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Music not stopping yet

16 Aug 2021 2 month(s) ago

No-one knows when the music will stop in financial markets. At the moment it is blaring away.

A scene in the film Margin Call is an excellent description of how sentiment works in the financial markets. John Tuld, who is played by Jeremy Irons, explains that the reason he runs the firm is that it is his job to know when the game of musical chairs has stopped:

John Tuld : Let me tell you something, Mr. Sullivan. Do you care to know why I'm in this chair with you all? I mean, why I earn the big bucks.

Peter Sullivan : Yes.

John Tuld : I'm here for one reason and one reason alone. I'm here to guess what the music might do a week, a month, a year from now. That's it. Nothing more. And standing here tonight, I'm afraid that I don't hear - a - thing. Just... silence.

That is a brilliant description of how ‘sentiment’ works in the markets. It is a game of musical chairs and the aim is not to be left standing when the music stops. No-one, of course, knows when that will happen.

At the moment, the music is very out of tune, but blaring away. Americans' consumer sentiment suddenly crashed to 10 year lows:

Yet the stock market is extremely optimistic:Wall Street analysts have not been this upbeat for two decades – which of course could easily mean bad times are just around the corner. As Zero Hedge reports:

“About 56% of all recommendations on S&P 500 firms are listed as buys, the most since 2002. It’s one more data point that shows the extent of the euphoria sweeping markets after a blockbuster earnings season.

“It's not just the US: in Europe, about 52% of recommendations on Stoxx 600 firms are buy or equivalent, a 10-year high. In Asia, that number jumps to 75%, the highest proportion since at least 2010.

“For all the fear mongering about the delta variant, China’s regulatory crackdown, waning Federal Reserve stimulus, and now geopolitical chaos in Afghanistan (again), stock prices have shrugged it all off with their eyes on Jay Powell.” Jay Powell is the head of the US Federal Reserve, which has been printing money like there is no tomorrow.

Morgan Stanley, meanwhile, says this is an unusually good moment to borrow money – another sign that the music is still playing. “While we’re mindful that ‘yields are low’ has been a steady cry throughout the last decade, today we’re seeing borrowing costs, ability and need align in a unique way. It supports equities over credit, and caution on government bonds.

“Corporate bond yields in Europe are at all-time lows, while US corporates haven’t been able to borrow this cheaply since 1955. Mortgage rates, from the US to the Netherlands, are at historical lows. It's a similar story for yields on government bonds.

Even more important, however, is the real cost. When debt funds an asset (capex, infrastructure, a house), it's likely that the asset's value, at a minimum, rises with inflation. This is why deflation is so bad, and self-reinforcing: if the value of things falls every year, you should never borrow to buy them, which constricts credit and creates even more deflationary pressure.

“US 10-year inflation expectations (2.4%) are nearly 40bp above the 20-year average (2.0%). Expected German inflation over the next decade is the highest since 2014. This is new, and improves the economics of borrowing materially.

That better inflation picture also lines up with a better growth outlook.”

For those interested in crypto as a form of (extremely volatile and risky) asset diversification there is also some interesting news. JP Morgan says:

“Ethereum trading volume outpaced Bitcoin’s for the first time. Ethereum trading volume amounted 26% of total 2Q21 trading volume, whereas Bitcoin’s trading volume amounted to 24%.

“Retail users are widening their scope of engagement and there is Rising institutional adoption as over 9,000 financial institutions are now clients of Coinbase. The company also claimed that 10% of the top 100 hedge funds by assets under management are using Coinbase’s services. It has forged partnerships with Elon Musk, PNC Bank, SpaceX, Tesla, Third Point LLC, and WisdomTree Investments.

“Institutional clients are demonstrating high sophistication. They are engaging with Coinbase as a single point of contact for trading, custody, lending, yield generation, and data. For institutional investors, liquidity is of paramount importance. Further, Coinbase has been providing global fiat payment networks, allowing institutional customers to reach new currencies and markets, improving their access to global liquidity pools.”

When the institutions start using crypto as a form of diversification, then it becomes, by the circular logic of finance markets, a potential means of diversification.


Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.

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