Told you so

Mint – Blain’s Morning Porridge

The four most beautiful words in our common language: I told you so.

Interesting markets! Gold up 9.5% since the vote to US$1368. Sterling teetering around $1.29. Bond yields across the globe have fallen to record lows. After the relative calm following the Brexit (British exit from the European Union) “event”, UK markets and risk-on markets are being battered by a second wave of consequential uncertainties.

These include first and second order UK, European and global risks. To address each individually would take pages, so I’ll try to keep it brief. I suspect the interaction between all the pressures on markets will set a recurring pattern of up/down interference-waves over the coming weeks.

We’re likely to see multiple domino effects across markets as sentiment is rock and roiled. Friday’s US jobs number is looking more and more pivotal.

As yet it’s still far too early to see clear or tangible evidence Brexit has caused real economic damage! Although everyone can point to anecdotal evidence of airlines looking to buy a European base, banks announcing transfers, lost orders, or stock price declines and tighter bonds (the latter are about sentiment), as yet there are no real facts to confirm the UK economy is in freefall. (But it feels like it..)

Sentiment is fractious, confused and in turmoil.

Fear, panic and uncertainty about UK property have been obvious triggers. Lots of people pondered if an exit vote might make London less attractive to the international community. Many pundits said UK property would crash following an exit vote. Sure enough, housebuilder stocks plummeted in an immediate reaction to the surprise exit vote, but even though we did see an uptick a few days after in housing stocks, the volume of cash back demands from panicked investors means a number of property funds have cancelled redemptions – thus triggering deeper and rising fears across the sector.

The result is talking heads on the box telling us it's an “irrefutable fact that UK property is worth diddley squat” – and thus the end of everything for the UK home-owning middle classes.. Which, of course, is absolute nonsense.

UK property is a good example of nervous markets anticipating further bad news. In the 12 days since the referendum, it’s far too early to say how much UK property might correct – but the fear has destabilised sentiment. Some would say sterling at $1.27 (a low it touched last night) surely makes cheap London property a screaming buy for overseas investors looking to buy a small flat to put their kids through university, provide a bolthole if things get “boisterous” back home, or to cash in on the historical inevitability that every London property tumble is followed by a stronger recovery within a two-year timeframe?

And panic becomes a cumulative thing. Crashing sentiment in property triggers a reaction in stock markets, which are already anticipating a sterling rate cut next week. Bank of England governor Mark Carney says he has a plan - always a mistake for a central banker to say he’s got a plan in nervous markets. It makes action inevitable. Market participants immediately assume what they want the plan to be and it pretty much becomes a self-fulfilling inevitability which has to be delivered.

So, Carney saying he’s poised to cut UK rates has pretty much become inevitable. And easing capital rules on banks to encourage them to lend? Please. Banks lend because they want to...not because they are told to. Smart banks are hunkering down ahead of the banking solids storm that approaches from Italy.

The whole issue of European banking is fascinating. At one level it’s shaping up as a punch-up between Italy and Germany. Ahead of October’s constitutional referendum, Italy Prime Minister Renzi needs to demonstrate economic sovereignty to his electorate, but Germany can’t afford to let Italy mutualise a bank bailout – they will want to see a bail-in.

What form will a bail-in of Italian debt take? The non-performing assets on their banking books are so substantial it should probably be right the way across the capital stack – leaving smaller deposits protected. But of course, that won’t happen as it would hammer the retail investors the Italian banks cannibalised by selling them sub and junior debt! (Bear in mind HypoVereins is a leading German bank and is also a key part of UniCredit.. Just saying….)

Some numbers on Italy’s 1400 tottering banks are worth considering. Non-performing loans stand north of €360bn, 18% of lending. Last year saw suicides when four banks bailed in 100k retail investors! The only solution is a massive recapitalisation – which, under current EU rules, would require 100% bail-in! 

Yet, European precedent is confusing. Bail-ins, switcheroos, ducking, dodging and diving.  Bail-ins of subordinated debt might not be binary – meaning investors may find a compromise means sub-debt holders lose only part of their investment. Is it worth buying Italian sub in the 30/40s? Or might there be money to be made in credit default swaps? So many opportunities…

Out of time and back to the day job…

Bill Blain

Mint Partners

44 207 786 3877

07770 881033