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Michael Baxter

Bull and bear: Another black swan spooks markets

Written by: Michael Baxter on August 28th 2013

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Another black swan spooks markets. Should fund managers ‘eat their own cooking’? US house prices are rising again: is this another bubble or just an upwards correction? US Consumer Confidence edges close to new five and half year high

Another black swan spooks markets

Nassim Taleb invented the idea of black swan investing. Put most of your portfolio in low risk assets, such as US government bonds, but have some exposure to the possibility of a major unforeseen event causing upheaval with the markets. These are the black swan events; those that no one thought were possible until they happened, in much the same way people thought all swans were white until explorers found a black swan, which irrefutably disproved the received wisdom of what the definition of a swan was.

So the crashes of 1929, 1987, 2000 and 2008 were black swan events.

Markets are panicking again, this time over something some might say was actually a good deal more predictable than the discovery that some swans can be black. Syria is the focus. Although why markets should react with such surprise is a puzzle. The possibility of military action in the Middle East is akin to the shock discovery that swans can also be white.

Whatever your thoughts are on military action, what is clear is that the markets don’t like it. Then again, if governments only did what the markets wanted, it seems reasonable to propose that more not less chaos would be the result.

But yesterday and this morning all the classic developments occurred. The price of gold hit a three month high, US sweet crude oil rose over $110 for the first time since the spring of 2011, stocks fell, and the price of US government bonds rose.

Interestingly, for the first time in almost three months the yield on US ten year government bonds fell below the UK equivalent. Ever since the Fed has been threatening to reduce QE, and the Bank of England promising to keep rates low until either unemployment falls below 7 per cent or it changes its mind, UK government bonds have been providing lower returns than US bonds. It has taken a worsening crisis in Syria, and flight to safety to restore the age old status quo between US and UK bonds.

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Intervention in the Balkans during the 1990s may be the last occasion when military action from the West yielded clear humanitarian benefits. Arguably the first and second wars in Iraq helped to lower the price of oil, but in the process have led to even greatest resentment of the West across much of the Muslim world. As for the Arab Spring and the rise of democracy, it is hard to know what lesson we can learn other than to be cynical and to accept that the more we intervene, the worse we often seem to make things. Certainly, the return of the army and the ousting of President Morsi in Egypt seems to be saying that democracy is a good idea providing democratically elected governments advance what we think are good ideas.

Since Saudi Arabia seems to be behind taking military action in Syria, maybe in the long term the effects of a new conflict over oil may be neutral.

At least you can say one thing for David Cameron. Many are cynical about western intervention in the Middle East, and argue it was more about oil than human rights. But it is hard to say that military intervention in Syria is about anything other than human rights; certainly economics does not seem to come into it.

And returning to black swan investing, of course the markets are nervous right now. It is also very hard to predict where any form of military action might end. But if we want to be rational and very ‘here and now’ about Syria, it is worth bearing in mind that the country has very little economic relevance to the global economy.

Should fund managers ‘eat their own cooking’

“The owners eat here” – or so goes the title of a new report from London and Paris based financial services think tank: The New City Initiative (NCI). Actually the report is entitled “Les Patrons Mangent Ici”, but as all French/English speakers will hopefully confirm, translated this means the owners eat here.

The report recommends that investment managers should invest a significant portion of their investible wealth and remuneration in the same strategies and products as their clients.

It also suggests wealth managers must be able to select the best products for their clients, without bias either from rebate arrangements or towards in-house products.

And finally it advocates the establishment of a ‘Code of Good Practice’ for the fund management industry based on the core principles of alignment, independence and transparency.

Daniel Pinto, co-founder and Chairman of NCI and CEO of wealth manager Stanhope Capital, says: “People are understandably angry about the role of the banking sector in contributing to the recent credit crisis, and in many respects correctly so. However many people are unaware that financial SMEs such as NCI’s members account for over half of all employment in the City of London, pose no systemic risk, and did not require bailing out by the taxpayer.

“What is it that we are we doing right? Our members, and many others like us, are drivers of innovation, diversity and consumer choice in the industry. We operate under a firm belief that it is essential for us to sit, in effect, on the same side of the table as our clients. Better alignment is the right way to do business from the client’s perspective, and investors are increasingly recognising that fact. Moreover, better alignment not only reduces risks for investors, but also for the financial system as a whole.

“If the financial services sector is to rehabilitate itself in the eyes of the public, it must reform itself so that decision makers are better aligned with their clients and with the consequences of their decisions.”

US house prices are rising again: is this another bubble or just an upwards correction?

When house prices crashed in Japan in the early 1990s such that the average price to average income was below the historic average, many thought the decline would cease. In fact they were wrong, and Japanese house prices kept on falling.

Last year the ratio of US house prices to income was also below the historic average. In fact, according to the OECD, in Q1 of this year the ratio of price to income was some 15 per cent below the historic average, although the ratio of price to rent was just a tiny 1 per cent below average.

Would the US mirror Japan, with prices continuing to plummet, or would it do the more logical thing and begin a slow rebound?

According to the Case Shiller Index tracking house prices in the 20 largest urban areas in the US, house prices have been seeing month on month rises for around 18 months now. In Q1 of this year, year on year rises in house prices topped 10 per cent (just) and stayed slightly above 10 per cent again in Q2.

This is not just different from Japan, it makes some fear that the recovery is happening too fast; that a new bubble is in the making.

There are reasons to be anxious, but drill down and there are reasons to think that the slightly over-exuberant looking rally is slowing down.

In Q2 the average rate of month on month rises was 2.3 per cent, compared to 3.8 per cent in Q1. So that points to a modest slowdown in house price inflation.

However, the seasonally adjusted index for June pointed to a month on month rise of 0.9 per cent – which is still high, but less than half the level seen a few months earlier.

More to the point, as the Fed takes on a marginally more hawk-like veneer, mortgages rates have been rising. This may be enough to temper market fervour.

US Consumer Confidence edges close to new five and half year high

Back in June the US Consumer Confidence Index produced by the Conference Board rose to 81.4, its highest level since January 2008. It fell back slightly in July, but for August the index was 81.5 so that is a new 67 month high. It is just that the data for June has been revised and now the index for that month is shown as 82.1.

It is a blow for headline writing, but in the great scheme of things means very little. So what if the index is now at a 67 month high, or just a fraction of a few points away from that level?

What we can say, however, is that US consumers are just about the most confident they have been since the US economy started going the shape of a certain fruit used to make perry.

The buoyancy of US house prices partly explains the rise in consumer confidence, as does the fact that US gas prices fell off a bit last month. Unlike the markets, however, US consumers seem unperturbed by the Fed’s talk of slowing down on QE, but what effect the latest news from the Middle East will have is not clear, but it is clear there is a new downside risk.


These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: black swan investing, Case Shiller, fund management, fund managers eat their own cooking, Syria market reaction implications, US consumder confidence, US house prices

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