Episode 11: Alice in Wonderland
- Who is right? The media, the economy or the stock markets?
- As lockdowns are relaxed, consumers resume spending...
0:00:04
Welcome to the latest edition of the Moses and Methuselah weekly podcast. My name is Jonathan Davis and each week I sit down with my battle-scarred but indomitably optimistic investment manager friend, Peter Seilern, to chew over the latest developments in the markets and debate what they might mean for governments, investors, and tax-payers.
0:00:26
[Jonathan] Well, Peter, I thought I'd start this week by commenting on something I've just been looking at. I've been looking at some indicators of what is happening across Europe in terms of activity. Traffic, people going on the roads, people going back to their offices; all of these things can be tracked these days thanks to Google and so on, and everything is continuing to go up at a steady pace of recovery. In other words, lockdown is ending, and people are going back to work, and the economy is very slowly reviving.
Yet despite that, in this week we've had quite a noticeable sell-off in the stock market which seems to be, once again, doing things that we don't expect. So, what do you think is going on with the stock market in that context?
[Peter] Jonathan, your observation that things appear to be moving is quite right. And if you look at the graphs that cover things like the movement of traffic, or another interesting one is the utilisation of electricity, these trends are all pointing upwards now.
Now, of course, the FT put it as follows. They wrote, "how can stocks appear so rosy while the global economy suffers so much pain?" The answer to that question, I think, lies in what you've just said. Mysteriously these things are beginning to normalise.
I saw an app the other day which my son showed me, as a matter of fact, where you could track air traffic. And he said to me, "what do you think that this picture will look like now, before I show it to you?" I said, "it will probably look very thin on the ground with practically nothing. Full of blanks and empty space". Instead what he showed me really surprised me. It was black with traffic whether it's over Europe or over America. There's a lot of air traffic going on.
I'm interested to hear what you think about the role played by the media because you've got the media which is trying to bad-mouth the financial markets and many participants and ingredients thereof; then you've got the stock market which is going up except for that one day this week; and then you've got the economy which is justifying what the stock market has been signalling to us in the last few weeks. So, I suppose my question to you is, what do you think made the stock market wobble to quite an important degree two days ago?
0:03:17
Well, it was interesting, wasn't it? Looking at the figures, on average, most European stock markets are down between, I think, five and seven percent this week, which is potentially quite significant.
I think it's fairly straightforward. I think the media has a part to play in it but I don't think it's really about the media; I just think it's a function of how these markets work which is that they have become what we like to call in technical terms, overbought. In other words, there's been such a strong recovery that the market has got a little bit ahead of itself. Therefore, people say there must be some trigger for this change in direction. And of course, there may be. But it's simplistic.
The ones you read in the newspaper headlines are very simplistic and I think what we need to look at is actually, if you like, the technical editions in the stock market more than anything else. In other words, what goes up for a long time tends to get ahead of itself and then there's a period of normalisation. Because as you say, the underlying economic indicators are, in fact, moving in the right direction.
And I know that you're not even a crypto-chartist but a declared chartist and I read a very interesting report about the various charts that have pierced through their ten day moving averages or longer moving averages, and stochastics and all the rest of it, which show clearly that - as you say - the market was overbought. And so, for the market to take a breather from those levels I think is completely normal because these things don't go in a straight line; neither up, down, nor sideways. And that's the market.
So, that didn't surprise me so much. The more interesting discussion is whether there is a new army of day traders who are all people who are home bound and they're all people who have hoarded cash either because they had to or because they had nothing to spend it on, and decided to play around in the financial markets. And for the bears of which there are still very, very many, this is another reason to be bearish because the bears will tell you that these are not serious financial markets agents or participants. They're also beginners and I would add to that, incidentally, that they're not as big in terms of size as the newspapers would have one believe. So, I think they're largely irrelevant, but they are being discussed and they have been discussed this week.
I don't know what you think. Maybe you're one of them, Jonathan.
0:06:19
Absolutely not. I'm absolutely not.
What is true, I think - and I have seen some figures on this - they do show that the number of new accounts opened at some of the spread betting firms, for example, have gone up. The share prices of some of those firms have gone up as well. There have been lots of new accounts opened, you're absolutely right. It may be some people being bored and having nothing else to do but looking at their computers; that's possible. But as a factor in the stock market movements, I would be very sceptical about that.
