Now, individuals are compensated come what may. Their inflated sense of self worth has long ceased to have any correlation to actual profitability.

Indeed, Barclays is a case in point. By their own internal measurements BarCap, (the investment bank), actually made a loss so why they are paying anything is something of a challenge for the enquiring mind. If though, you want one scary statistic to mull over then think about this. BarCap's Gross Notional Derivative Exposure is growing again, up 24% year on year to £48.8 trillion.................................

Our old friend and contributer, Bankvilgilante has been looking under the skirts of Barclays and is somewhat troubled:

"The Barclays stock price performance on results day, and YTD, reminds me of 2010. Surging upwards on rumours of "good" FY 2009 results and then well-crafted FY results that drag in momentum investors. And then a long slow slide as actual results for the year show up a far less rosy, less spun reality. This might well have applied to all Euro-banks in 2010 and is what may be occurring in 2011 for the sector again.

Barclays is not an attractive entity to own. Eighty (80%) of 2010 PBT was from BarCap, £4,780mn. And this is more or less normal situation at Barclays Group these days. Some very high loan losses from something called "Barclays Corporate" led to that unit showing a negative PBT of £631mn and possibly inflated the BarCap relative contribution to group profits, but not by much.

The "Corporate" loan losses came from what was once the Spanish unit inside what was once "Global Retail and Commercial Banking". It's not easy to keep up with the constant re-shuffling of operating units at Barclays, itself a bad sign from any company, especially a bank. What the heavy losses in that unit illustrate is that non-organic, non-BarCap growth at Barclays is very challenging and not such a priority anymore.  There were also losses in Western European Retail, falling Pre-Provision Profits in UK Retail (8% down), flat profits in Barclaycard (quite recently a major growth story) and in ABSA (a recent, expensive acquisition).

So Barlcays is BarCap, and BarCap is Barclays. Mysteriously BarCap has 80% of the PBT but only 35% of the "economic capital". This ratio doesn't seem right, but then the head of BarCap is now officially running the bank and all the best paid, best brained, people are in BarCap. Those BarCap guys effectively run the capital allocation and it is no surprise it massively favours them. Thus, BarCap is the growth pole inside the group as it shows the best return on economic capital, by far.

It's just that no one should want to own Barclays as BarCap's real, market-tested, economic capital would be 2x or more what it gets allocated internally, and the cost of that capital  (COE) would be above the group's own 12% COE calculation. BarCap returns would then be below the COE and,logically, it should shrink severely. Barclays itself showed an "economic loss" for 2010 of £2,488mn an increase from the 2009 "economic loss" of £1,890mn. The loss is calculated by deducting a capital charge at a 12.5% COE from net profits. More "losses" going forward would be a problem, surely, for the group. However, the new CEO, approved by the FD and the Board, is going to lower the COE to 11% in 2011 and 10% in 2012.

This should help.

I note that that old bugbear of mine, the Gross Notional Derivatives volume is growing again, up 24% YoY to £48.8tn (yes, trilliion). Obviously this is not a risk, according to banks, as the positive replacement values (the asset) are just £420bn  and the negative replacement values (the liability) a handy £15bn lower at £405bn. The accumulated, unrealised gain (sorry, positive balance) on derivatives, was up by £1.5bn in 2010. These derivatives are mostly interest-rate derivatives. The £420bn assets is subject to bilateral "counterparty netting" that reduces the net exposure to £80bn, and £37bn of collateral is held for the gap, leaving £43bn of "net exposure less collateral" according to Barclays. There are many risks in all this: the valuation of the gross notional derivatives to get the replacement values only a small minority of the contracts are traded on exchanges or even centrally-cleared; the quality of the counterparty netting, especially its legal enforceability across subsidiaries and jurisdictions in the event of a group-wide default; the quality of the collateral.

In my view, Barclays is operating in something of a fantasy-land, egged on by brokers at similarly structured investment banks and seemingly unconstrained by the regulators. However, market reality does eventually assert itself as all the investment banks compete hard with each other, driving returns down, leading to higher (largely hidden) gearing, and much volatility in results. They can't help themselves while they are able to arbitrage the benefits of sitting in (on?) a core Too-Big-To-Fail retail bank."

Icebergs Ahead?