It's quiet, too quiet...
July 11, 2017

Mint - Blain's Morning Porridge

It's quiet. Too damn quiet out there. The private schools have broken up, Wimbledon dominates the afternoons, and the only sounds disturbing us are the zzzs of sleepy traders snoring in the background as the dust motes dance in the midday sun.. (OK – that last bit isn't true.. but you get the drift).

It's cloudy today with rain in the afternoon. Maybe markets will wake up from the summer lethargy? We could look at the UK data from yesterday and conclude that falling consumer spending and declining business confidence bodes ill for recovery. The outlook remains pretty awful. Markets hate uncertainty and negativity – which is exactly what we have in spades here in Britain as Brexit fears, the Theresa May political car-crash and sinking confidence dominate investment thinking.

Such steep declines in confidence should be short-term – a short downturn in domestic confidence, a reassessment of the better global outlook followed by an up-spike, but the impasses in politics and European intransigence, plus the apparent split in the Bank of England where tighter policy looks on the cards, makes this UK downturn Speshul. Very Speshul. And very frightening..

I got a furious call from an investment fund yesterday. The principal ranted about yesterday's Porridge. He fulminated about how my comments on political uncertainty were far too anti-Conservative, and therefore they no longer wish to read my socialist ramblings. Fine. He's welcome to bury his head in the sand. I'm not choosing political sides – I merely point out how political instability in the UK is now the biggest market threat I've sensed in years doing these markets – the threat is it magnifies the negative and malign influences of Brexit. It's simple fact.

Nothing I read, see or listen to is changing my position that the current government is now a destabilizing influence and running on fumes. I'm as peeved as anyone at the current political disaster and its implications for the UK and markets at potentially the most vulnerable point in our mercantile history!

In fact I'm thinking of asking the Conservatives for my vote back.

As for Brexit what concerns me most is it's become a matter of irrefutable faith and dogma. My European chums (and I do have some) really don't understand why the UK isn't being more pragmatic about its relationship with Europe – accepting some issues, taking the exemptions we've been offered, and coming to an understanding on a new relationship. They wonder if the "likely" fall of the May government may spell the end of Brexit. Hope over reality.

Nope. It won't. Brexit has become an issue of holy writ and faith across parts of the UK political classes. It's become tangible in its own right – and right or wrong it will be pursued to the end. Despite being a marginal Leave myself (purely on economic reasons), I'm now concerned the Holy Fire of Brexit at Any Cost might blind us to other options. There.. I've said it.. will the Brexit thought police have me arrested?

Meanwhile…back on planet market.. Let's talk about high-yield and ETFs (exchange-traded funds). There is a great article on Bloomberg this morning by Katie Linsell (well worth reading her stuff.) She is talking about the sheer scale of growth of European high-yield as below-investment grade corporates sold over EUR 1.5 billion of new debt last week. Spreads in high-yield have ratcheted down dramatically – fuelled by the hunt for yield, prompting concerns many high-risk companies are now becoming over-levered. Many companies are raising debt to pay dividends or buy back shares – prompting concerns from traditional credit buyers.

Many readers will be familiar with my Ukrainian Chicken Farm Moment scenario – that ultra-hot new issue markets get terribly overenthusiastic and end up sinking themselves in over-optimism. I read a variation on it this morning – following the launch of a Hapag-Lloyd AG deal last week, a portfolio manager is quoted: "Shipping deals are a good bellwether that the market may be peaking… banks see this as a good time to market and investors are swallowing it because they are desperate for yield."

And the search for yield and return is the critical aspect. So, this morning I've been looking at an ETF – the iShares European High Yield Corp bond index – which aims to track the iBoxx Euro Liquid HY index on Bloomberg. Returns in HY have been phenomenal and incredibly robust. It's a EUR 5.3 billion bucket of over 450 non-investment grade credits.

The attraction of an ETF is it strips out the idiosyncratic risk that a single name goes bust. One name out of 450 will hardly dent the returns – even a cluster of defaults across the sector is unlikely to cause more than a wobble.

A key thing to look for on the HY ETF is the spread, which is currently 269 basis points over the aggregated Euro asset swap curve spread – comparable to the iTrazz x-over index, currently at 251 over swaps. It's not a bad proxy.

The risk is the credit tail – what happens if the whole high-yield market was to snap down – perhaps on rising real rates triggering a bubble burst in over inflated markets like HY? Although we don't expect a massive back-up in rates, more long-term normalization to a new-normal rate, it's worth considering as a "reset risk". (I think it would take a full-scale Global Financial Crisis part 2 to really push HY back to 2010 levels! That isn't on the cards.)

A big concern most traditional credit buyers have is how liquid an ETF like euro high-yield will be if a crisis hits? In normal markets our ETF guys reckon these funds provide a cushion now most market makers are no longer active. At present you can easily trade 25k shares (EUR 2.5 million) on a 5 cent bid offer. If a crisis hits we think that may blow out to 50 cents, but the market is now so wide and deep we're more than convinced it will remain liquid.

Worth thinking about – if you want to talk to my ETF team, let me know.

Finally, it's only one month to go before the Crew of Batfish V take on the Fastnet Race. We're sailing for two charities: Wessex Heartbeat and Sail4Cancer. If you can help, here's the link to our charity page: Fastnet Charity: http://www.sail4cancer.org/fastnet-2017-bill-blain

Out of time

Bill Blain

Head of Capital Markets/Alternative Assets

Mint Partners





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Mint - Blain's Morning Porridge

It's quiet. Too damn quiet out there. The private schools have broken up, Wimbledon dominates the afternoons, and the only sounds disturbing us are the zzzs of sleepy traders snoring in the background as the dust motes dance in the midday sun.. (OK – that last bit isn't true.. but you get the drift).

