This runs a bit longer than usual, but a lot has been happening.
We will start with hidden opportunities, those typically out of sight of UK-based investors, seduced by our media gloom. Then we will move on to the less positive bits.
The most obvious opportunities, though not the only ones, are in Asia, which has been relatively unscathed by the recent banking crises in the West.
18 months ago, the new Japanese Prime Minister, Fumio Kishida, pledged to deliver a “new form of capitalism.” To date he has been a bit short on detail. An exception is the announcement of an expansion to their own version of our ISA, called a NISA. The objective is simple, to encourage a switch from saving to investing amongst the Japanese. They are traditionally very conservative, with only 15% of their assets held in risk investments (stock market and similar), compared to 30% in the UK and Europe.
Kishida is very keen to unlock this huge cash pile in Japan, and for domestic savers to invest into their own stock market, the second biggest in the world. This will not impact their stock market overnight, but will underpin the potential for years to come.
There is also a new broom at the Bank of Japan. If he begins to push their interest rates higher, this will likely draw the attention of foreign investors to the fact that Japanese equities are very good value compared to the US.
Confidence is building amongst Chinese retail investors too. They also have traditionally large cash savings, and these grew substantially midst lockdown. It is from a low base, but openings of new stockbroker margin accounts doubled between February and March. We will be keeping a close eye on this metric of confidence as the year progresses.
Their economy is also taking positive steps forward, in ways which are seldom acknowledged in our Chinese-bashing media.
For example, Chinese electric car sales are booming, and they will likely hit their 2030 target this year. The infrastructure is in place and the 2nd best-selling EV car starts at about £4,000. Two weeks ago, you might have heard the head of the German Green Party applauding the progress made by China on climate-related issues, and holding out their approach as one which Europe should follow.
China’s latest GDP (economic growth) was well above expectations, and retail sales even more so. If the Chinese stock market has really just broken out of a 15-year bear market, these are solid foundations, and the positivity will be Asia-wide.
Asia has not had the inflation problems encountered in the West – to a considerable extent because they did not suffer the negligent action series of mis-steps by our central banks. In the West, the result of the latter is a very sharp increase in interest rates, so let’s turn our attention closer to home.
“Throughout economic history, interest rate tightening cycles
tend to end with a bang, not a whimper” (FT Lex column)
Put another way, when interest rates start heading up sharply, things break – markets, economies, businesses.
Breakages To Date
Things began to break before the pandemic, with some classic end-cycle early warnings, which we have regularly highlighted. From 2018-2020 these were just some of the collapses:
Woodford, GAM, Greensill, Credit Suisse, H20, Wirecard
These were triggered by one or other of over-confidence and complacency, massive debt and illiquidity, and, in some cases, fraud and criminality.
But there was only one common thread. These are the symptoms of the ending of a long cycle of falling interest rates, and, in the decade from 2009, a reckless experiment by central banks.
Fast forward to 2022. Bizarrely, it was the collapse in some “low-risk” assets which were the real shock in 2022, in particular, UK government bonds and index-linked bonds, ordinarily one of the quietest corners of the investment universe. At one point falls exceeded 50%. The weak points in the world’s financial plumbing were being revealed – and it is a world problem, the UK aberration merely being the first reveal.
The extreme fall in cryptocurrency assets in 2022, and the widespread fraudulent activity, barely rate a mention because they were so predictable (and were indeed predicted here and by numerous others).
Earlier in the year we said:
“In 2023 you should expect similar collapses, derived from a mix of fraud,
mis-sold financial models reliant on fictitious maths,
and zombie companies built on sand piles of debt.”
Our expectations were not disappointed…
2023 Banking Crises
On 8th March 2023 a classic bank run was revealed – a bank run is when depositors of a bank or building society panic to withdraw their money, as occurred with Northern Rock in September 2007. Now it was the turn of Silicon Valley Bank (SVB), not a name widely known in the UK, though it was the bank of multi-billionaire tech moguls in California. It went bust!
Why? Because to meet withdrawals they had to sell their assets in US Government bonds. That’s another ultra-safe asset class, but which suffered sharp losses in 2022. It is those losses which hit SVB when these “safe” bonds had to be sold.
After similar depositor withdrawals up to and including 10th March 2023, it was the turn of Signature Bank to go belly up. This was the second biggest banker to the cryptocurrency industry.
The spotlight quickly turned to Europe, and the less-than-venerable 167-year-old Swiss Bank, Credit Suisse, also went bust. They had also endured a bank run, though Credit Suisse had been mired in crime and corruption and mis-managed for years – it was about time they were closed down. That was 19th March.