At the margin, yes, it would mean there'd be some more people interfering, but I'm not a great believer that actually. If you know the old story about the stock market, of someone coming along and asking you, 'why is the stock market going up?' and somebody would reply, 'there are more buyers than sellers', well even that isn't true, I don't think, because it's not the number of buyers or sellers, it's the nature of those buyers and sellers which is relevant to how the market behaves as we've seen. Because if we just look at all the surveys of people's views about the market, the majority are still very negative, very cautious and so on, and yet the market has been going up very strongly.
So, somebody has been generating some extra demand from somewhere. And that's why, incidentally, looking at charts, it's not because I'm an out and out chartist in the sense that I believe in all this mumbo-jumbo that people come up with, but all the charts do is they look at trends and deviations from trends. That's all it is. And on the whole, most of the time there is a trend in one direction and sometimes the market moves a little bit above and sometimes it moves a little bit below. And sometimes it moves significantly above, and I think you can look at the charts today or see that things like Nasdaq and so on, they have performed very strongly, but they look - what we call - over-extended. In other words, the deviation above the trendline has become significant. But that normally means there'll be a bit of a setback and it will move back towards that basic trend.
So, I'm sceptical about the day traders. I'm sure there may be some of that going on, but I can't believe that's actually significantly driving the stock market in the direction it is.
I want to ask you also about headlines. It's very interesting. Having worked in the media, I remember the days when I used to be asked to write a market report. They'd come to you and say, 'look, the stock market has gone up by one percent today. What is the reason for that?' And as I said, if you reply with, 'there were more buyers than sellers', they didn't think that was very impressive. They always wanted to assign a reason to every movement in the market. And this week, for example, in the UK we've had the Bank of England with some official figures about the recession saying that in April the economy shrank by the most it's every shrunk in the history of mankind, and that must have an impact. In other words, that goes into the newspapers, that fills the headlines, and that has an impact on people's sentiment, I think.
We all know from behavioural analysis, financial finance rather, that people are overly influenced by the most recent news and the one that is most extravagant in its apparent implications. I think that's what we've been seeing. Basically, the headlines came out this week. It’s given people an excuse to sit back and maybe take some profits or however you like to think about it. And we’ll see.
But of course, it doesn’t mean there can’t be new news. If there was a sudden and really serious second wave of infections, then that would have an impact on the stock market. But at the moment, the trends as far as I read them anyway, are continuing to fall. The rate of infection is still pretty low. There are some anomalies in the States – that was a good example of how the newspapers attributed this week’s movement in the stock market also to indications that in one or two states in America, the number of deaths were going up and so on with a risk of a second wave. But there are all sorts of things going on, swirling around, that go to make the market.
I don’t suppose that you’ve been day trading, Peter, in any sense this week, have you?
Well, I think day trading means when you buy something on Wednesday, and you sell it again on Wednesday. Or if you sell something short – or not short – on Wednesday and buy it back on the same day. I don’t think I’ve ever done that in my life.
If you’re asking me whether I took the plunge and invested when the markets were extremely week, the answer is, I did, because that’s what markets are there for. They’re there to be used. And if you’re convinced by a longer-term scenario and provided you buy the sort of stocks in companies and businesses that I like, then you should take advantage of share price weaknesses for no real reason as happened on Thursday.
I hasten to add that I read that there is the fact that as far as the Standard and Poor’s 500 is concerned, for the first time since World War Two, this index rose more than forty percent in fifty days. And that’s quite something. It caught a lot of people by surprise – not everyone, but a lot of people. So, you have this sort of reaction to that sort of fact.
But your comments about what the newspapers put in as headlines is quite right and that’s because readers prefer bad news to good news, especially when it comes to the financial markets, and especially when the majority of players are bearish and not bullish. It’s an ideal breeding ground for the media’s negative messages to get through.
I remember very well your writings in the Financial Times and elsewhere which I read with keen interest at the time, but I didn’t think that you had that sort of brief that you had to have a catchy headline all the time. Yours was very thought through and reflective. But of course, you’re right.
That takes us back to what I said earlier. You’ve got a three part wrangling. You’ve got the media and the investors, and the market as a whole in the middle. And I think that it comes back to the message that we must not have a lot of respect for individual market players, but we need to have unlimited respect for the market as a whole. In my experience, the market does tend to be right much more often than it tends to be wrong.
To address your final point about the virus, that is indeed something very worrying that I’ve noticed, and I think it’s more or less everywhere, is that people have become very nonchalant about the virus, especially the younger people. And so, the discipline with which they practice social distancing and mask wearing, face coverings, that discipline is very lax in very many parts, and as I say, especially with the youngsters who continue to assemble in numbers which are too great because they think they’re not going to catch the virus.
