De kampioenbeer: Andrew Roberts van RBS

De global rate strategist Roberts van RBS kreeg het voor elkaar de aandacht te trekken met het onderstaande bearish verhaal:

we thought it worthwhile to update our big picture FI strategy thoughts on where yields go, how they get sub2%, and how quickly. And how much equities might fall. The end game is coming very soon in my view. Please do say all and every feedback. Thanks


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Get ready for the cliff-edge. Be maximum long duration of nominal government bonds in safe haven markets. This means US, UK, Germany, in that order, and perhaps others. Be long gold. Think the unthinkable – we always do, and you should ask yourself why the consensus refuses to do so, and seems perpetually on the ‘everything is ok’ side of events. This is identical to 2008, including the incredible complacent (and we believe wrong) consensus.

Get ready for sub 2% on 10-yr USTs; sub 2% on 10-yr bunds; and the UK not far behind, 2.5% 10-yr Gilts. Our long held US$2000 gold view as a trade for the breakdown of the financial system looks increasingly ok. We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe), and for the global economy (particularly in the US/Europe). We have been wrong before, but we think the risks associated with us being wrong are low (ie, rates just stay where they are, yields back up a little bit, after all we are not about to enter a new global economic upswing!). The risks associated with us being right are >10% returns in 10-yr USTs at the same time that equities/commodities will collapse far beyond what even some equity bears anticipate.

For instance, rather than say non-financial corporate balance sheets look fine (which they do, but that does not mean much when the consumer and the government balance sheets are bombed out and we should start focusing on what happens when the consumer turns down), let us sit back and take a historical perspective on risky asset valuations. Especially when consensus has been arguing all year (as it always has done) that equities are a good investment. Last time we looked S&P500 total return YTD: -2.8%, Eurostoxx -7.9%, NIKKEI -6.2%, and what of those allegedly better investments of emerging markets we are told will decouple? China is -21.4%, and the big picture global EM ishare is -8.2%.

For a counter consensus look at just how rich equities actually are if we are right about the economy, and how far they can fall, look at Robert Shiller’s 10-yr real adjusted P/E ratio on the S&P500, which uses ten year smoothed earnings. We have used this as our marker for proper (unbiased) long-term valuations for many years – and is freely available to all investors to look for themselves on his Yale website – and it sits at 20.0. One pillar of our framework is that sometimes it is right to buy equity, sometimes it is right to sell equity. And call us old fashioned, but we will buy at low PEs, and sell at high PEs. So a PE now of 20, sits very uncomfortably right at the TOP of its range if we take out the pre-first great depression spike in 1929 and Nasdaq 2000 spike. We argued in 2007/08 pre crunch that we would buy equities again when they looked cheap, which would be at something close to 6-8 PE on this metric. That is an equity fall of 60-70% from here. Fine, call us mad with such big numbers if you desire, and say we will miss the big equity rally on a structural view (what rally, having been short for 10 years, S&P500 total return since 1Jan2000 is actually -8.1%!). Meanwhile an investment in 30yr USTs has returned you +126%. You do not have to see -60-70% off risk assets to be cautious here, we are just suggesting this is what the numbers say are attainable if certain circumstances prevail, using a 120 year snapshot. This does not seem unreasonable to have that discussion, though we suspect by even writing this it will be regarded by the plethora of equity bulls as somewhat outlandish. Nevertheless, the big turnover in the US economy will lead to dramatic turns down in valuations we suspect – and may finally destroy the world’s worst cult: the cult of the equity, which has no basis in fact but yet seems universally accepted.

This all sounds somewhat doomsdayish, so we should update how the real economy/banking is panning out for us. It is saying: the end-game approaches.

