It’s a game of two halves. And global markets aren’t a beautiful game either. Now that we’ve got the distraction of England at the World Cup behind us, I deliberately held back on this week’s missive so we could put the first half of 2014 in perspective.
Frankly, it wasn’t the best of games – it’s been messy and confused, with lots of investors caught the wrong side of markets. Lots of people thought 2014 would be the first year of true post crisis economic recovery. They thought it was all over, but until we see a real strong run of numbers of the US, we can’t say.. “it is now.” We could stop worrying about QE and the taper, and the global recovery would mean growth, growth, and more growth – well that’s the dream.
Back in January, the clear tactical call looked to be sell bonds and buy equities. But if you bought equities, then you were a year late. Last year saw the biggest gains. Even though a sort of global recovery appears to be underway, stock markets will not have stretched your wallet over the last six months – unless you were timing it. The Dow is up a fraction, the FTSE has flatlined – surprisingly Germany is up nearly 3%, but heaven knows why.
Instead, the winners have been bond holders – which we all expected would get spanked this year as markets anticipated the Federal Reserve and the Bank of England tightening policy by encouraging higher interest rates. Instead, and despite the end of QE, rates remain low and there is healthy demand for bonds. As a result the bond funds have done better.
For the serious bond investors, the most interesting sector has been credit markets – taking the risk corporate borrowers will repay the money they borrow. These have tightened and then tightened some more. Why? Because government bond yields (Gilts, Treasuries and Bunds) are so low, investors are prepared to go down the credit curve, take greater risks of non-repayment, and buy more risky bond investments.
As more and more investors look to buy corporate debt – because it yields more than safer government debt – is that a good or a bad thing? If they were borrowing loads of money to build new factories, plant and distribution, yes, it would be. Instead, corporates have been borrowing heavily from the bond markets so they can buy back shares, thus pumping up their share price, meaning executives get paid bigger bonuses without actually adding anything tangible like rising sales to their companies.
Or corporates have been pumping their new found bond market cash into investments – borrowing cash to pump up the company pension fund or invest directly. Again, not productive or growth enhancing in the short-term. And ask corporates why they aren’t growing their productive capacity and they will say.. “demand is muted”.
Consumers aren’t consuming – as has been said many times this is a “joyless recovery”. Large swathes of the middle class are earning less than pre-crash and simply have no excess income to spend. Try explaining “low inflation” to a householder confronted by rising education bills, food prices rocketing and petrol prices remaining high. Large parts of the working class find themselves on zero-hours contracts or trapped in the minimum wage and aren’t consuming.
How do governments break this apparent impasse? In the US and UK they are talking about favoring suppliers who pay more than the minimum wage or raising local wage thresholds. Which will be another cost for businesses unwilling to pay higher production costs.
Or they are looking to improve business conditions through infrastructure investment. Build new roads, new railways, new airports, new ports.. all of which cost enormous amounts of money. That can only be raised from the bond markets because personal taxation has to fall because we’ve got elections coming in the US and Europe, and corporate taxes have to fall, lest every single country in the world re-locates to Ireland to benefit from tax breaks.
As I said, economics and markets are not beautiful games unless all the parts are aligned. At the moment they are not. It’s very complex, but it does feel the global economy is caught in some kind of net that’s filled with lethargic consumers, low wages, limited demand, low volume markets and severe doubts on how strong any recovery can really be.
So… what is the trade to put on?
Well, my eldest son seems to have worked it out. He’s been betting on the World Cup and after the Holland vs Mexico game he is massively up. Mrs Badger game me some pocket money that I promptly squandered on England, but the son is calling for the Netherlands.. Go with it I think. Germany don’t look convincing and Brazil ain’t going to pull it off.
Put it large on the Cloggies…