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In April 2020, the world economy stopped. The extraordinary drop in activity made the dramatic collapse in demand at the height of the credit crunch appear as a blip. Millions of jobs were lost, or furloughed. Global airline traffic plunged by 92% compared to levels a year earlier.
The word unprecedented is used too frequently in finance, yet the market moves on 20 April 2020 are without precedent. This was the day that the global benchmark for the oil price turned negative. The day ended with the oil price for the May 2020 futures contract closing at -$37.63.
A confluence of events came to push the price below zero. First, was the collapse in demand. At the same time, two of the world’s biggest oil suppliers, Saudi Arabia and Russia refused to cut supplies as they engaged in a price war that aimed to push prices lower. The outcome was a glut of oil that filled storage facilities across the globe. The abundance was such that tankers were used as floating storage facilities. Tankers storage cost as much as $100,000 per day.
Thrown into this mix was the expiry of the most widely traded oil futures contract, the West Texas Intermediate (WTI) Oil future. A futures contract allows producers to lock in prices for output in advance of the oil being pumped out the ground. For investors, a futures contract creates the opportunity to take advantage of rising and falling prices, by buying or selling the right to take delivery of oil at a future date. Unsurprisingly, with few investors owning oil storage facilities, these contracts are closed before the expiry date.
The challenge with the contract expiry on 21 April 2020 was that with storage near bursting point, there were few with the ability to take delivery of the oil. This was especially true in landlocked Oklahoma, the point where WTI oil is stored. With storage at Oklahoma landlocked, transporting WTI to alternative storage is much more challenging.
Over the course of a single trading day on 20 April 2020 the oil price plunged more than $55. The imminent contract expiry, falling open interest and deteriorating liquidity exacerbated the price decline. In normal conditions, investors and traders can roll their contracts from the front month (the nearest dated futures contract) to longer dated contracts. This maintains exposure to oil price movements without having to store oil. The distortions caused by the pandemic made rolling contracts increasingly difficult. With no ability to accept delivery of the oil, contracts had to be sold.
Remarkably, $0 didn’t stop the collapse – holders of the May 2020 WTI contract were willing to pay others to take delivery of oil. Investors had no way to store the oil themselves, and the strategy of hoping that the problem would be resolved in time failed catastrophically. The price eventually settled at -$37.63. Rather than being paid for the oil they owned, each contract that represents 1,000 barrels of oil cost the holder more than $37,000 to escape.
18 October 2021
The end of the 1990s was a period of economic boom across the major economies of the world. As with growth in recent years, the US was the epicenter of this expansion in demand, led by an explosion of new technologies. As the economy boomed, 'normal' indicators pointed to the need to raise interest rates.
The first chart shows growth in real activity. The shaded area highlights the years 1997 and 1998. In the late 90s, US real GDP increased at an average of more than 4% a year (figures reported at the time were similar, however, viewing history through the lens of revised and updated statistics is always straightforward compared to the messy, inaccurate data produced in real-time). This was a welcome return to robust expansion after the disappointment of the faltering jobless recovery.
People joke that if you get two economists in a room, you will end with at least three opinions. Yet for most economists and investors, all schooled in the 'Philips Curve' and Wage-Price spirals, agreement was almost universal. Strong activity and low unemployment would lead to rising wages, generalised cost pressures, and soaring inflation.
Chart 2 demonstrates how the booming economy pulled the American unemployment rate to its lowest levels since the 1960s. With unemployment this low, a cycle of rising interest rates to prevent an inflationary overheating as seen in earlier decades was nearly universally expected. Chart 3 plots the 3-month interest rate in the US Treasury market. The dotted lines show market expectations for interest rates at the end of each quarter from March 95 to the end of 1997. Through 1996 and 1997, the market belief was that higher interest rates were simply a matter of time. The Federal Reserve did raise rates by ¼% in March '97. Yet, unlike the hikes in 1994 instead of a series of rate increases, this policy tightening was 'one and done'.
The final chart shows that inflation pressures didn't emerge as standard economic theory implied. Inflation measures, especially 'core' inflation that excludes food and energy costs, continued to moderate despite the tightening labor market. (Given this failure of the Phillips Curve, it is remarkable this theory has become a core of central bank forecasting and policy since the Credit Crunch).
What the domestically focused forecasts in the industrialised world missed was the impact of global trends. The series of crises that had begun with the Mexican Tequila Crisis in 1994 continued to reverberate through the global economy. It was only after the Russian debt default in the summer of 1998, and the failure of LTCM, that September that markets capitulated removing any belief in higher interest rates. Inevitably as expectations shifted to pricing no rate increases ever in late 1998, the persistence of strong growth and tight labor market finally cause the Federal Reserve to hike interest rates to a new cycle high!