First, we have been waiting for the last of the US fiscal easings, the first time homebuyer tax credit, to pass, and have been arguing strongly for some weeks to investors to get ready for the violent turn down which is about to occur. And the trigger (not the only reason, but the trigger) is the US housing market. This is all falling into place lovely. Last week saw the NAHB housing index dip; housing starts at -10%mom (6.3% under consensus), and building permits -5.9%mom (8.4% under consensus). This week has seen existing home sales -2.2% (8.2% under consensus); and new home sales -32.7%mom (14% under consensus). Our theme is building. The BoE financial stability report today shows there is a surplus of 1.75m housing units built since 2006 and even with normal household creation this will take two years to remove. So the weak housing theme should now pollute its way into consumers, and kickstart the rebuilding of the savings rate (just 3.6% and delayed from rebuilding by the fiscal/monetary shock and awe).


Second, the European banking system faces problems. We have seen downgrades continue in Europe this week. We discussed in last week’s weekly overview about the US$450bn shortage of dollar asset funding for non-US banks, and why the Fed had to reopen swap lines. We are amazed there is not now immense market & media focus on the new letters that will bring forward the end-game and worsen it: 2a-7.

What is this? The new (well ‘new’, it comes in on 30 June but has been known for a year despite no-one discussing it at all) SEC rule. This forces US money market funds – up to now the provider of USD liquidity to those who need it – to become ‘safer’. The SEC puts it thus: ‘The amendments tighten the risk-limiting conditions imposed on tax exempt money market funds by rule 2a-7…the amendments are designed to reduce the likelihood that a tax exempt fund will not be able to maintain a stable net asset value.’ (source: SEC). Our short-term strategists plan a piece next week. The key for us in FI is that these US$2.8trn of 2a-7 funds now have to a) own 30%, not 5%, of assets in sub 7 day liquid paper; b) weighted average maturity of fund has to fall to 60 from 90 days. We can all see the logic – the sovereign defaults from EMU have the power to hit EMU banks badly, and the USA does not want to repeat the calamitous ‘breaking the buck’ problem when in 2008 Reserve Primary Fund wrote down its Lehman assets, took its net asset value sub $1, caused a run on money funds which then forced them to sell their assets, cutting NAV for other funds, etc. Contagion.

From what we can see, the USA is basically pulling up the drawbridge and retreating into its fortress, trying to protect its financial system from coming European banking problems. A fine ideal (for the US). But the consequence is clear. Banking is about confidence. If you are reliant on markets to fund yourself and that confidence wanes, a total stop can occur immediately/within days. Northern Rock (75% reliant on wholesale markets) was the first example of this in the UK, though not the last. Once we apply 2a-7 (and the ability of US money funds to ‘put’ their EMU bank assets back to the issuer EMU banks within 7 days on signs of trouble, since the US money funds will from now on increasingly own 1yr securities with a 7 day put) to our economic slowdown/deflation themes, this means one thing. If there is a slowdown and sovereign trouble, the problems facing EMU banking have through this rule potentially become a whole lot worse. This worsens – and brings forward – the ‘cliff edge’ potential.

Monster QME coming. With fiscal policy off the agenda, we have always expected more QME (quantitative monetary easing). And this time will be different. We have always argued that buying of bonds is less efficient than guaranteeing yield levels, and that yields are the key, not raising money supply, given demand for credit is dead (so all QME did was raise bank reserves and show money velocity collapse). There has been a subtle shift from central banks toward our view, most evident from the UK MPC, whose £200bn programme started by foscusing almost purely on underlying M4, but ended differently with MPC speeches about how successful it was in keeping Gilt yields low.

The next shock and awe will be in the form of large scale QME, but with one massive difference – it will be focused on lowering yields, not expanding money supply (I think). So do not be surprised if the next QME is about guaranteeing yields at, say, 2% 10-yr US, or lower. Even if it is a vanilla buying programme as before, expect it to focus along the curve and bring all yields down in a monster bull flattener (you cannot bring down 5s and not 30s because that just changes savings’ maturity preference, it does not deter saving). Note today’s Telegraph article alleging that the Fed are already mulling more QME of another US$2.6trn (to take their balance sheet to US$5trn), which is totally unsurprising (we think CBs are far more dovish worldwide than investors/investment banks are). The ECB will follow. We are getting more bond bullish, not less. Great Depression II is coming. Be prepared, be long.