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Insight - Making Sense of the Narrative


Fifteen years ago Ben Bernanke had to ask for $700bn to bail out the US Financial system otherwise "We might not have an economy on Monday", but the often overlooked reason why a financial crisis became an economic one was the role of the Money Market Funds which were effectively funding corporate working capital through Commercial Paper markets. When they froze, so did the economy. Fifteen years on, they are once again dominant, but this time crowding out bank deposits rather than bank loans. Let's hope they don't cause a similar, but different liquidity problem this time.

UK Inflation is driven by essentials like Food, energy and Housing - the cost of living crisis. The BoE's policy appears to be to raise 'taxes' in the form of higher mortgage costs to 'tame' this inflation. The only way this will work is to completely collapse demand for everything else. Crucially, the orthodoxy ignores the impact interest rates have on supply, rather than demand - lower rates increase supply and lower inflation, higher rates do the opposite. Bond vigilantes think this policy will support their market (which is why they are demanding 'credibility'.) Far more likely is stagflation, which is bad for everyone.

The recent squeeze in Mega Cap tech is actually part of a recent series of gyrations between Tech and Energy that was stimulated by the arrival of huge flows into ESG and has been exaggerated by front running both their inflows and the flows around momentum investing strategies that have been rebalancing

Including this year to date, Chinese Equities are down for the third year in a row, while Japanese Equities are up for the fourth year in five. Covid, Geopolitics, and Index weightings for diversification are all part of the story, but we also think that just as western models that assumed low interest rates would cause inflation singularly failed to recognise their role in a savings based culture as return on savings on the downside, so they are also missing the point that higher rates will generate higher demand and inflation in Japan

SVB was a shock as everyone assumed everyone else had done the due diligence, but in reality it is a simple story of a bank that became a bond fund and failed to manage its duration and funding risks only to be hit with the equivalent of a redemption as its almost entirely corporate deposit base asked for their money back. By contrast Credit Suisse is hardly a surprise, but coming at the same time, and also in options expiry week, helped to create an exaggerated sense of a banking crisis. There isn't one. Both banks are the collateral damage of the shift to a new New Normal, where interest rates are set at 'normal' levels and normal companies can make normal profits (while great companies can make great profits). Investors should use the sell off from expensive end of fair value to cheap as an opportunity to renew or place their bets on the likely winners under this new paradigm.