12 September 2021
After the boom of the 1980s, the failure to rekindle growth in the 1990s led to the close of the Millennium becoming known as 'The Lost Decade'. Today investors are accustomed to the challenges in Japan - a shrinking population, high government debts and loss of competitive advantage to the rapid expansion of Chinese exports. However, it is only after repeated disappointment at the failure to return to past growth rates that this understanding really arose.
While the bust has extended, the market backdrop has altered. The early stage of the bear market (i) came as both monetary and fiscal conditions tightened. This lifted bond yields above late 80s peaks. Strong growth in the real economy kept unemployment low. With persistent inflation pressures monetary conditions remained tight, squeezing the past financial excess. A brief hiatus as bond yields peaked was followed by further equity price falls (ii). It was only as unemployment finally rose, and inflation dipped below 2%, that a proper relief rally begin.
Under performance by Japanese equities was not permanent - from August 1992 to August 1993 the Nikkei 225 index rallied 35%. This massively outpaced the 6% S&P gain over the same period. Strong rallies in Japanese equity prices were repeated in both 1995 and 1999. The only consistency was that any attempt to extrapolate recoveries was met with disappointment. Such was the cumulative market decline that in the aftermath of the TMT bust, the Nikkei index dropped below 8,000 in Q2 2003. This was less than 20% of the level reached in 1989, and was a level first surpassed over 20 years earlier. Global investors typically stayed away from Japanese equities through the 1990s. Though valuations moderated from the extreme excesses of the 1980s, at 20-30x Price to Earnings multiples, opportunities outside Japan offering growth potential and lower valuations remained more attractive.
Poor equity market performance did not mean that niches within Japanese stocks failed to perform. Identifying these could be very rewarding. Japanese exporters faired well through the 1990s, boosted by a weaker yen and strong demand for their technology. Equally, demand from an ageing population differed from the general domestic sluggishness. Banks and financials performed poorly - as the overhang from the boom repeatedly returned and low interest rates sapped the ability to maintain net interest margins.
Extraordinary monetary policies did not revive the economy. 1-year Japanese Government Bond (JGB) yields that approached 9% as policy was tightened in the early 90s fell below 1% in 1995. The comparable gilt and US Treasury yields at the time were near 7% and 6% respectively. With other government yields significantly higher, and JGB yields dramatically lower than any recent history, forecasting a rise in JGB yields was obvious(!). As yields refused to return to 'normal levels', those positioned to benefit from rising JGB yields named this trade 'The Widow-maker'. Despite repeated expectations of 'normalising', 1-year JGB yields have not risen above 1% since.
22 August 2021
The bond bull market is the period of falling bond yields (and rising bond prices) that has extended over the decades since 1981. Conditions have changed dramatically through this bull market. At the outset inflation and interest rates were in double digits. Paul Volcker, the Chair of the Federal Reserve had been appointed with a mandate to rid the US (and world) economy of inflation that had contributed to the wild economic swings, high unemployment and political discontent of the 1970's. Unlike central bankers of today, future policy choices were not telegraphed to the market in advance. Surprising markets was intentional, so much so that Volcker even announced a rate increase on Saturday 6 October 1979.
It was not just policy and the desire to squeeze inflation pressures that was different, Baby-Boomers - the Post-WWII generation born between 1946 and 1964 were aged 18-36. This important demographic group had entered adulthood, and was heading towards the age of peak consumption. With easy access to credit being relatively new and governments incentivsed not to borrow by high interest rates, levels of personal, corporate and government debt were significantly lower than today - US and UK government debt stood at 31 and 45% of GDP. Today these figures are 127 and 105% respectively.
In addition, few at the start of the bond bull market anticipated the extent of political change that the world would experience. At that time, The Cold War and the division of the world between Communism and Capitalism reduced the scope for global networks and trade. The collapse of Communist economies, together with improved trade links and technologies, allowed globalisation to contribute to expanding consumer choice. This trend further reduced price pressures, creating what was increasingly known as 'The Great Moderation' - a prolonged period of (relative) economic stability in the wealthiest nations.
The Credit Crunch brought the idea of the Great Moderation to an end. The faltering recovery and rolling crises that have characterised the period since 2008 flipped policy making on its head. With inflation 'too low' and unemployment stubbornly high, central banks now actively promote the belief in their ability to stoke price pressures. Policy decisions have gone full cycle from intentional surprise and opacity to clear, long-term guidance about likely changes. Where the bond market was a means to manage the economy, leading the political adviser to Bill Clinton, James Carville to say that if he was reincarnated, "I want to come back as the bond market. You can intimidate everybody". Now no policymaker wants to wake the sleeping beast!
