Out to pasture!
Updated: Jul 20
This is my first blog in a while as I have been working on a new exciting project which has consumed all of my time. Those people who warn that running your business results in 14 hour work days, even at the weekend, are right. They are also correct in saying that its fun and fulfilling. More on this new adventure later.
I posted 38 times (46 including updates) since I started this blog in mid March, with subjects ranging from debt and inflation dynamics to issues with asset liability management, with personal views on financial markets. It has been rewarding writing this blog for 3 reasons:
I have been able to outline key debt and inflation trends with hard data - it is quite extraordinary how many people (including those in financial markets) don't have or understand the underlying data and its impact on economies and markets. After 30 years of being involved in financial markets, it has become my view that debt and inflation dynamics and their consequences ARE NOW THE DRIVING FORCE of economies, central bank and government policies and thus financial markets. It used to be policy led to debt and inflation trends, but now debt is leading policy. Furthermore, understanding the difference between Consumer and Asset Price Inflation (API vs CPI) is vital, as is the link between the two and debt trends.
The feedback has been tremendous, both from people in finance and those affected by financial markets. Its been great to pass on this knowledge to other people.
I have been dragged into the new age, learning how to create a website and use Twitter (thx Jou, my first follower!) which meant that some articles were opened (and I hope read) by more than 900 people.
So the Old Grey Horse is being put out to pasture to roam free for a while, but before that, I just wanted to share some last thoughts on macro as well as some new experiences gained working in the "real" world which are important for future leverage. Finally I will take this opportunity to plug what I am doing - with a request for advice, thoughts and help.
Right from my First Blog I asserted that fiscal support for Covid19 was a political decision, and that it would be huge and matched by Central Bank balance sheet expansion, which laid out my reasons for buying Gold. This call on Gold was not because I believe there will be inflation - my view remains disinflation will be large for some time due to excess supply of goods and services trumping declining demand for them - but because there will be so much more money in the system that can and will buy gold. One of the biggest misbeliefs in financial markets is that Gold rises with inflation - that's simply not true...look at Gold's appreciation since 2000 when inflation was low and stable (chart below).
After the turn of the century money supply increased tremendously due to US and European banks substantially expanding their balance sheets as the private sector became very indebted (charts below for US - others available). From 2008 to 2015, banks and householders deleveraged and governments went on austerity drives.
Ever since Trump started his fiscal largess in 2018 and banks expanding their balance sheets again (and corporates levered up), Gold started rallying again. My team wrote about this in Oct 2018, recommending to buy Gold. Until I see governments start becoming austere, I will remain bullish on Gold and gold miners. Fred Hickey's ~$180 a year newsletter is probably the best value honest research out there in all matters tech, gold miners and macro (his research is a real steal).
Early on I also demonstrated that the Japanification of the US was now fully priced into the rates markets (as it was also in the Eurozone and UK). I outlined the low rates for longer argument and why I remained bullish long end rates as they all going to zero. I have detailed the numbers and trends, and unfortunately they clearly show that the United States, Japan, United Kingdom and Eurozone ARE ALL IN DEBT TRAPS. I therefore expect a "lower rates for longer" environment to persist (so yield curves NOT steepening significantly). That said, as yields move towards zero, then it will time to rotate into something more interesting. After 20 years of being a bull, I explained why I no longer saw any value in the Bund, unless of course you are resident in Italy and are worried about a Eurozone break up. I don't expect Bund yields to go up at all, but if there are any further capital gains on a Bund from declining Bunds, then there will be better gains to be had in other asset classes!
Recently there has been discussion about yield curve control (YCC), and whether the FED will introduce a new policy on managing interest rates. Do not be fooled - this is a rather large red herring, as the debt is now too large in the US (as it is in most major economies ) to raise rates without the increased interest cost having a debilitating effect on annual government budget figures.
There is no longer $ 1trn of outstanding US federal Bills - in June the outstanding amount surpassed $ 5trn. If rates rise from 0.2% to 2%, the ANNUAL interest cost just on that segment of the outstanding $19trn debt would rise from ~$ 8.5bn to ~$ 102bn. Naturally you would also need to also factor in the impact of higher interest rate costs on leveraged households and corporates.
This is the red herring - the size of the debt will force monetary policy. To think that the central bank can raise rates means ignoring the consequence from the debt stock. And this is the root of my lower for longer view, which is obviously influenced from years of studying Japan, and which is now almost completely priced in to rates markets. Remember that the YCC in Japan led to a severe reduction of the BOJ buying of JGBs - it just did not have to.
