Adam Parry – A week for fireworks and a tale of conflicting asset classes
In the early hours of 24 March 1603, the last of Henry VIII’s descendants – Queen Elizabeth I – died at Richmond Palace. A few hours later Robert Cecil – who had been entrusted by the Queen to prepare the way for a smooth succession – proclaimed the new King of England to be James VI of Scotland.
James I succession was by no means universally popular thanks to the fact that he was a Protestant. In the first year of his reign James survived two conspiracies to remove him from the throne, one of which led to the arrest of Sir Walter Raleigh, among others. A couple of years later, a Catholic cove by the name of Robert Catesby along with a group of provincial English Catholics decided that enough was enough and hatched a plan to blow up the House of Lords during the State Opening of Parliament.
Thus in July of 1605, 36 barrels of gunpowder were brought into an undercroft of the Lords with the intent to be ignited on July 28. However, the ever-present threat of the plague delayed the State Opening until November 5.
And so it was that on a grey, dank November 4 day, a chap named Guy Fawkes had ensconced himself in the cellars with specific orders from Catesby to ignite the gunpowder as the King arrived to open Parliament. The only problem for Catesby, Fawkes and co was that they had a mole, and a letter had been dispatched to the King’s men in late October, informing them of the plot.
A search of the building took place as the sun fell and as the clock struck midnight, the Kings men discovered Fawkes lurking in the cellars, guarding a pile of wood that had been assembled not far from the barrels of gunpowder. Fawkes was taken to the King later that morning and confessed three days later, no doubt after some rather unpleasant medieval torture.
In January 1606, the conspirators were found guilty of treason. Fawkes was hung, drawn and quartered on January 31 opposite the building he had planned to blow up. Catesby escaped the executioner by being shot during the Kings men’s siege of Holbeche House on November 8. His remains, however, were exhumed and decapitated, with his head exhibited on a spike outside the Lords. Nice!!
For the last 415 years, those of us in the UK have celebrated the foiling of the plot every November 5 by throwing an effigy of Fawkes on a bonfire and letting off fireworks.
But as with everything else this year will be different. There will be very few organized events, which means most of us will have to resort to letting of a few rockets and bangers in the back garden.
Before we get to the pyrotechnics though, there are a couple of matters that need to be addressed.
Now if any of you managed to wade through the meaningless drivel a couple of weeks ago, you will be well aware of the propensity for October to throw a bit of a spanner in the works, and the end of October in particular. And while we did not see a full blown Halloween nightmare last week, the markets were definitely a bit spooked as it becomes more and more apparent that further lockdowns across the globe are increasingly likely. Wednesday saw European stock indices drop between 3 and 4%, with similar drops in the US.
Secondly, Tuesday brings us the little matter of the US Presidential election. The polls are indicating that the Donald might get a bit of a shoeing from Joe Biden, but then Hilary was expected to beat him comfortably in 2016 and look what happened then.
In terms of the markets back then, there was a major equity and credit rally when Trump was elected on the basis that he would be jolly good for business with the Dow rallying from just under 18,000 to just under 20,000 in the six weeks after the shock result. And to a certain extent they were right. Until the start of the pandemic that is.
Now we are in a quandary with equity and credit markets telling us one story and sovereign yield curves telling us quite another.
Let’s take a look at 30yr bond yields. Now the 30yr sector of all curves is the most volatile, and there is a very good reason for this. It is called “gearing”. Basically that means that in normal times we have a pretty good idea where interest rates will be in 6 months and out to 2 years. We are less sure where they will be in 5 years, even less sure in 10 years and by the time we get to 30 years we shouldn’t have a clue.
But these are not normal times, and the bond markets are telling us that the impact of Covid 19 will hit global economies for years to come. In the US, CT30’s are yielding 1.66%. That is the highest yield level since March, but if we look further back, bonds were yielding nearly 3.5% two years ago.
In Europe, 30yr yields tell an even more telling story given the added nightmare of the sovereign debt crisis hangover. 30yr Bunds remain in negative territory. France is just in positive territory, but it is the periphery where the tale is most marked. Spain yields just below 1%, Italy just above 1.5%. In the UK, 30yr yields are at 0.8%.
What that tells us is that the bond markets are fully pricing in an ultra-low rate environment for a very long time indeed. And given government borrowing and the ensuing hike in debt to GDP ratios, you have to say that there is a certain amount of solid logic to that point of view.
The same cannot be said for equity and credit markets.
Despite the drops this week, equity markets must surely be over-valued with a couple of notable exceptions, namely the tech sector and online retailers which is why the NASDAQ has massively outperformed other indices in 2020.
Most other sectors are going to suffer a Halloween style horror story as these new lockdowns hit the economy and hence at current levels, it appears that most equity markets have got their heads in the sand and ignoring the logic on the economy seen in bond markets.
There are of course reasons for that apathy. The support of the central banks – which, incidentally is the reason for the price action in sovereigns – has created that most dangerous of market forces. The apparent back-stop bid. What happens when that back-stop finally disappears? Fireworks.
The same is true in credit markets. As the economy suffers and struggles to get back on track over the next few weeks, default rates will inevitably rise. Let’s look at the iTraxx Crossover index, which tracks High Yield corporates in Europe. At current levels of 370bp the default rate is around 27%, which may seem high, but you must remember that most constituents of the Crossover index are on the junk end of the credit spectrum. If you believe that around 50% of those HY corporates will fail to survive the toxic shock that must surely be on the way, the Crossover should be trading at 800bp.
So we can clearly see that the old inverse relationship between equities and credit and sovereign markets no longer exists. In these strange times it appears that we either have to buy everything or sell everything. Somewhere down the line, surely that has to change.
And to end, a little recipe for using up any leftover pumpkin from Halloween. A nice warming soup…
Finely dice an onion and crush a clove of garlic and sweat gently in butter until translucent. Add diced pumpkin and a pinch or two of cumin and continue to cook for a couple of minutes. Add some nice homemade chicken stock, bring to the boil and simmer for 10-15 minutes.
Once the pumpkin is very tender, blend in a liquidizer and then strain through a chinois so that you have a velvety texture to the soup. Return to a pan a add double cream to turn the soup into a veloute. Check the seasoning. Serve with a garnish of wild mushrooms sauted in butter and a couple of drops of truffle oil. Lovely.
Have a lovely week and always remember, remember, the fifth of November. Gunpowder, treason and plot.
On the Agenda this week:
Obviously the main event of the week is the US election on Tuesday. But there may be more fireworks on November 5 with the latest FOMC rate decision at 19:00 GMT. Expectations are that the Fed will keep rates in the 0-0.25% range. Before we get to the Fed, the MPC in the UK will announce its rate decision. Again no change is expected from the current rate of 0.10%. There are, however, many economists forecasting another rise in the QE programme £845bn from the current £745bn.
- Monday: ISM Mfg; construction spending
- Tuesday: Factory Orders; Durable Goods
- Wednesday: ADP employment, services and comp PMI; ISM services.
- Thursday: Initial Jobless Claims.
- Friday: Employment report; NFP’s exp at 600k; unemp rate exp at 7.7%.
- Monday: Mfg PMI’s.
- Wednesday: Svcs PMI’s; Area wide PPI.
- Thursday: Area wide retail sales.
- Friday: Italian retail sales.
- Monday: Mfg PMI.
- Wednesday: Svcs and comp PMI.
- Thursday: Construction PMI.
If you would like to know more then please get in touch.