Make a desert and call it peace

Mint – Blain’s Morning Porridge

They make a desert and call it peace….

Sorry for late Porridge this morning, but it’s already been a topsy-turvy day of meetings and early activity in the CoCos (contingent convertible bonds) market. I’m struggling to figure out what’s changed since Thursday regarding the underlying toxicity of CoCos, but the whole market is bouncing higher after the Commerzbank results and Deutsche Bank announcing a bond buyback. Remember: “the market has no memory” is one of my key mantras!

So what is the outlook for this week? Are we likely to see cautious optimism - or are we set for more downside? The Nikkei’s storming performance this morning – up 7% despite poor GDP (gross domestic product) data, is an interesting riddle. Is it higher because of economic confidence or because NIRP (negative interest rate policy) forces folk out of the bond market. Go figure…

Otherwise, there is a growing realisation things simply aren't as bad as the headlines suggest. For instance, China growth is slowing, not contracting. Main Street USA is spending. Despite doom and gloom at the higher end of the property market, the picture across the UK is one of robust property health. And how will markets react to potentially positive noises from Draghi today, or other central banks climbing on board the NIRP express?

There is a slew of fluffy articles suggesting this may be the time to step in and buy. "Fundamentals look attractive", "sell-off exaggerated" etc. My stockpickers have been drawing lines on their charts and reckon this week could see a strong recovery. Unless of course it doesn’t hit the upside, in which case we could quickly test new lows! Thanks for the clarity!

But, but and but again… There is also a growing sense of unease that “things” are not fixed, and need to be before we get genuine upside in markets. The laws of mean reversion, and high asset prices in stocks, bonds and property, still smell bubblesque. For markets to recover - we need normalisation which probably means further price corrections. I detect rising scepticism from the experienced financial professionals I talk to daily about the diminishing ability of central banks and regulators to "cure" markets. They've run out of levers and have exhausted the efficacy of the policies they've employed.

While my favourite economist has "don't fight [Bank of Japan governor] Kuroda" tattooed across his forehead, I can't help but feel intervention, and the increasingly desperate attempts to move market sentiment up and the currency down, are doomed to failure - and not just in Japan! Sadly, the lesson we are learning is intervention in market processes via aggressive monetary policy experimentation has created an economic desert.

Inflated financial asset prices need to correct the unintended consequences of QE (quantitative easing) and the rest. The negativity that triggered the recent crash in global stocks and wider bonds remains essentially unresolved. And the place most distorted by monetary and regulatory experimentation remains the banking sector.

Whatever the surprising strength of Commerzbank results last week suggests, or the fact Deutsche Bank feels able to mount a €5bn buyback, the underlying picture on European banks remains fraught!  Something has to happen in Italy to resolve the broken banks and the reality of 18% NPLs (non-performing loans) which could well trigger another wave of contagion.

Plus, it's not just a short-term NPL/capital crisis for banks - long-term low interest rates (and especially NIRP) are deadly for the whole financial sector – and could still spell a bank liquidity crisis, forcing the European Central Bank to act.

Sorry for rushed comment, normal service tomorrow..

Bill Blain

44 207 786 3877

44 7770 881033

[email protected]

[email protected]