No evidence of intellects brightening in the world of UK and US politics! Since the last note two weeks ago, UK politics are midst a black comedy, though financial markets are largely unmoved. Trump is plumbing new depths of corruption, but US politicians have no backbone to push back. Necessity might drive an increasingly paranoid Putin to contrive a victory which will end the Ukraine conflict. Iran has Trump over a barrel, and this conflict remains a global wild card. And the world leaders continue to flock to China, with President Xi probably feeling quite smug.
It is these political issues which tend to dominate headlines in the West. But events in the US government bond market are a fundamental concern which isn’t grabbing headlines, but should. Similarly with the ticking time bomb to economic chaos if Gulf oil supplies do not re-start soon – more on that next week.
Let’s start with the Trump visit to China. The good news is that it was not confrontational. Beyond that Trump gained nothing – the much lauded order for Boeing planes was less than expected. And apparently he got a flea in his ear at an early stage. Xi gave Trump a very direct and unusually stark warning over Taiwan, a red line which Trump must not cross because:
“If handled poorly, the two countries could collide or even enter into conflict.”
Publicly at least, both sides downplayed explicit tariff negotiations during the face-to-face session. Some observers noted that Xi effectively linked progress on Trump’s key issues, such as the rare earths on which much of US manufacturing depends, to how Trump’s administration handles Taiwan.
This need for Chinese rare earths does mean that a Trump-ish shock is very unlikely to be generated in this corner of the world, at least not in 2026.
On China as an investment destination, Louis-Vincent Gave notes that China enjoys a very powerful combination - low costs of capital, labour, and electricity and the cheapest global currency. It is similar to where the US stood in 2010, when many analysts and experts believed there was a lost decade ahead. Again, similar to the US in 2010, at client meetings he reckons 50% believe China is uninvestable – a typical indicator of a trend in its early stages.
China generates 16% of world GDP, but most investors have less than 5% in their portfolio. In contrast, the US represents 25% of global GDP, but two-thirds of global stock markets. If Chinese consumer confidence builds, the whole of Asia will benefit, dependence on the US will reduce, and more global money will be drawn to investment in China and Asia as a whole. In contrast, the outlook for the US stock market is mediocre at best for the decade ahead – see later in this note for historical precedents where stock market bubbles coincide with a wobbly bond market.
Now the UK, the home of political black comedy, where a culture of political incompetence has been entrenched for too many years. We have moved from florid Boris, all colour and combustion, to flacid Keir, say nothing and hedge everything. Labour has now entered the Boris-style black comedy stage. Let’s buy jet fuel from Russia so that we can all go on our hols, even if it’s at the cost of the lives of Ukrainian civilians – extraordinary.
The result? If you believe the media financial markets are crumbling. This is one headline from last Friday:
“FTSE 100 plunges as Burnham triggers bond markets turmoil”
There was no “plunge”. The FTSE 100 fell 1.7%, about the same as France, a Burnham-free zone, and less than Germany. The trigger was US government bonds, Treasuries, as yields spiked higher (and prices fell). Why? Yes, concerns over inflation for years to come, which are very well founded. But there is also a supply and demand issue. New supply of US government bonds is considerable and growing, as their government continues to spend well beyond its means. Who will buy? There is a growing trust issue, and alternatives are emerging, notably China. So the yield must go higher to attract buyers.
Most retail investors don’t hold US government bonds, and worrying about their yield feels a bit esoteric and distant. But as their yields rise they become more attractive versus a uniquely over-valued US stock market. These bonds also set the price of credit/debt globally – as US yields rise so does the cost of debt around the world, hurting economic growth.
It is no coincidence that cracks in US government bonds combined with stock market bubbles have triggered the worst bear markets, downturns, in US stock market history.
Looking at the major multi-year bear markets in history (i.e. losses exceeding 30% sustained over more than a year) the pattern is consistent:
· 1929-32 collapse (-89%) was preceded by banking stress and eventual bond market chaos
· 1937-42 decline (-60%) followed tightening fiscal and monetary conditions
· 1973-74 bear (-48%) was preceded by inflation, oil shock, and bond market stress
· 2007-09 financial crisis (-57%) was fundamentally a credit and bond market event that spread to equities
· 2022 decline, the first major episode in decades where bonds and equities fell simultaneously and there was nowhere to hide in a traditional portfolio – not multi-year, but an early warning.
The 2000-02 tech bust (-49%) is the main exception, when bonds rallied midst a flight to safety while equities collapsed. But on that occasion it was a valuation and speculation-driven collapse, not a big bond problem. Current conditions more closely resemble those earlier periods where there was debt-saturation combined with stock market over-valuation and mania.
Please don’t get complacent about these sorts of risks. Midst the 2000 tech bubble, Intel was one of the darlings, the world’s dominant hardware company. It was all very exciting. Then it fell 82%. Not because it was a bad business, but because investors paid silly prices and kept feeding the bubble and the wider mania. It finally returned to its bubble peak in April, last month, a timely reminder of the devastation after a bubble bursts. It took 26 years to recover. 26 years.
Darwin said life is the struggle for existence. Today investing is the struggle to survive the next bear market. More precisely, you must substantially preserve the value of your portfolio because the opportunities as markets tumble will be as extreme as today’s risks.
It won’t be the smartest people who will survive and thrive in the years just ahead. Nor those with the most money and “smart” advisers. It will be those who stay composed and adapt.
For example, you would have made good money in the last year avoiding the US, and have achieved more growth than in US-dominated alternatives. We expect this trend to continue for years ahead, and set out what your portfolio might look like in the last webinar.
Quick catch up on markets in the last fortnight. China, India and Japan were off 2-3%. Predictably the tech-dominated ASDAQ was the winner, up 2.8%. More surprisingly, the FTSE100 was up 2.5%, barely different to the NASDAQ. Global investors are more attracted to the cheaper valuations in the UK, than they are concerned by political comedy.
In commodities, oil had a good fortnight, up 6%, whereas gold miners, uranium and platinum were poor, down 7-9%.
On technical analysis for the S&P 500, the world’s pivotal stock market, last Thursday it hit a new peak just above 7500, a little higher than I suggested. Nonetheless, as set out previously, as I look out for a complete upward move of significance, it won’t look ideal without a fall towards 7100, followed by a final rally to a bit above 7500.
Next week I will return to the ticking time bomb that is dwindling oil supply, and the parochial issue of economically illiterate politicians and what might get the economy moving – clue – it’s not reduced VAT on trips to theme parks.