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Credit deflation and the reflation cycle to come (part 2)


spunko

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7 hours ago, JMD said:

When you say '...does not lend securities', in relation to etfs, are you referring to things like swaps and derivatives?

Some (most) ETF providers lend out their holdings for a bit more cash.  You can see the details for say iShares for each ETF detailed on their website.  This introduces a number of risks.

https://www.dosbods.co.uk/topic/6958-financial-risk-management-case-hardening/?do=findComment&comment=323114

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sancho panza
13 hours ago, Castlevania said:

Or use a buying agent. 

Makes a lot of sense.WHen I buy a car,I pay the mechanic I've been at for 25 years to take a look and then give him a cut of whatever he saves me off the asking on top of his turn up fee.

I amazes me how people purchase something as life changing debt wise as a hosue and then scrimp on good legal/buying advice.

I spend a lot for us on info/data services.The good stuff is worth every penny including my monhlty donation to wolf richeter.

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sancho panza
12 hours ago, DurhamBorn said:

Yes there is,and i admit i do very very little work on house prices because they dont affect me.The only work i do is more low level and out of interest,plus the fact i promised my partner a holiday home on the coast if silver hits a certain level xD.

The difference with the 70s though is house prices are starting from a much higher level,and we started the 70s as an industrial waged country,so wages grew with the inflation.We arent in that position now.Rates are going to increase faster than wages mid cycle,a 4% SVR might be a 33% increase where wages go up 7%,the next year at 6% is another 50% increase where wages go up 8% etc.Its servicing the debts that will be the problem.

The more we get nearer to what's coming the more it starts looking like the 70's ie credit deflation/price inflation.WE hevan't even had the oil price spike yet.

HAard to see how labour will have much pricing power in the next few years.

12 hours ago, Talking Monkey said:

I've thought about the wage inflation a lot and beyond the minimum wage moving up I can't see huge increases on the higher tiers. Automation and tech along with offshoring (I still expect it to continue) will suppress wage inflation. I can't see the white collar worker on say 35K having his wages keep up anywhere near the rate of inflation

This is what could turn this into a depression.Huge chunks of the country have 'hope' as the main strategy.

9 hours ago, BearyBear said:

https://www.cnbc.com/2020/05/22/imf-says-banks-will-struggle-to-be-profitable-through-2025.html

KEY POINTS
  • In a new report Friday, the IMF said banks across nine advanced economies will struggle to generate profits through 2025.
  • Banks’ earnings have already been hit hard by the economic shock of the coronavirus pandemic.
  • The IMF said the economic downturn will “test banks’ resilience” as they face loan losses and tighter margins from low interest rates.

I think that's replicated in the share prices for even the more qulaity stocks.I can currently buy Barclays for less then I paid back in 1991.

ANd thsi is before we get the alrge scale defaults on CRE/mid grade and below corporate debt

image.png.5d4d6f55f51952d0b7206d474d5afdd6.png

8 hours ago, DurhamBorn said:

Very much so,its going to get interesting.The economy is nowhere near large enough now to support the demands on it.Its incredible the amounts of parasites sucking the host dry.Its like the poverty industry.The civil servants push and push to get more and more for the "disadvantaged" so both they and them end up cushy,while the working tax payer pays for it.So far though the Tories arent looking very much up for it.They are failing at every turn.

Without being overly political,it's hard to disagree.Churchill oversaw a world war that culminated in the victory against totalitarianism.Boris has been cajoled by Porf Magoo at Imperial College into shutting down society to such an extent that a load of old dears with covid would be sent back into care homes to reinfect the rest and kids with near zero risk of dying from covid would be scared to go to school due to the fear spread by Prof Magoo.

The comparison finishes there for me.

Boris taking on tax credits/triple lock/migrant crisis/1%/unions....................no.

1 hour ago, Barnsey said:

Whitbread worth laddering into?

WTB got rid of the costa jewel in the crown.Not sure Premier Inn is worth that much.from investing.com

'The Company is organized into a single business segment, Premier Inn. Premier Inn provides services in relation to accommodation and food both in the United Kingdom and internationally. The Company's restaurant brands include Beefeater, Brewers Fayre, Table Table, Cookhouse & Pub, Bar + Block, Premier Inn, hub and Thyme. The Company operates over 800 Premier Inn hotels and over 80,000 rooms across the United Kingdom. Its subsidiaries include Whitbread Group PLC, Premier Inn Hotels Limited, Premier Inn Kier Limited, Silk Street Hotels Limited, Elm Hotel Holdings Limited, Brickwoods Limited, Duttons Brewery Limited, and Silk Street Hotels Limited.'

