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May 17, 2022
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This weekend we had another article in Australian Financial Review. It is behind a paywall, so we reproduce it here.

Nowhere to hide as Fed liquidity evaporates (afr.com)

Links within the article or shown below are to other AFR articles.

Nowhere to hide as Fed liquidity evaporates

The tide of Fed liquidity has reversed, leaving a whole variety of public and private equity strategies stranded, writes Mark Tinker. Here’s who is swimming naked.

In recent years, the mantra “don’t fight the Fed” has fuelled a perception that it was effectively selling a put on the markets.

Now it seems it has flipped 180 degrees and is writing calls instead, and equity markets are getting the message: rallies are being sold and dips are not being bought. As such, the Fed remains the biggest risk to markets, not just in our opinion, but in the opinion of most investor surveys.

To the extent it believes in a wealth effect driving GDP, the Fed should be happy, the asset bubble it created with its (in our view reckless) previous policy of quantitative easing and zero interest rates is deflating rapidly. The collapse in crypto valuations over the past two weeks has destroyed enormous amounts of, admittedly mainly perceived, wealth, and revealed the uncomfortable truth that bitcoin was just another way to play the Nasdaq.

Instead of being diversified, investors were heavily correlated.

Meanwhile, as the latest news from the unicorn-wranglers at Softbank and Tiger Global has revealed, the Indian rope trick of overpaying for pre-IPO tech stocks and then also crowding into them post-IPO with help from ARK and the options day-traders has well and truly collapsed.

The tide of Fed liquidity has reversed, leaving a whole variety of public and private equity strategies stranded. Not since the dotcom bubble has Warren Buffett’s aphorism about the tide going out revealing who has been swimming naked been more apposite.

At a broader level, the sudden lack of diversification and increase in correlation between bonds and equities has blown a hole in the core theory behind most pension fund models and significantly impaired actual wealth for many pensioners.

After years of returns averaging 6 to 7 per cent for 60:40 funds, year-to-date they are down 10 to 15 per cent. Meanwhile, as the RBA and other central banks follow the Fed in lockstep, the impact on ordinary households’ cash flows from higher mortgage rates is starting to weigh on the housing market.

In order to solve the inflation caused by their previous policies, they are now threatening stagflation. Everything is getting hit, with nowhere to hide except US dollar cash and perhaps ultra short-dated bonds.

May has also seen almost every currency collapse against the dollar – including pseudo currencies like crypto – and even gold. However, while the current strength of the US dollar is being represented as a flight to quality and the last place to hide, we suspect that this is temporary, even if it is true.

Much more likely in fact is that dollar strength is part of a wider deleveraging play across all asset classes. As the Fed shrinks its balance sheet, so too do most of the financial players running carry trades and leveraged positions generally. A sharp move in exchange rates – both the Aussie and the yen for example dropped almost 14 per cent in a month – means a currency mismatch is devastating, forcing a scramble to close down dollar borrowing.

Beyond this, however, is an even bigger issue, that of a weaker dollar based on the recognition that, for most of the world, the dollar is no longer low risk.

Indeed, for investors outside the US, arguably there is no longer even a common risk-free rate to base things on. The unprecedented move by the Biden administration to freeze and essentially confiscate the overseas assets of Russian people has effectively destroyed the concept of the dollar and especially US Treasuries as a risk-free asset.

Put simply, an asset that can go to zero overnight can no longer be regarded as risk-free for anyone outside of the US, or perhaps the broader West, but given that most of the world’s excess savings originate not in ‘The West’ but in ‘The Rest’, this has significant implications for long-term capital flows. Indeed, we don’t believe it is an exaggeration to say that this is the biggest potential systemic disruption to financial markets since Nixon took the dollar off the gold peg in 1971.

What it also means is that anyone with US dollar assets, but who is concerned that their government may fall foul of US foreign policy at some point in the future, will now be looking to move those dollars into “safer” assets outside of the dollar zone.

Indeed, it will be interesting to see how demand for trophy properties in Sydney and Melbourne, let alone London, Vancouver and San Francisco holds up, now that they are functioning as risk multiplication rather than risk diversification.

Having said that, with the dollar where it is, the purchase of commodities or real assets outside the US looks very attractive right now and we wouldn’t be surprised to see an upsurge of M&A throughout the whole of Asia-Pacific and emerging markets.

As for China, with $US1 trillion of US Treasuries, it may choose not to sell, but it seems unlikely it will be a buyer of many more, and indeed one angle might be to obtain a lot of dollar liabilities against those and use them to buy real assets.

Perhaps China could borrow in dollars against their Treasuries to pay for the next phase of One Belt, One Road? Who knows? Perhaps they have done that already.

Mark Tinker is chief investment officer of Toscafund Hong Kong and the founder of Market Thinking. He blogs on behavioural finance and markets at Market-thinking.com.

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Political Cicadas - no change in the product, just the sales team

The habit of spending long periods underground before re-emerging is not limited to the Cicada, for while this year sees the coincidence of the 13 year year Cicada cycle and the 17 year one, something that last happened 221 years ago, it is also 17 years sine Tony Blair was last in power and 13 since Francois Holland (likely PM in the French Hung Parliament) was. Both now look to be re-emerging to ensure continuity of policies that never really went away. The key sources of protest across Europe - crippling expensive wars against Russia and Climate change as well as uncontrolled immigration have only been addressed in the doubling down - the first thing UK PM Starmer did was fly to Washington to offer more money to NATO, while his Chancellor promised more money for Net Zero. Meanwhile, the left alliance put together to thwart Le Pen is even more pro immigrant than Macron. For markets, there is no prospect of lower spending and every prospect of higher taxes - the only 'Change' visible but not the one promised. The Technocrats and Globalists expecting this 'democracy' means that the populous will go quietly will be disappointed, especially with the arrival in the Autumn (once the Cicadas have gone) of the great populist, anti open border, anti net zero and anti war populist Donald Trump.

Market Thinking July 2024

The scorecard for the first half puts Equities, commodities and Gold in the top half of the table, with cash and fixed income in the lower half. This is consistent with the steady but uninspiring macro backdrop and positioning ahead of a tricky H2 from a political perspective. The anomaly of the Market Cap weighted SPX out-performing the equal weighted SPW by over 10% points tells us both that the SPX is no longer telling us anything about the US economy and that this excess return is for taking (considerable) concentration risk. Meanwhile, with Bond analysts 'pivoting from the Pivot' the fixed income markets have calmed down a little and leaving The Donald' rather thna 'The Fed' as likely the biggest policy influence on Markets over the next 12 months. In particular, we would look out for a 'Trump Plaza Acord" early next year, 40 years after the last one- something the FX markets aren't talking about, but the asset allocators seem to be (at least subconsciously) pricing in.

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