"If opportunity doesn't knock build a door " Milton Burle

Plenty of economic data for the capital markets to study over the past couple of days, and possibly ignore if the past few months is anything to go by. Average earnings in the UK remained constant at 2.2% for the year, this has resulted in real incomes falling by about 1% in the past 12 months. This was then reflected in some degree in weaker than expected retail sales for the month of September. Although research house Capital Economics make the point that overall the underlying retail sales picture is possibly slightly rosier than the headlines would suggest.

China announced its estimate for 3rd quarter growth, coinciding with the start of the 19th Plenum. The estimate for growth came in at a healthy 6.8%. Considering the timing of the release it would have been surprising for a disappointing number to be announced. Despite this news equity prices wobbled in Asia as a report Financial Times drew attention to comments from the Peoples Bank of China which referred to a phrase known as a “Minsky moment”. Hyman Minsky is an economist apparently known for his theory of a collapse in asset prices created by an excess of credit. Most asset price collapses are because of excess credit built on overly optimistic assumptions at a point when the central banks of the world look to curb credit growth. China’s economic growth has been driven by credit growth, its debt to GDP ratio has climbed to over 200%. This has led to concerns that if the PBOC reigns in this credit growth it will have a detrimental impact. One would suggest that fear is not isolated to China alone.

Thursday was the 30th anniversary of the 1987 crash and we remember it well. Waking up that day one wondered if the world would ever be the same, the shock was so great and unexpected. Some market commentators are trying to draw analogies with then and today, as asset prices seem to creep higher most every day, that seems to be where the analogy ends. The 1987 crash lasted 3 days, equities fell 40%, and many people were instantly ruined. One favoured trade in 1987 ahead of the crash was the selling of put options in the indexes and taking in the premium. This trade, with hindsight, would have exacerbated the move down as traders were forced to close out positions. The best similarity is the Lloyds underwriting that wiped some many fortunes. Whilst the premiums came in it was great, the day the ship sank, oh dear.

One of the major dissimilarities between then and now was the yield gap between bonds and equities, as it was getting more and more stretched. Equities were rising as were bond yields. For example, at one point the yield on the thirty-year US treasury bond on the 19th of October rose to 10%, yields on equities were close to two pct. The risk premium to owning equities had collapsed. Today the yield on the US ten-year treasury is 2.8%, pretty close to the current yield in the equity market.

Posted on October 19, 2017 .