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March
29
2019

When This Insane Monetary Experiment Ends
You Will Have Zero Chance To Exit
Bill Blain

This is the day the UK isn’t exiting Europe. Surprised? Not really.

Think I’ll try something different this morning - a review of the week touching on some of the key themes we should be thinking about. Let me know what you think.

But firstly let me apologise for the lack of porridge this week. On Wednesday it was being unable to find anywhere to sit with a computer in London City Airport. Yesterday it was courtesy of Flybe from Edinburgh - I’d like to thank them for leaving us standing in a cold bus while they tried to rustle up a crew. The BA flight took off on time, although I wonder if it went to Duesseldorf?

Let me start with a rant:

Bond Yields and the END OF ABSALOOTLEY EVERYTHING…

While everyone is panicking about US curve inversion and the possibility it is signalling recession, is the real issue even simpler and more obvious? Should we be worried about tumbling global bond yields? Aside from it being impossible for funds to meet long term liabilities, what’s not to like about lower for longer? Actually - quite a lot. Even the ECB has noticed zero bond yields haven’t exactly stimulated growth and jobs across Europe and done nothing in terms of stimulating inflation.

Equities seem blithely unconcerned despite all the cack about trade-wars, rising political anarchy, and a distinct feel this business cycle is likely to wind-down into a slough of earnings downgrades and suchlike unpleasantness. The smart money is not worried, because they understand the truth - there is nothing to worry about BECAUSE A STOCK MARKET MELTDOWN IS ACTUALLY IMPOSSIBLE!

Apparently the taxi firm that isn’t Uber is going to IPO at $72 bln, a phenomenal $25 bln valauation, beating all records as the company getting the most money for losing the most money ever…  Why? (Clue the answer is not because Lyft and Uber will be an unbeatable oligopoly - they will probably eat each other, and I have 4 different taxi apps on my phone and none are UBER!)

Nope. The reason is because when bond yields are zero, then stocks become more attractive because they not only offer the potential of dividend yields but also the HOPE of stock price upside. As a result, even the most fantastical, utterly hat-stand, loss-making off the wall crazy as a Mad Fox, Unicorn proposition looks attractive if/when the stock price is likely to rise… (But, remember: Hope is never a good strategy.)

Forget reality - in today’s world equities are all and only about the stock price. And you can square that equation when Global Central Banks can’t afford to admit all their monetary experimentation has been about as much use as tea strainer bailing on the Titanic. The reality is the non-normalisation of monetary policy leaves every single fundamental thing I thought I understood about markets; valuations, yields, risks and returns to be wrong. Utterly.

Central banks are complicit in the illusion - understanding the brutal reality of what their monetary experimentation has led to: a world where the most sensible corporate investment is buying back stock, and stock markets can’t be allowed to fall, because such a collapse in sentiment would utterly undo the little financial good zero interest rates created. Ouch.. “Its a rat trap baby, and you been caught!”

My only recommendation would be in such a mad, mad, mad world… fill yet boots….

There is no point in worrying today about stuff you will have to worry about tomorrow: if and when the illusion ends, you will have zero chance of being able to exit, because concurrent with insane monetary policy experimentation and distortion, global regulators decided they’d better get in on the act and thus they stepped in to regulate markets to prevent a repeat of 2008. So they introduced new rules and killed liquidity, made hedging irrelevant, and turned markets from being vibrant centres of wealth creation into despondent job creation schemes for compliance officers.  

THE FUTURE OF FINANCE AND INVESTMENT

I was up in Edinburgh earlier this week, at Heriot-Watt University’s Centre for Finance and Investment. I’m hoping to become an advisor to the centre. I’d see my mission as altering today’s graduate and post-graduate students to the dangers of regulation, monetary experimentation, but, when all around in financial assets is distorted, especially the opportunities inherent in my alternative assets investments! Get them young I say.. give me the boys and girls today and I shall give you tomorrow’s CIOs!

One of the areas we discussed were ideas for research projects - and that’s particularly interesting; for instance turning around my long held belief that firms with large cash piles tend to underperform because their management lack the imagination to deploy money effectively - empirical research demonstrates they’ve actually outperformed in recent years.

Discussing research ideas with the Centre’s advisory board through up lots of fascinating ideas, concepts and approaches. Topics ranged across the board - from the underperformance of Absolute Return Funds, Corporate Governance and Behavioural Bias, The Woodford Effect, Private Equity distortions, liquidity and a host of other stuff including the promotion of gender equality across finance.

