The market is the story of cycles

Mint – Blain’s Morning Porridge

The stock market is the story of cycles, and human behaviour is the story of over-reactions… 

Yesterday’s markets sum it up: while some whirling dervishes are out buying on the back of an oil uptick, real activity looks tired and unconvinced. The new Vodafone bond deal was trading heavy as the market choked on the upsized deal. Thin volumes in stocks, and unconvinced buyers across the frame.

Sterling was the big story of the day – with 43% of the ruling Tory Members of Parliament backing Brexit, suddenly the political risks are right at the fore. Lots of people are saying: give us the facts! Well here are the facts: 43% of the elected government of the UK want to leave Europe. I am more and more convinced they are wrong – but Tories being wrong is hardly a new thing… (Yes.. I know that means 57% of them are probably right.. but I just don’t have a witty retort for that.. yet!)

And still so many things to worry about like Venezuela looking likely to press the “can we have some more” button on their oil wells. Or… after yesterday’s HSBC shock, poor Standard Chartered confirms the gloom with an immediate 6% nosedive. Get over it. Markets go up. Markets go down.

Lots of talking heads pontificate on their smart strategies to seize opportunities. They are bravely hunting alpha – without realising they are simply beta pawns. The great casino of markets continues. Alpha: the fine art of achieving stellar non-market asset specific excess returns… Beta: travelling with the herd.

We were looking at the alpha phenomenon yesterday. What is success based on? Smart and complex trading strategies? Market timing? Stock picking? Credit knowledge? Consumer insights? Political understanding? Squiggly lines on charts and throwing chicken bones at them?

My colleague The Prodster rather cleverly took a chart, cut off the dates, and then asked us what it was: A massive spike on the left hand side and a choppy series of peaks and troughs going to the right hand side.

The scale down the side – from 40,000 to 10,000 - gave it away. The Nikkei. Prodi told us his chart ran from the market peak in 1989 to today. (How well I remember those days in December 1989; selling Nikkei 44K puts embedded in a 3x levered Nikkei-linked medium-term note to a Japanese insurance co.. Ah, Dougie, Bas, Strides and I had such fun..) From the peak to today you would be down 61.5%, despite all the false dawns such as Abeonomics, Kuroda, three broken arrows and the rest.

Sadly I did buy a Japanese fund from a now defunct UK pension fund provider: Allied Dunbar. I never had the heart to lose it, so it’s worth a fraction of what I invested.. a dull testament to how little I really know..

I rather suspect the truth about alpha is it's little more than a spot of luck. Calling that big market short because you are clever enough to spot it, or picking that winning stock. Then watching your gains fritter away by the day trying to replicate the trade again.

Or the truth might be KISS. Keep it simple (stupid). Look for alpha in the obvious. When the market is losing its head on worries about oil’s ups and downs, or whether China will or won’t, or which of Cameron or Boris can micturate higher up that wall, or when Mario will actually deliver on a promise, or what the point of investing in negative yield bonds is. Instead...look for the obvious.

Step 1 – an asset that throws off predictable, safe and secure cash flows. Step 2 – Buy these safe and secure cash flows. Step 3 – Reinvest these cash flows in more safe and secure cash flows.

Simples. But it’s never that simple. It does take a bit of work to cut through the noise, and all cash flows are subject to some degree of risk. That risk determines their return. So a series of cash flows of equally predictable cashflows on one kind of asset might yield more than similarly predictable cashflows on another.

One of the things that’s really got me thinking today is my big “No-See-Em” risk for 2016. What if the global economy is actually in better shape than we think, that it's stronger and more resilient than today’s casino markets suggest? What if the US really is going to justify a whole series of interest rate hikes and the G20 get their act together to foster growth?

Consider this – in such a scenario, some of the cheapest, most unregarded assets on the planet are going to look much more attractive. For instance, global shipping is universally loathed, but as the cycle turns, smart money can achieve superb cash flows from very simple, reliably leased ships. Yes – I know German banks have billions of shipping loans they want to sell – and I just happen to think this is the time to be thinking about buying them.

Or what about oil? The crisis in the US with producers and wells poised on the edge of bankruptcy and banks looking to foreclose? The smart money might just be thinking this is the time to be investing in a vulture fund run by smart oilmen and geologists who realise that while oil takes millions of years to create, it is possible to profit from it in a short time frame.

Or when folk are panicked about commodities and selling right at the bottom of the cycle – maybe buy a mine or two. Or folk assume business sector expectations have been overinflated just as the cycle turns. Or.. or…or...You get the drift…

My gut feeling is chasing the dice of public stocks and bonds is a lottery, while chasing smart cashflows and going for the smart long as this depressing cycle turns is the smart new alpha.. If you are looking for ideas on how to do it, just ask for our current Alternative Asset Pipeline..

Just call for thot’s on the oil fund idea, or shipping, aviation, renewables or whatever. We’ve got all kinds of stuff bubbling under!

Out of time and back to the day job.. Now who fancies 4-yr 6% super-senior returns on secured Uk resi-portfolio… or would you rather own Standard Chartered Tier 2?

Bill Blain

44 207 786 3877

44 7770 881033

[email protected]

[email protected]