Key Points
Global Political Risk is still tiring.
Biden’s Pocketbook is leaking red ink.
UK consumer is still spending, which isn’t great- buy less Rose wine, one less sausage on the barbecue – every little bit helps, please. The wrong people are paying the price.
Debt Ceiling- the science bit of the commercial.
Equity market rebasing opportunity to invest in the growth stories of the future.
Will Everybody Please Play Nice!
Growing up with twin brothers a little under 3 years younger than me, I can remember that plaintive call coming from whatever unfortunate aunt, uncle or grandparent was asked to watch over us as our parents entered respite care- three boys between 10 and thirteen. I recognise I was the eldest but there were two of them and they would always bite…and so this brings us to the debt ceiling negotiations between people of greater age and wisdom, in the US the politics is vicious and there are worse things than a bitten arm. I am not talking about Russia/Ukraine, China/Taiwan, Sub Saharan Africa- playing nice is a global aspiration rather than any sort of reality, which is very sad.
Biden’s Pocketbook Doesn’t balance
The government spending in the US is not under control the federal government ran out of ready cash in January and the ‘special measures’ (borrowing from Peter to pay Paul) is at an end.
UK Economy still Chaffing
On our jewelled isle we have inflation that is falling but not necessarily in the right way or quick enough to stave off further rate rises over the summer, although that might strengthen UK GBP, making our summer holiday Sangria a little more affordable. (Every cloud has a silver lining you just must look really hard)
Back Across The Pond
Returning our compass bearing to the economic north that is the US it seems that Biden and McCarthy’s teams have a workable deal, with some noises off from the most viperous Trumpisms and hand wringing from the democratic progressive left they’re going to give themselves a 2 year window (beyond the next election) taking the cap off the debt the US owes the world. There are some long range and short term challenges, but the practicalities may give us an opportunity to sensibly rebase assets- it is important to remain relatively defensive. In a medium risk portfolio, we will stay at 60% equity rather than the 65% we held until the last quarter of last year- but we are reducing our tactical cash positions from 10-15% to 2-5% for clients outside of their portfolio construction period.
The new tide we cannot turn is that after the debt ceiling has been agreed the US needs to swiftly replenish its cash flow for real things- so they will need to raise $700BN in the next three months and probably a total of $1.25Trillion over the next twelve months, debt being issued by the treasury is important for global markets liquidity and currency stability, but is this too much of a good thing?
Who’s Going To Buy This Debt?
So, this is the science bit of my missive, feel free to skip on- but it is important (There are many googleable things, which I know is popular). Well, the US central bank (Federal Reserve-FED) they could buy it, but they are in the middle of the process of reducing their debt holdings from the current $13.5 trillion ($4 trillion in 2011) the process is known as QT (Quantitative Tightening) the reverse of QE (Quantitative Easing- remember when you struggled to pronounce Quantitative?). If they buy all the debt that would be a loosening of policy- when they’re trying to bring down inflation. The US and other countries commercial banks could buy the debt, but as we saw in March, they’re at capacity and they don’t have the deposits to buy the debt, indeed the emergency funding for US banks (Bank Term Lending Facility) has risen to $91BN.
Where’s the money gone?
Well, the mini banking crisis has pushed the funds held at Money Market Funds (MMF) to an all time high of over $5Trillion- but they are maintaining their liquidity by parking a large proportion of their funds with the FED under their overnight reverse repo purchase agreements- so if the MMF needs the money to pay out the next day to the market (you and me) they have no liquidity issues as it’s the FED- the FED just prints the money. The rate therefore offered on the new debt will have to be higher than that that offered by the FED overnight as the MMFs will have to take on liquidity risk (If they need to raise cash, someone will have to buy the bonds from them- the FED isn’t their banker).
In truth all these participants will buy some of the bonds, but we are going to see some volatility as they will have to sell something else to buy that bond, and the ripples will spread across all assets, including equities- last time we had a similar situation the S&P 500 fell 12%, this isn’t the same but there’s plenty of reason to be cautious.
So What’s The Opportunity?
If we do see the froth blown of the top of equity prices that take into account the persistent inflation and associated high interest rates, with a cooling of the global economy then we are ready and willing to invest in the growth stories of the future, you will see an up tick in activity from the relatively quiet period we have had since the start of the year- a mini banking crisis and debt ceilings do that to you. We have and are making investments in the long and short side of US smaller companies via the Cooper Creek fund, looking at Commodity trends via the Dunn fund, on the direct side we are adding to Microsoft, Service NOW and topping up some UK holdings to support the yield (income) of portfolios- in this higher interest rate environment we are constructing our return to be 2.8-3.5% in income with similar amounts in capital over a five year period- there is going to be some capital volatility so income can help support the return our clients need. As always if you have any questions or queries do let us know.
Important Information
This article is for information only and does not constitute advice or recommendation and you should not make any investment decisions based on it. The views and opinions of this article are those of Casterbridge at the time of writing and may change without notice. Any opinions should not be viewed as indicating any guarantee of return from investments managed by Casterbridge nor as advice of any nature. It is important to remember that past performance and the value of an investment, and any income from it, may go down as well as up and the investor may not get back the original amount invested.