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sancho panza

hattip kaplan

 

to be fair,we're not positoned too dissimilarly ie oil price up/dollar down,buy UST's/big kahuna/buy stocks.

 

https://seekingalpha.com/article/4347067-2-crashes-to-come

Summary

Conditions are looking ripe for a crash on two fronts, first in bonds, and then in stocks.

Inflation expectations are too low and a rally in oil could lead to a bounce in inflation, signaling the crash No. 1 in bonds.

Bonds are signalling conditions like another period – early 1987 – that could lead to a similar meltdown. This is crash No. 2.

I do much more than just articles at The Lead-Lag Report: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

The function of economic forecasting is to make astrology look respectable. – John Kenneth Galbraith

Well, we’ve had it. The market melt-up from the March 23 lows has been significant, with the S&P 500 gaining just over 28% to May 12. I mentioned in The Lead-Lag Report in early March that I thought this was a real possibility, given the conditions for a melt-up in stocks seemed to be appearing even as the world seemingly was ending. And in late March, after the initial rally, I mentioned we were potentially on the verge of a bubble in the making. Now seems like a good time for an update on those thoughts. I believe things are potentially setting up for two crashes to come, with crash No. 1 in bonds, and crash No. 2 in stocks.

39580-15893358486778407.png

Inflation expectations are low right now, but also trending higher, with good reason. It will be hard to have increasing prices when the consumer is petrified of going to shopping malls and a vast amount of people out of work. Sometimes, though, expectations need to be checked against a backdrop. And the context we are in right now is global fiscal and monetary stimulus to a level we have never seen before. Tens of trillions of dollar equivalent has been deployed against the virus. How do you fight a pandemic? Throw money at it. How does inflation react when the economy finally does reopen, and a large portion of job losses are crawled back, as many economists posit with their V-shaped or U-shaped recoveries? And when does the stimulus stop? I think the chances of inflation overshooting the minuscule expectations are high, as conditions are warranting right now. That, along with a spectacular rise in oil prices after going negative in April, will likely lead to more cost-push inflation as gas prices rise from a supply side just as demand starts to increase with the economy opening up around the world. Combined with food shortages and higher prices at groceries, there are real pressures building here.

 

39580-15893358489236875.png

And then there’s the action in credit that's being under concentrated. Spreads have spiked, as shown below, but not nearly to the levels that the economic conditions are reporting. Do we not think there are going to be more bankruptcies in the BBB and BB space? According to yield spreads, we’re nowhere near 2008 levels. The AAA spread has barely moved, and BBB space is at levels that we saw in 2016, in much better economic conditions. I’ve been noting credit spreads as of late in the risk-on, risk-off signals that I alert subscribers to in The Lead-Lag Report on a weekly basis.

39580-15893358497380297.png

A significant spike in inflation and a blowout in credit could lead to a massive bond selloff, or crash No. 1.

39580-15893358492507873.png

39580-15893358492573314.png

However, many say that the bond market is a much better predictor of economic conditions and what the stock market will ultimately do. If you buy into that rhetoric, you better be paying attention. As I mentioned in The Lead-Lag Report, this is the greatest disconnect between stock markets and economic conditions in history, and something must give eventually.

 

When you look at what happened to 10-year bond yields leading up in 1987, you can draw the correlation to what's happening in 2020. For those not paying attention, October 1987 contained a terrible day in stock market history, with Black Monday having a drop of 22.6% for the Dow. Remember that while the Fed can control short-term interest rates, several studies have shown that Papa Powell and the League of Extraordinary Bankers have little control over longer-term bonds.

Look, the stock market could certainly go higher, and bond yields could stay low for some time. Given the amount of liquidity injections, it's not out of the question, and the market can remain irrational far longer than you or I can remain solvent, as the great John Maynard Keynes said. And credit where credit is due, the Fed did act fast, and the fiscal stimulus came much quicker than expected, especially given how polarizing politics have become in the last half decade. It's possible all that this economy needed was a short-term boost, and if given, things could return back to 2019 conditions in a V- or U-shaped recovery, possibly faster than we have ever seen before coming out of a recession. I just think that given the uncertainty, and how financial conditions are flashing warning signs right now, that it's better to be cautious and prepare for the worst.