So, I think that is the risk that we’ve got, that the black swan, which was the first wave of the virus, comes back to surprise us at some time when it gets colder again. And of course, when that happens, if it happens, then restaurants will no longer have terraces on offer where people can eat outside and they will not be allowed to eat inside – and I’m just taking one example in the hospitality area – but of course, that would cause the economy to go down again in a second wave.
So, that’s the risk.
0:14:39
Absolutely. I think that’s been clear from the very beginning that there is what appears to be this trade-off between the pace at which you allow normality to return and the risk of a second wave of infections. Though of course, it’s not just the stock market about which there’s enormous arguments for both sides. You can be very passionately on one side or the other about this virus as well.
Some people are now saying that of course, actually, a lot of these lockdown measures weren’t actually necessary because if you look at the data more closely, it appears that the rate of infection, the famous R number, was actually declining before the lockdown actually started. Well, I don't know, I’m not that good a mathematician or let alone an epidemiologist, and that controversy is going to run on, I think. And of course, there are people particularly associated with business who are saying that governments around the world are being far too slow in getting us back to normality because meanwhile the bill for all this is rising.
Again, that’s something which I think we need to confront, the possibility that we can’t see clearly yet – at least, I can’t see clearly yet; you may be able to do this in your wisdom, Peter – exactly how this whole massive programme of monetary and fiscal stimulus that we’re seeing around the world is going to play out and what impact it’s going to have in the longer-term on things like inflation, employment, and so on, not to mention the way that society is organised, the levels of taxation, and the way that businesses are treated. There are a lot of issues out there which I think we can’t just wish away, but as far as I’m concerned, they’re not yet clear enough to be sure about which direction that’s going to go in the medium- to longer-term.
I don't know what you think about that.
What I certainly think, I know in fact, is that these topics are going to stay with us for quite a long time and you and I will be talking about this on a very regular basis.
I think that one needs to be looking every week at the ingredients which could either spark inflation or which could spark deflation. And although governments have borrowed huge amounts of money and although the pessimists expect that Big Brother will come back with a vengeance and tax rates only have one way to go, last week we discussed the fact that the German government lowered VAT rates from nineteen percent to sixteen percent, I think across the board. Now I read again this week that a couple of other governments are following down that path. Maybe a little bit more selectively – for example, when it comes to restaurants, food outlets and so on, the VAT rate has gone down.
That rather surprised me, but that points to an ongoing fight against deflation and a deflationary bust rather than a worry that too much money has been chasing too few goods. Money which has been printed as if there was no tomorrow by the central banks and money that is being borrowed from the capital markets and underwritten by the same central banks. And so, older people, like Moses and Methuselah, would normally, from their tendency, expect that inflation has got to come back. Because they remember it. But younger operators who don’t know really how to behave during inflationary periods, not to mention how to invest during such periods, they’re scratching their heads.
I told you before my view – you asked me about my view on this. I’m firmly in the non-inflationary camp and I’m firmly torn between expecting either a deflationary bust or a deflationary boom. If it’s the former then as an investor one has to be particularly careful about what one invests in, and if it’s the latter, then you can expect, as the Fed chairman told us to expect, at least two more years of very low interest rates and very low bond yields.
If you have that background with an environment of growth, then of course there is very little scope for inflation to come back, there is very little scope for why the markets should push up bond yields, and above all – above all – there is very little scope for pessimists to argue that the markets are very expensive. Because they’re not.
0:19:42
Well I mean, it has been quite extraordinary. I think people have commented on the fact that if the Federal Reserve’s famous Dot Plot – the expectations of the members of its monetary policy making committee – is correct then we’ve never seen anything like it before. It’s basically flat and zero for the foreseeable future.
I have to say, I’m a little bit of a sceptic about this. I think if I had done a lot of betting, I would be betting against the Fed Dot Plot because anyone who lives through this knows that what actually happens has little bearing on what they actually say they expect to happen. And that’s not their fault. It’s just that’s the way the word goes.
So, I would be surprised if that actually turns out to be the case but I wouldn’t necessarily disagree with your main thesis that inflation is going to take a long time to come back, if indeed it does come back. Not least because we’ve got ourselves into this kind of policy mindset where everything will be done in that direction.
I suppose the concern is still that the policymakers have learnt something from recent crises – the global financial crisis and now this one – they have discovered that it is possible to influence significantly market sentiment and investor behaviour. But they’re kind of hooked on this drug. The question is, at some point, like all drugs, this one is going to run out of efficacy. And there may be some bound to it. We don’t know what it is but there may be some bound to how effective it can be in achieving short-term alleviation of deflationary fears but at some point one still feels – or at least I still feel – there has to be some kind of day of reckoning. It can’t be that easy. There must be a price attached to all this and the question is, what is that price? I think that’s something we still have to find out.