The US authorities acted fast, protecting depositors and preventing widespread panic across the banking system. The Swiss authorities did similar, though not precisely the same. Depositors were protected, but bondholders and shareholders were largely wiped out. That’s the way it should be.
Over the weekend another US bank went pop, First Republic, and that has now become the second-biggest bank failure in US history. Some say the crisis is now over. Frankly, we can’t be sure, and need to stay alert in the coming weeks.
Some commentators believe these events are one-offs, idiosyncratic. But once you get a series of apparently unrelated events, does it not occur that there might be a pattern?
Of course these are not idiosyncratic. Those who are still feeling relaxed miss the bigger point, which I hope you will not get bored with us repeating for the umpteenth time – these banking failures are yet another result of the ending of a 40-year cycle of falling interest rates and falling inflation.
The necessary unwinding of complacency, bubble US equity valuations, and mountainous debt (and occasional fraud and corruption) has a way to go.
How long that might take is not knowable, but probably years. Yet we are encouraged by the opportunities beyond the US, particularly in the East, and that they were unscathed by these bank failures.
What Will Break Next?
From where will the next “shock” emerge? It was safe index-lifted gilts in 2022, then safe banks in 2023, because of losses in safe US government bonds.
No one knows. Just remember that there is fundamental fragility, and you should be ready to act.
But there are some clues already.
Commercial property prices are falling across the US, UK, and Europe. Falls of 40% are expected in Europe by Citi. House mortgage applications have plummeted in the US. Apparently over 500,000 2-year fixed mortgage rates are ending in the months ahead – the impact is predictable, with new 2-year rates at about 4%. Bankruptcies and defaults are rising in all these developed economies.
Perhaps the regulated banking system can cope with this ongoing property downturn. After all, we were told that, in the wake of 2009, the banking system is now bomb-proof – but for the shock banking failures in recent months, but let’s not split hairs…
Less predictable is what problems lurk within the shadow banking system. You will likely hear much more about this area as the year progresses. The key facts are:
- They aren’t regulated.
- The size is 10x the total assets of all (regulated) US commercial banks (says the Fed).
The shadow banks do stuff which regulated banks cannot do, particularly after the 2008 debacle when the business possibilities for regulated banks were cut back. They don’t take retail deposits, which is why they are not regulated, and they can make very big, and highly geared, bets. So where does their money come from? Much will come from regulated institutions like conventional banks. This worries a lot of smart people, and feeds some of the more apocalyptic analysis.
The Central Bankers Dilemma
Can central banks tame the inflation monster (which is the ECBs colourful language) without blowing up the world’s financial infrastructure?
The central bank dilemma is whether to prioritise the fight against inflation, or prevent a global financial crisis on the scale of 2008? Do they have the tools to do both? Will taxpayers and voters accept vast sums being deployed to save the financial infrastructure, and not being used to build hospitals or provide adequate childcare or even fill in potholes?
These questions are already being posed today, before a seemingly inevitable recession later, which will create a scale of new problems in the indebted West economies.
Cautious Optimism – Attack And Defence
The optimism means adopting a process which consistently identifies the best investment opportunities. This is our attack, and at its heart is our in-house research.
Sufficient caution means acknowledging that bad things happen, which demands a clear process to keep you out of trouble. In particular this means using a stop-loss i.e. selling when falls of a certain size occur, literally stopping losses.
In the foregoing you have clearly seen (again) the reasons for our caution. But at the opening we also gave you a taste of the good things that are happening.
We must not bury sight of other opportunities in the justifiable gloom arising from US-centred vulnerability. A range of opportunities persist:
- Value-style funds around the globe, including the UK; cheap-to-good value.
- Japanese smaller companies; ditto.
- China; good value and re-opening opportunity.
- Asia; good value, growing middle classes, China beneficiary.
- Emerging markets; ditto.
- Commodities; lack of supply combined with growing long-term demand.
These opportunities are multi-year. In the shorter term, these must be balanced against US-centric risks, and that balance is not easy to achieve. Nonetheless, the following approach has the attraction of simplicity and is supported by a depth and breadth of experience and research:
- Don’t get sucked in by the indiscriminate buying of some other investors.
- Gradually drip some money into favoured markets, month by month.
- Retain some cash to reinvest at the (unknown) time when there are notable falls…
- …and in the meantime, benefit from a decent interest rate.
- Apply a stop-loss (typically on 10% falls).
These bullets are the foundation of our Discretionary Fund Management (DFM) service at the moment. In particular, in the world now unfolding we must be able to act quickly, and we can do that with this new discretionary service.
If you take a different and more immediately optimistic view, and want to take more risk, please do talk to your usual adviser. Better still, if you haven’t already done so, talk to your usual adviser about our Discretionary Fund Management (DFM) service, which includes all of the above features.