What I see happening here is that government and central bank stimulus will lead to higher inflation, along with oil price’s cost-push, as discussed above. That will lead to a spike in bond yields, much like in the early 1987 period. As stock markets have already rallied so much in 2020, investors will see these relatively attractive bond yields and start to take their profits. That could be the catalyst for crash No. 2, as the disconnect we see in the economy and stock markets is the largest we have ever seen. Add in some heavy algorithmic trading and institutional/pension fund rebalancing, and we could be in for some substantial volatility in the next few months. With what we have experienced in December 2018 and early 2020, would you be surprised to have another massive selloff that “is an overreaction?” The way I see it, there are two crashes to come, first in bonds and then in stocks. I’ve maintained my stance since March that what happens after the crash may be more surprising than the crash itself. Buckle up.

39580-15893358492668445.png

Ideas for your portfolio

Simply, make sure you are diversified properly, but actual diversification. Know that the S&P 500 (SPY) might not be as diversified as you think, with 22.3% in technology and 13.5% in financials alone, with a whopping 15% in just three stocks – Microsoft (MSFT) 5.66%, Apple (AAPL) 5.08%, and Amazon (AMZN) 4.27%. Consider gold (GLD) as an uncorrelated hedge. With your fixed income, reduce your duration exposure via ETFs and/or stick to short-term U.S. Treasuries as opposed to corporates. With your stock exposure, make sure the companies you own are well capitalized, and do not have unreasonable amounts of debt on the balance sheet. It could be a decent time to take some profits off the table of your recent stock winners as well, especially if they are printing new highs. Think of those companies you wished you had taken profits of in February, the Fed has given you a second chance here. Don’t waste it.

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Ellandback
1 hour ago, Sasquatch said:

Working in construction also. We heard today of a local builder going into administration. It's going to be tough but the stronger leaner firms will survive. You are correct regarding diversity (or choosing the right sector). Retail fit out for example is not the place to be!

Construction here also, I'm employed by a QS practice working with one of the 'big four' supermarkets. CapEx budget has been ominously slashed in comparison to previous years but nobody seems particularity concerned about job losses in the office, perception being that the supermarket industry is recession proof - no one is anticipating a depression obvs.

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12 hours ago, MrXxxx said:

The thing is there are people where I work on such funds where they have the option to do a taper into bonds from 55 or stay 100% in stocks...what will they do?...nothing, and so they will automatically end up in the `safe` option of bonds and cash!

Have to be careful here because derisking as you approach retirement is sensible to ensure that your can crystalise the gains you have hopefully made with high risk equity investments throughout your work life. No one would have wanted to have their pension 100% FTSE 100 invested at the beginning of March with an April retirement due!

So cash is "safe" for a year or two as are short term bonds. Tapering is absolutely right. Just select the right assets!

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7 hours ago, Ellandback said:

Construction here also, I'm employed by a QS practice working with one of the 'big four' supermarkets. CapEx budget has been ominously slashed in comparison to previous years but nobody seems particularity concerned about job losses in the office, perception being that the supermarket industry is recession proof - no one is anticipating a depression obvs.

I have no construction knowledge at all but if I had then perhaps I'd look to build for Aldi and Lidl instead.

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8 hours ago, sancho panza said:

I think that's replicated in the share prices for even the more qulaity stocks.I can currently buy Barclays for less then I paid back in 1991.

ANd thsi is before we get the alrge scale defaults on CRE/mid grade and below corporate debt

image.png.5d4d6f55f51952d0b7206d474d5afdd6.png

 

How about RBS..? Anyone holding since 1988? Using BoE inflation calculator, 720p in 1988 is approx 1950p in todays money.

image.thumb.png.e034474b1401174403d7cb211125c3bc.png

 

I do wonder how banks will perform in inflationary environment..?

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geordie_lurch
3 minutes ago, BearyBear said:

I do wonder how banks will perform in inflationary environment..?

I am just an amateur with all this but I would expect lots of European banks including the likes of RBS in the UK to end up being nationalised (again) to prevent runs on banks etc when the defaults really start to hit so can't see any reason to hold any of them but open to counter arguments?

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Bricormortis
9 hours ago, sancho panza said:

hattip Kaplan

 

39580-15893358492668445.png

 

 

 ( re Kaplan ) Very interesting Sancho. I am thinking there is a lot more downside risk than upside potential in stocks, and was already considering selling most of my modest portfolio gradually. I have 22k in an isa, about 25% of that is metals and miners, the rest reflation stocks. Also have a 11k Silver holding. Thinking of  keep the silver, keep the metals and miners stock, sell about 70% of the remaining stocks and sit in cash to get back in after a bust. One can take the view that it might not all bust, but I strongly believe every sector is going to get whacked.