I recently watched the Big Short. It gives a timely reminder that markets can go in your face in the short term, even when you are right in the long term. I learnt this being long the German Bund in early 2008, which was also a great lesson about position sizing, market timing and risk management all in one painful go! It is for that reason I do not buy or sell equity or corporate bonds on a "valuation" basis. I cut my teeth as a Credit Loan Officer and understand balance sheets. Credit spreads and equity valuations are so far removed from underlying credit fundamentals which means that a credit fundamentalist like me will nearly always be carried out with losses. Luckily I realised that you could replicate "risk assets" with 50 year bonds and gold, but with less volatility. key was an understanding that once QE was let out of the bag, it would always be there to support ridiculously expensive government bonds.
Given that I have made too many mistakes getting involved in Credit and Equity, I will continue to steer clear of them. What I do know is that we are "late cycle" and there are a lot of highly valued companies with negative or poor net cashflow who are entirely dependant on refinancing debt to survive. If the private sector stops lending to anyone in the private sector, an individual equity or corporate bond will suddenly change value. To that end, I think keeping an eye on price patterns and momentum indicators will remain key to following those markets, and to that end the divergence between price and price momentum that I flagged on the key FANG index, which has been the biggest driver of the S&P, sends a very ominous signal.
I have little doubt that equity indices will not collapse like they did in Japan in the 90s, and indeed they could get more expensive. The Japanese entered a huge fiscal expansion when their debt fuelled equity and land bubble burst, and that fiscal expansion was financed by the private sector. Without central bank funds available to finance the Japanese deficit, domestic private sector savings HAD to be diverted to fund the public sector, so it is hardly surprising that private sector assets did not rise in value, especially given that there was a concurrent tremendous deleveraging trend in the private sector (especially bank and corporate balance sheets). This all happened DESPITE INTEREST RATES AT 0%. The same has been happening in Europe AND to the US household sector post GFC, again despite historically low rates.
The difference is that Central Banks in the US and Europe ARE funding the deficits, so private sector savings can remain invested in the private sector. This is the crucial difference that will allow for the rates to be zero AND valuations to be high. But as mentioned time and time again, more and more CB balance sheet expansion will be needed to feed the debt monster. So any equity correction will be accompanied by more balance sheet expansion - its now just a question of size.
Are rates at 0%? They might be for government bond issuers and holders, but not for all borrowers or all savers, as I have experienced in my new adventure helping out with the finances.
The time difference between having to pay suppliers upfront and being paid by customers after a sale leads to a need for trade financing facilities to tie over that time gap. My 3 weeks experience early in my career in the NatWest Redhill branch learning about factoring has finally brought dividends! My search for financing facilities reaped some interesting lessons:
All those sales pitches made to clients were useful. A company prospectus discussing business strategy, plus some details on the product, projected cashflows and manufacturing/inventory order flows led to offers of credit lines.
However, Covid19 has severely reduced the capability of the traditional High Street banks - they just don't have the staff numbers in the UK (and are quite understandably prioritising debt holidays for existing customers). It took me 3 days to get through to one, and that was after waiting 5 hours on the phone. We have an appointment to open a bank account in October......
The High Street banks have no interest in offering a credit line, even where there are guaranteed orders and positive monthly cashflow - they require a track record.
However, there is a fantastic second tier of financiers out there, some FCA regulated others not. The interest rate for 30day funds ranges from 1.0% to 3% (i.e. 12% to 36% p.a.!)
The interest we have had in our product has been overwhelming. But even though our product price is very reasonable, the demand to purchase on Lease/Hire Purchase has been high. Balance sheets and cashflows are very stretched and many businesses have already used their government loans. Furthermore a sale on a lease is not a guaranteed sale at all - our financial partner recently turned down a potential customer as it had been losing money for the last two years, and in an increasing fashion. We have been speaking to a wide variety of businesses - it seem much much tougher out there than the data would suggest, and the coming gradual pull back to the furlough scheme will be a tipping point for many.
This anecdotal evidence has two huge takeaways. 0% is not what is being charged and even if it was, you are not guaranteed funds.