As the left hand chart below shows. There have been many occasions throughout the bond bull market where the downtrend in yields has been challenged. Each time yields have threatened to break this descent, another 'unexpected' crisis has emerged and served to reinstate the downtrend. With policymakers redoubling their efforts to push price levels higher, globalisation increasingly under pressure as nations question the benefits of market led economics and debt levels much higher than they have been in the past, will it be different this time?
16 July 2021
In technical analysis, a 'death cross' occurs when the 50-day moving average of a price drops below the 200-day moving average. In contrast to the more positive 'golden cross', this is taken as a signal of a more significant sell-off in the relevant security price. At the start of this week, the price of Bitcoin completed a 'death cross' as the sharp decline from the late April price high near $64,000 dragged the average price of the last 50-days below the 200-day average. Since 2014, Bitcoin has experienced two significant death cross events, after the strong price advances in 2013 and 2017. The charts below plot these periods, together with the smaller advance and set back in 2019.
In each case, the Bitcoin price had declined substantially from its high before the death cross occurred. The charts also show that while the price action was more extended after the death crosses occur, further significant price declines occurred before the ultimate price low was reached. The table below sets out this information in more detail. The typical loss following the death cross forming to the final low has been about 50%. The decline after the death cross has extended for as long as 8 or 9 months. The table also shows that on each occasion the death cross has occurred, there has also been a short-term rally during which the Bitcoin price has rallied back to the 200-day moving average.
27 June 2021
For bond investors the months of May and June of 2013 marked a significant turning point in the post-Credit Crunch era. The extraordinary downturn in 2008 pushed the Federal Reserve into launching equally extraordinary policy responses. As official interest rates had effectively been cut as far as they could be, central banks considered alternative approaches to underpin the financial system and economy. Most notable amongst these new policies was 'Quantitative Easing' (QE). Under QE the central bank buys long-term bonds with newly created bank reserves (money). The idea being that as financial institutions sell their bonds to the central bank, they then will use the money received to increase lending to the real economy. In turn, this is supposed to boost activity.
With the sluggish recovery from the Credit Crunch, and repeated use of QE by central banks, investors had become used to the support from monetary policy. Through the summer of 2013, official statements continued to indicate that the Federal Reserve would change little and "maintain downward pressure on longer-term interest rates". Yet in testimony to Congress on 22 May by Chairman Ben Bernanke hinted at a change, saying "If we see continued improvement [in the economy] and we have confidence that that’s going to be sustained then we could in the next few meetings … take a step down in our pace of purchases [of bonds]". Nothing had changed and everything had changed. Bond markets reacted swiftly to the new possibility that QE could be unwound in the near future. The gold price, which had dipped sharply a month earlier, fell even further. The chart below shows how this statement effectively ended the declining trend in real yields that had been in place since the Credit Crunch.
The increase in yields pushed down bond prices. Perhaps the biggest reason the 'Taper Tantrum' has entered market folklore is because equity market values dropped too. This synchronous fall in bond and equity prices caused Risk Parity funds to 'blow up'. Risk Parity funds rely on bond and equity prices moving in opposite directions to provide the stability in their returns. This approach had benefited massively from the fall in bond yields, both heading into and since the Credit Crunch. Because the strategy applies leverage to bond positions, the impact of the fall in bond prices was even more dramatic without a positive offset from rising equity prices.
Partly because the market turmoil this pronouncement on 22 May created, Dr Bernanke had to wait until December 2013 before officially announcing the tapering of QE bond purchases. This was just one month before his retirement as Chair of the Federal Reserve. While the reduction in QE bond purchases marked the start of policy tightening in America, the Federal Reserve interest rate itself did not rise until December 2015.
18 June 2021
Through 1979 into early 1980 the price of silver soared. The price rise was so large that Tiffany's placed an advert in the New York Times calling the price increase 'Unconscionable'. For most, enormous purchases of silver by the billionaires Bunker and Herbert Hunt caused the price increase. History records this as an audacious attempt to corner the market (i.e. force an artificial shortage by buying a large share of supply) .
Whatever the intention, the silver buying by the Hunt Brothers - which had begun in 1973 with the purchase of 35 million ounces of silver - accelerated in the autumn of 1979. (In 1973 individuals in the US were still barred from owning gold by the 1933 ban on the yellow metal - the Hunt brothers claimed they merely wanted to protect their wealth from soaring inflation). By the start of 1980 they each owned 21 million ounces of physical silver, most of which had been transported to vaults in Switzerland. In addition, they also owned more than 60 million ounces of 'poor mans gold' via futures contracts.
