David Jane
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
The art of repeating patterns
A favourite activity of financial markets is to look for analogues, historical examples similar to market current market events. In some ways, the whole asset management business is one of large scale pattern recognition. Some edge can clearly be gained by recognising a set of circumstances and acting early. However, no set of circumstance are identical, so recognising the differences as well as the similarities is important.
2020 vision
From 2020, we have been of the view that we were entering a higher for longer inflation phase. Bond yields have bottomed from their multi decade falls and disinflation moves to reinflation for reasons we have outlined numerous times. We did at the start of this year warn that this process would not be a straight line, the upward move would occur over an extended period.
This year we have been experiencing a period where inflation has been falling, particularly after the US mini banking crisis in the spring, and central banks have been easing liquidity conditions. This has led to a dramatic rally in the equity markets, particularly the racier growth sectors such as US large cap technology.
We would normally be very happy with such a move, were it not for the obvious risk that continued high interest rates and weak bond yields might suggest that we are not fully out of the woods. It is quite possible that further credit events will be unearthed by these tighter financial conditions.
Parallels from history
A parallel from history could be the global financial crisis: as early as August 2007, Northern Rock failed, followed by Bear Stearns the following March. Markets rallied from the Bear Stearns failure until the Summer when they started to drift lower again. In the autumn, there was the major collapse as Lehman failed and threatened to bring others down with it.
Our worry is recent events, particularly the seeming failure of Japan’s yield curve control program and continued rises in long yields elsewhere, may yet unearth further structural weaknesses in the highly leveraged financial system. This would be particularly the case if inflation persists, and even begins to rise again in the Autumn, as an ongoing strong economy combined with the end of the positive benefit of lower oil prices leads to short term rates remaining higher for longer.
A further credit event, by its very nature, will be unpredictable, those with terminal financial issues do not tend to highlight the fact. We can point the finger at a number of areas of concern, such as the US commercial property market and that markets impact on the US regional banks. Lending to the Chinese residential developers is another obvious example. The reality is these things tend to creep up and then spiral out of control.
Certainly, a further credit event is a possibility, conditions are tight, areas of the US economy are weakening and internationally, particularly in Japan, central banks seem much less in control than the past. The major difference from the 2008 crisis is that not only is private sector indebtedness higher, government borrowing and deficits are already very extended. The potential for a meltdown is there, but that does not make it certain or even likely. We have to be prepared to act appropriately if things materialise.
Embracing prudence
In the meantime, our view is we are likely to see a correction in any case, much of the market has run up on euphoria, relating to artificial intelligence (AI) and the absence of recession. Hence, we have been trimming many some of our bigger positions of late.