This reminds me of Japan in the late 1990s. The customers that banks wanted to lend to did not want to borrow, whilst those who wanted loans could not access them. The only way out of this is either default or through Fiscal Policy (Loans and Grants) financed by central bank balance sheets - exactly what I described in my Central Bank Evergreening post. This will keep zombies afloat and prolong their lives. Whilst that may be good for debt and equity valuations for those companies, it is not good for PROFITABILITY (excess supply remains high, compressing margins) and thus will limit the ability to exit the ZOMBIE nature of finances.
The key question is therefore what will happen when the fiscal help comes to its end, when furloughing payments expire and granted loans need to be repaid. My bet is that it will be followed by more money, financed by further Central Bank balance sheet expansion - that's what historical precedent suggests.
In 2014 I hired and started mentoring a very smart graduate on the Citi investment banking graduate program. Christian had already worked in start ups and as a management consultant, and so was clearly not your average green behind the ears grad. We built a strong multi-asset franchise in the 5 years that we worked together, offering clients profitable non consensus trade ideas backed by hard data with good risk rewards. He eventually left to go into "real business" and unsurprisingly thrived. Recently he and his brother approached me to ask whether I would introduce them to my contacts, who held senior positions in diverse businesses, in order to help them with their new venture that is Rensair (Danish for "Clean Air").
In summary, their father Henrik was a Danish ventilation engineer who developed and patented a portable hospital-grade air purification unit, called Rensair. It has been independently tested to show that it effectively kills 99.97% of airborne viruses (including the corona virus family), bacteria, pollen and other airborne pollutants. Henrik was successful with his Rensair units, which have now been distributed and used in Scandinavian hospitals for more than 10 years. Henrik is now in his late 70s and retired (or so he thought!).
Christian and his brother, who are based in London, have recently set up a UK company to revive, manufacture and sell their father's Rensair air purification units to help the healthcare sector, offices, care homes, education institutions, restaurants, hair salons, bars and other businesses deal with the threat from airborne corona virus transmission. Businesses have never had to deal with this sort of threat and so there is a lack of high quality products on the market that are as well engineered, tried and tested to be so effective against viruses, let alone with a track record of more than 10 years.
Most recently the Head of Operations Estates for a large region of the British National Health Service (NHS), who had been researching air purification systems around the world for the last 3 months, concluded that our Rensair unit is the best air purification unit that he has come across. He praised the engineering which employs UVC light on sealed HEPA filter that kills viruses and bacteria on the filter units, which also makes infrequent servicing and maintenance of the units especially safe and easy.
The demand for Rensair has naturally been very strong and the new company has sold these units to a Care Home group in Florida (following extensive independent testing by them), office spaces in Europe and Yoga studios, Pubs and Restaurants in the UK. There are talks about distribution with the US Military, a large Californian Art Gallery, a well known holiday operator for their Japanese resort and many other individual large and small businesses.
Seeing the hugely positive feedback that my introductions were giving me, and the other help that I could provide, I accepted an offer to join the founders and jump on board. This new venture passed all my "smell tests", the first being that its something my mother would approve of! In the month I have been working for Rensair I have become fascinated by the subject of air purification, not only with respect to Coronavirus, but also in the context of general air pollution. The long hours worked have been hugely rewarding, and its great to see Henrik so motivated with some amazing new ideas up his sleeve. The downside has been finding out much more about virus transmission, in its many forms.
We at Rensair are looking for introductions to anybody who wishes to discuss the provision of portable hospital grade air purifiers. We are talking to businesses who want to buy them directly, or want to distribute them for us and so we are very appreciative of new leads. I also welcome any advice on how to grow the business - its going tremendously well, but we are also noting just what a big wide world it is out there! Sorry for the unashamedly blatant plea, but I feel this is a just reward for the blogs that I have posted and emails replied to!
As always, its good to always keep a teaser at the end, which in this case is the price of the Rensair unit. Assuming an average UK electricity price per kWh and a straight line depreciation for the cost of a unit over 3 years (even though the oldest unit built 13 years ago is still going strong), then a Rensair unit costs less than a cup of cappuccino a day to own and operate.....that is one heck of an upside downside trade!
I wish all my readers a great rest of the summer and thanks for reading the Grey Fire Horse (my Chinese sign is a Fire Horse and the grey bit you can guess). Do feel free to reach out for any questions on macro - I will still be looking at markets on a daily basis and updating the debt, inflation and pension numbers when time allows.
Thanks in advance for any feedback, advice and introductions with respect to Rensair. It is really appreciated. Regards Edward.