  If I knew what Repsol and Gazprom were going to do to their divis going forward It would help my thinking. 

Re the tweet above, it confuses me, not clear what he is alluding to, The scale of the crash might surprise some, a melt up may or may not occur from here, whats he on about "what happens after the crash". ?

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10 minutes ago, geordie_lurch said:

I am just an amateur with all this but I would expect lots of European banks including the likes of RBS in the UK to end up being nationalised (again) to prevent runs on banks etc when the defaults really start to hit so can't see any reason to hold any of them but open to counter arguments?

I wouldn't buy them now, but if I was to apply a contrarian logic they are the ones to watch.

@DurhamBorn do you have an opinion on UK banks..?

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geordie_lurch
22 minutes ago, BearyBear said:

I wouldn't buy them now, but if I was to apply a contrarian logic they are the ones to watch.

@DurhamBorn do you have an opinion on UK banks..?

I'm all for contrarian logic but we saw what happened to bank share holders bank in 2008 etc when they got nationalised and I really don't see the public accepting ANY sort of cash towards shareholders. This will be especially unpalatable when Joe and Joanne Bloggs are defaulting on their mortgages and credit cards debts because their furlough payments have stopped as they are now unemployed and have to make do with universal credit O.o

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Bobthebuilder
11 hours ago, Loki said:

@DurhamBorn What's your gut feel on another round of covidbucks for the self employed?

Cant see it myself. I was suprised how many tradesmen i work with did not get it, all top quality trades been the best in our area for decades but most are LTD company or just over the limit so got nothing. Most of the guys i know are prepared to sit it out, all saying its going to be tough but as guys fall out the trades and get other jobs the work hopefully will pick up. (domestic).

Ps, all the guys i know doing domestic repairs, boilers, sparkies etc. Have gone from 3/4 jobs a day to about 2 a week currently.

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41 minutes ago, Bobthebuilder said:

Most of the guys i know are prepared to sit it out, all saying its going to be tough but as guys fall out the trades and get other jobs the work hopefully will pick up

What other jobs though, I'd actually been considering the possibility of increased competition as more former service sector staff have to find work elsewhere.

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12 hours ago, Loki said:

@DurhamBorn What's your gut feel on another round of covidbucks for the self employed?

I actually have to go back to work 2 June. Gutted. My shite employer is actually still selling their crap. Paying no rent and min wage prob helps the fuckers. I’ve already been in contact with my old employer to work for them again. Told my current employer wanted to work on my other days and they have gone crying to HR to see if I’m allowed to work for someone else in my own time. Fools all.

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Castlevania
1 hour ago, BearyBear said:

I wouldn't buy them now, but if I was to apply a contrarian logic they are the ones to watch.

@DurhamBorn do you have an opinion on UK banks..?

If they can get through a debt deflation they’ll be worth buying for an inflation cycle. But that’s a big if. The big risks have moved from the derivatives books to the lending books and who knows who they’ve lent to. A lot of those loans won’t be paid back.

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Bobthebuilder
22 minutes ago, Loki said:

What other jobs though, I'd actually been considering the possibility of increased competition as more former service sector staff have to find work elsewhere.

I am talking about self employed sole traders Loki, in my experiance of the past those with big bills to pay fold and get a PAYE job, usually under pressure from the misses. Its not easy for someone new to say domestic electrical re wires to just set up and compete with those who have been doing it for decades, too many contacts etc built up over the years. Some try just by being cheap but usually shit as well so dont last very long.

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15 hours ago, DurhamBorn said:

https://www.liverpoolecho.co.uk/news/uk-world-news/national-holidays-shearings-fall-administration-18299134

Lots going bankrupt,but really sorry to see these go under.My parents enjoyed many a holiday with them and they were always very good value.The irony is its likely their UK holidays would of proved very popular over the cycle.National Express will gain of course and if i was one of the big coach companies id be running the rule over the business.

What was shearings will come back under a less leveraged owner who can actually run the company.

Demand and margin are there.

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Watching Rick Rule (Sprott) on Kitco mention high yield bond ETFs are very liquid but their underlyings are not so could go no bid in a crunch, a bit like you know who's income fund.  Just something to think about.

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25 minutes ago, leonardratso said:

whos that then? is it uncle neil?

Indeed, of the Woodford variety.  I doubt he will be alone if we get another crunch.

"Liquidity - Boom - Solvency"

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