The market became so tight that from a price of $6 in early 1979, silver hit $50.42 in January 1980. Companies from jewelry makers to industrialists and photographic film makers were badly affected by the price rise. Ultimately, the Hunt Brothers scheme unwound as dramatically as the price had risen, as exchanges allowed contracts to be settled with cash, rather than the physical deliver of silver that had been the norm, leaving the pair nursing heavy losses.
While the Hunt brothers have been vilified, many commodity prices - including gold and oil - rose sharply to significant highs around the same time. Though bond yields continued to rise for the next 18+ months as the Paul Volcker led Federal Reserve, squeezed inflation out of the US economy, the increase in consumer prices also reached its high within months of the silver market high. Was the market cornered, or was silver merely acting as a very sensitive indicator of inflation?
11 June 2021
This week has brought a stark reminder of the extraordinary volatility in cryptocurrencies. With the announcement of a ban on financial companies in China from offering services using crypto, followed at the end of the week with a further crackdown on mining and trading, the price of all these digital assets has plunged.
For a time on Thursday, Bitcoin had lost more than 50% from the $64,000 peak it reached in April as FUD (Fear, Uncertainty and Doubt) replaced FOMO (Fear Of Missing Out). Time will tell if this is part of the 'normal' wild price swings that occur in this space or confirmation that cryptocurrencies are a financial excess greater than even the 17th Century Tulip mania and the 1990's NASDAQ boom.
Bitcoin has certainly experienced extraordinary volatility in the past. Both 2014 and 2018 saw the digital currency collapse by more than 80% from its high.
Yet as the charts to the left here demonstrate, the upward trend through 2017 was far from smooth. Although the price of Bitcoin started 2017 at $959, peaking a $20,089 on 17 December (the day before the Chicago Mercantile Exchange began trading Bitcoin futures), there were five declines of more than 30%. Some of those falls occurred within a single day.
The price declines this week have been extraordinary, even for the normal volatility of cryptocurrencies. 2017 shows that wild price swings - down as well as up - have long been part of the cryptocurrency experience so far.
21 May 2021
March 2000 marked a significant turning point for financial markets. 10 March saw the tech heavy NASDAQ index reach an intra-day high of 5,132. Five years earlier the NASDAQ index value was less than 1,000. Returns had compounded 45% a year. Yet, NASDAQ would only return to its 2000 peak once again in April 2015.
Born in the recovery from the late 80s Savings and Loans crisis in the US, the 1990s Tech Boom continued through the a series of crises: the collapse of the Japanese economy, the ERM crisis, the Mexican Tequilla and Asian Currency crises and the failure of LTCM. Every company became desperate to have its 'dot.com' strategy.
In March 2000, few realised the extent of the change. Despite the existence of many of the markers of financial excess that often occur at market peaks, those warning of the risks had done so for years. They didn't understand, the new tech giants needed to 'Get big fast' - offering products for free built brand and reputation that would pay back later. Blank cheque companies could pounce on new opportunities fast, it didn't matter they had no business plan.
There are many theories about why the market peaked in March 2000, was it the announcement that Japan had once again entered recession on 13 March, or that Yahoo and eBay ended merger talks 2 days later, or that the Federal Reserve made a 'policy mistake'? The Fed raised interest rates on 21 March and 'inverted the yield curve'. The series of rate rises since early 1999 finally lifted the official central bank rate above the 10-year US Treasury yield - usually a signal of approaching market turbulence and often a warning of recession.
Whatever the cause of the turn, the changes were profound. Stocks and sectors that had struggled through the 1990s boomed. Where the 'old economy' and companies that paid dividends to shareholders had been unloved, the capital discipline this imposed contributed to surging returns after the Millennium.
14 May 2021
US Treasury Secretary Janet Yellen rattled investors nerves this week suggesting that higher interest rates may be needed to prevent the US economy from overheating, because of the level of fiscal stimulus planned by the Biden administration. Mrs Yellen quickly back-tracked on her comments the next day, aligning herself with the Federal Reserve view that there is unlikely to be an inflationary problem.
Uncertainty over how long interest rates will remain low after a recession has always challenged investors. The chart above looks at how bond investors anticipated a return to 'normality' after the Credit Crunch. The graphic splits the 10-year bond yield into two parts; the 5-year yield and the 5-year, 5-year forward yield (i.e. the average yields in years 1-5 and 6-10 of the 10-year bond).
Markets did not expect interest rates to remain low, as they have done (remember, when Quantitative Easing ,QE, was launched in 2009 it was supposed to be temporary too).