It's cloudy today with rain in the afternoon. Maybe markets will wake up from the summer lethargy? We could look at the UK data from yesterday and conclude that falling consumer spending and declining business confidence bodes ill for recovery. The outlook remains pretty awful. Markets hate uncertainty and negativity – which is exactly what we have in spades here in Britain as Brexit fears, the Theresa May political car-crash and sinking confidence dominate investment thinking.

Such steep declines in confidence should be short-term – a short downturn in domestic confidence, a reassessment of the better global outlook followed by an up-spike, but the impasses in politics and European intransigence, plus the apparent split in the Bank of England where tighter policy looks on the cards, makes this UK downturn Speshul. Very Speshul. And very frightening..

I got a furious call from an investment fund yesterday. The principal ranted about yesterday's Porridge. He fulminated about how my comments on political uncertainty were far too anti-Conservative, and therefore they no longer wish to read my socialist ramblings. Fine. He's welcome to bury his head in the sand. I'm not choosing political sides – I merely point out how political instability in the UK is now the biggest market threat I've sensed in years doing these markets – the threat is it magnifies the negative and malign influences of Brexit. It's simple fact.

Nothing I read, see or listen to is changing my position that the current government is now a destabilizing influence and running on fumes. I'm as peeved as anyone at the current political disaster and its implications for the UK and markets at potentially the most vulnerable point in our mercantile history!

In fact I'm thinking of asking the Conservatives for my vote back.

As for Brexit what concerns me most is it's become a matter of irrefutable faith and dogma. My European chums (and I do have some) really don't understand why the UK isn't being more pragmatic about its relationship with Europe – accepting some issues, taking the exemptions we've been offered, and coming to an understanding on a new relationship. They wonder if the "likely" fall of the May government may spell the end of Brexit. Hope over reality.

Nope. It won't. Brexit has become an issue of holy writ and faith across parts of the UK political classes. It's become tangible in its own right – and right or wrong it will be pursued to the end. Despite being a marginal Leave myself (purely on economic reasons), I'm now concerned the Holy Fire of Brexit at Any Cost might blind us to other options. There.. I've said it.. will the Brexit thought police have me arrested?

Meanwhile…back on planet market.. Let's talk about high-yield and ETFs (exchange-traded funds). There is a great article on Bloomberg this morning by Katie Linsell (well worth reading her stuff.) She is talking about the sheer scale of growth of European high-yield as below-investment grade corporates sold over EUR 1.5 billion of new debt last week. Spreads in high-yield have ratcheted down dramatically – fuelled by the hunt for yield, prompting concerns many high-risk companies are now becoming over-levered. Many companies are raising debt to pay dividends or buy back shares – prompting concerns from traditional credit buyers.

Many readers will be familiar with my Ukrainian Chicken Farm Moment scenario – that ultra-hot new issue markets get terribly overenthusiastic and end up sinking themselves in over-optimism. I read a variation on it this morning – following the launch of a Hapag-Lloyd AG deal last week, a portfolio manager is quoted: "Shipping deals are a good bellwether that the market may be peaking… banks see this as a good time to market and investors are swallowing it because they are desperate for yield."

And the search for yield and return is the critical aspect. So, this morning I've been looking at an ETF – the iShares European High Yield Corp bond index – which aims to track the iBoxx Euro Liquid HY index on Bloomberg. Returns in HY have been phenomenal and incredibly robust. It's a EUR 5.3 billion bucket of over 450 non-investment grade credits.

The attraction of an ETF is it strips out the idiosyncratic risk that a single name goes bust. One name out of 450 will hardly dent the returns – even a cluster of defaults across the sector is unlikely to cause more than a wobble.

A key thing to look for on the HY ETF is the spread, which is currently 269 basis points over the aggregated Euro asset swap curve spread – comparable to the iTrazz x-over index, currently at 251 over swaps. It's not a bad proxy.

The risk is the credit tail – what happens if the whole high-yield market was to snap down – perhaps on rising real rates triggering a bubble burst in over inflated markets like HY? Although we don't expect a massive back-up in rates, more long-term normalization to a new-normal rate, it's worth considering as a "reset risk". (I think it would take a full-scale Global Financial Crisis part 2 to really push HY back to 2010 levels! That isn't on the cards.)

A big concern most traditional credit buyers have is how liquid an ETF like euro high-yield will be if a crisis hits? In normal markets our ETF guys reckon these funds provide a cushion now most market makers are no longer active. At present you can easily trade 25k shares (EUR 2.5 million) on a 5 cent bid offer. If a crisis hits we think that may blow out to 50 cents, but the market is now so wide and deep we're more than convinced it will remain liquid.

Worth thinking about – if you want to talk to my ETF team, let me know.

Finally, it's only one month to go before the Crew of Batfish V take on the Fastnet Race. We're sailing for two charities: Wessex Heartbeat and Sail4Cancer. If you can help, here's the link to our charity page: Fastnet Charity: http://www.sail4cancer.org/fastnet-2017-bill-blain

Out of time

Bill Blain

Head of Capital Markets/Alternative Assets

Mint Partners



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