Easy to say, the price will be inflation, but as you’ve argued, that may not be the case.
Just one other thing, I’m also more concerned a little bit about what impact this has. If it’s going to be effectively easy money for almost everybody, which looks like being the case for the time being, what is going to happen to the normal process of corporate renewal, if you like? In other words, the issue of whether or not bad companies survive or whether they go bust and are replaced by new and more successful, entrepreneurial, innovative companies. So far, there have been some more bankruptcies in America but not as many perhaps as the markets were originally expecting.
What’s going on there, do you think? What do you make of this Hertz business, which I know you have been keen to talk about?
The Hertz business is absolutely fascinating because I’ve never seen anything like this before.
Hertz went into Chapter Eleven to protect themselves through the courts against their creditors while they rearranged their business. Meanwhile, of course, the bond price has collapsed and therefore any additional debt to be taken by Hertz would be very expensive for Hertz and, of course, there’d be a lot of collateral conditions attached there too.
So, what Hertz did I find really fascinating. There was a difference between their authorised share capital and their issued share capital and so, they have come out with an issue of new shares on the basis that the cost of equity is much lower than the cost of debt. Of course, that is not true in the wider bond market and certainly not in the sovereign bond market, but when it comes to junkie areas in the corporate bond market, it is an interesting phenomenon that has indeed developed.
Hertz is raising money through issuing new shares which of course is immediately met with protests from existing shareholders who felt diluted and went to court, and the judge waved them away. So, you’ve got this situation which I’ve never seen before and I’m very curious to see whether it will be taken up by other indebted companies, of which there are, of course, quite a lot.
In a way, I hope that it will. Because it will make it less likely that the corporate bond yields will widen again compared with sovereign bond yields and it makes it less likely that there’ll be waves of bankruptcies out there.
So, it’s positive but it does show that there’s not uniformly, across the board, very, very cheap money to be had by all and sundry. The market is selective in that. But the Hertz story I find fascinating and I assume that you’ve never seen something like this either, have you?
0:24:56
No, I haven’t. That’s certainly true.
I suppose stepping back a little bit, Chapter Eleven itself is sometimes seen as a controversial method of allowing companies to refinance effectively when they’re about to go bust. That’s effectively what it is, I think. And it’s very interesting.
The question is, is Hertz a good company in its current format? Obviously, it’s been very badly affected by the virus because obviously people have stopped driving, taking holidays and all the rest of it, but actually, was it a good company before? Is it a good company now? I did notice that it did have quite a lot of cash as well which is interesting. It had about a billion dollars in cash when it went into Chapter Eleven.
It’s a very confusing story. I haven’t seen anything like it before. I suppose the question I’m asking therefore is, what would have happened if we weren’t in these extraordinary times? What would have happened to Hertz? Would it actually have gone bust anyway or would it have been a company that could continue to thrive? You’d think it would be because it’s a significantly large company with a strong market position.
Yes, I haven’t done even the beginnings of an in-depth study on Hertz. I don’t know much about it. I know that they have a lot of leased cars so, they might have cash on one side, but they’ve also got liabilities. And the other thing to bear in mind is that the lifeblood of their business lies in renting out cars to passengers who have landed at airports. Given the fact that airports are now more or less dead in the water for the time being still, they’ve therefore lost a major source of income. Before the virus, that would have happened from time to time because the car rental business a relatively cyclical business.
So, I can’t tell you whether they would have gone bankrupt or not. Probably not. But be that as it may, I just think that there are things moving in the background which means that the economic agents of yesterday, whether they’re governments or corporations or consumers or platforms – those new and very powerful economic agents – I think that their roles are going to morph into something else. I find it very interesting to observe, and then one must try to forecast who are going to be the main players in five years’ time, let’s say.
0:27:51
That’s a very good question, Peter, to which I have to say, at this point, I do not have an answer. It will be interesting to discuss in future weeks.
I think that’s really it this week. We’ve seen an interesting week in the markets with the stock markets falling particularly in Europe, and a lot of discussion about where we are in the cycle of the virus and also in the cycle of the economic recovery that we’re all hoping to see quite soon.
That’s all we’ve got time for this week, Peter, but I look forward to discussing all these matters again next week.
So do I, and thank you very much indeed, Jonathan. Have a nice weekend.
0:28:43
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