Though investors were willing to price in lower rates than had been typical, in early 2010 the 5-year yield was still above 2%. With short-term interest rates remained close to zero, this implied a swift tightening of policy. This belief in a rapid 'normalisation' of policy was also reflected in the 10-year Treasury. With this yield at 3.5%, investors anticipated the average interest rate in years 6-10 of the bond (i.e. from 2016 to 2020) would be above 5%. These were pre-crisis peak levels. Reality turned out differently!
7 May 2021
"there can be little doubt that exceptionally low interest rates on ten-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of homebuilding and home turnover, and especially in the steep climb in home prices. Although a "bubble" in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels."
Federal Reserve Chairman, Alan Greenspan, 9 June 2005
"So, one of the areas is asset prices, and I would say some of the asset prices are high. You are seeing things in a capital markets that are a bit frothy. That's a fact. I won't say it has nothing to do with monetary policy"
Federal Reserve Chairman, Jay Powell, 28 April 2021
Later in 2005, Alan Greenspan also reflected on periods of high market valuation saying "what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values".
Federal Reserve Chairman, Alan Greenspan, 26 August 2005
30 April 2021
In financial markets, the 1990s are mostly remembered for the boom in technology stocks. Underneath this headline, the reality was anything but calm. One example of this was the failure of the hedge fund, Long Term Capital Management (LTCM) in 1998. Founded in 1994, the fund had produced stellar returns. Their approach was to spot small price differences between two similar securities, and wait for the mismatch in pricing to close. Using derivatives and borrowing to amplify gains, returns rolled in.
This strategy was also to prove the undoing of LTCM. As others imitated the approach, opportunities reduced. Then, in the summer of 1998, Russia defaulted on its debts. This was a surprise to those who believed a country would never default when it can print its own money. LTCM failed as its leverage positions rapidly lost money.
The turmoil hit markets globally. Market liquidity collapsed - even the US Treasury market became difficult to trade. The impact was so great that in the middle of its extraordinary bull-run the tech heavy NASDAQ index fell 30% from its July '98 high to the 8 October low. Eventually, a rescue organised by the Federal Reserve helped restore market calm (Bear Stearns chose not to participate in the rescue, a decision that was to prove costly in 2008).
The events proved to be a major turning point for markets. Prior to this, equity markets typically fell as bond yields rose. This hang over from the 1970s reflected fears that rising inflation would lead to sharp interest rate rises. The collapse of LTCM and the rolling currency crises of the late 90s, signalled that falling asset prices were at least as big threat. For all the recent worries about inflation, the relationship between equities and bonds has yet to flip back.
23 April 2021
Arguably one of the biggest changes in the use of money came at the trough of the Great Depression in 1933. Newly elected President Franklin D. Roosevelt banned private ownership and exports of American gold.
After enforcing a Bank Holiday in March 1933 on entering office, on 5 April the new administration ordered any gold coin, bars or certificates worth more than $100 be handed in to the Federal Reserve. The price offered was $20.67 an ounce, the fixed price under the Gold Standard, which had been in place since 1879. Failure to turn in gold by 1 May was punishable with up to 10 years in prison.
Then in January 1934, the Gold Reserve Act transferred all monetary gold – including that now held at the Federal Reserve - to the US Treasury. With the price of gold also raised to $35 per ounce, the paper US dollar was effectively devalued by 59%.
The Coinbase IPO may mark another step on the road to acceptability of cryptocurrencies, history suggests that there are likely to be more regulatory bumps along the way.
16 April 2021
While most investors have heard of the equity market bust after the Millennium. Fewer know that for most equities the biggest losses came in 2002, long after the recession in the largest economies had ended.
As the chart here shows, corporate excess from the boom years hung on market sentiment. Though the US Federal Reserve cut interest rates aggressively, this only provided temporary relief. When sentiment sagged in mid-2002, the scene was set for a sharp sell-off.
The market recovery needed the support of new Fed Deputy Chairman's infamous "Helicopter Ben" speech in November 2002. To read the full article, follow this link https://bit.ly/3uh5w3I.
9 April 2021
“In terms of the overall fiscal sustainability of our federal government, we’re on an unsustainable path, meaning that the debt is growing faster than the economy. That doesn’t mean that the level of debt today is unsustainable. It’s not. Given the low level of interest rates, there’s no issue about the United States being able to service its debt at this time or in the foreseeable future”
Jay Powell, Chairman of the US Federal Reserve, 25 March 2021
Gold hasn’t changed over time, but money buys a lot less today than it used to. Should cryptocurrencies be viewed as digital gold?
2 April 2021
12 March 2021
5 March 2021