Very happy to hear ideas from readers on areas for academic research - I’ll feed the sensible ones to the centre.

BOEING - A MORE FUNDAMENTAL ISSUE?

A few weeks ago Boeing stock tumbled in the wake of the second B737 MAX crash. Then the price stabilised, waiting for the investigative reports to come in. Markets took the view the situation would quickly be fixed, the production run of over 5000 aircraft would continue, and that the 350 B-737 Max aircraft parked around the planet would be allowed to fly again.

Easier this week Boeing released a software update to the suspect MCAS stall prevention system. Yesterday officials investigating the Ethiopia crash confirmed it was broadly similar to the earlier Lion Air disaster: the MCAS system activated. The  Ethiopian Airlines flight crashed soon after. 346 people died in the two related disasters.

We know that in the Lion Air the crew spent their last precious seconds desperately trying to find out what was wrong with their the plane from the manuals - a failed sensor meant the stall system was repeatedly pointing the nose down every 15 seconds. As they didn’t know the system was even installed, and the airline hadn’t fitted the “extra cost” warning light, the crash was inevitable.. Pilots are on the record saying crews would have less than 40 seconds to save an aircraft if the stall system went off due to a faulty system - if the crew were unprepared or unaware, then it was impossible.

You can imagine the horrific situation on the very busy flight deck where the alarms are screaming, the plane is gryating up and down the sky, the sensors are telling them the plane is flying straight and level, but the automatic stall prevention system is trying to plow the plane into the ground. They have 40 seconds to figure it out, switch off the system and resume level flight.

Boeing might be in more trouble than we think. Although Boeing reacted quickly to the first crash and warned operators of the problem, the immediate issues will include; why weren’t operators more fully informed of the system from the outset of the Max programme and did Boeing deliberately downplay the significance of the stall system so they could cut the need for additional pilot training to make their aircraft a cheaper system? The law suites are coming in.

It doesn’t help the rest of the world now distrusts the US Federal Aviation Authority - considering their oversight of Boeing to have been lax, and that they were slow to act following the second crash. While US B737 Max aircraft may be back flying in US airspace in just a few days, the rest of the world could take months to approve the Boeing fix. That has serious implications for deliveries, for current schedules, for aviation linked paper, and replacement aircraft values - call for more info.

There may be a much bigger problem.

At its root is the venerable B-737 design. The decision not to replace the 50 year old design with something new now looks a mistaken management compromise. Back in the 2000s, Boeing embarked on Project Yellowstone. It was (and may still be) Boeing’s plan to replace its ageing designs with new designs using new composite technologies, cleaner more efficient engines and other next generation design enhancements. So far only the 787 Dreamliner has come to fruition. It’s a fantastic plane.

Plans to replace the B-737 (and the 757/767 series) were dropped/postponed when Boeing decided to go for the cheaper option of simply stretching the workhorse B-737 at little bit more to produce the B-737 Max. That was great for Boeing - no need to tool up for an expensive new plane, instead, keep making something they’d already delivered 10,000 of.. they could make it cheap and cheerfully. And they could say it was a completely new plane because it incorporated modern stuff, and it was called… MAX!

The pitch-book to customers must have looked perfect: an aircraft type they already knew and flew, no need for additional expensive pilot training, no major conversion costs. And it would be pretty efficient.

But, the new design MAX is a lash-up compromise. The new fuel efficient high bypass engines have been made to fit, but only by squeezing them in and making them a little bit less efficient. The are bigger, heavier and change the trim. The undercarriage has to be bigger, upsetting the trim a little more, and was difficult to fit making it a little more less efficient. The shape and weight of bigger engines changed the design – giving a nose up position, hence the need for a stall-management system.

Its now becoming clear its not such a great proposition. Pilots apparently don’t like it - knowing what was once a thoroughbred now has the aerodynamics of a brick, a carthorse of the skies. Passengers are concerned. Airlines are cancelling orders - although Lufthansa just came in with talk of a new order. The good news for Boeing is the Airbus A320/321 series is 30 years old, and is going through a similar modernisation process - the Neo series.

Supporting Boeing is the need for 30,000 new mid-size aircraft in the next 20 years. There just are not enough planes being made.  Should they have been introducing a brand-new but expensive aircraft now to take that market? Probably. It will take years before a new plane, the B-797, is ready.

In the meantime, what happens to the 5000 B-737 Max’s currently on order? If I was an airline executive.. I would not be happy.. If I was on the Boeing board…. I’d be nervous.

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