Welcome to Finance and Fury. I was looking at an interesting survey that is regularly conducted – so in this episode What do investment managers think the top risks to the markets are?

  1. This is a survey that Deutsche Bank regularly does where it surveys investment managers and Wall Street participants –
  2. The results help to gives some insight to the thinking of portfolio positions from those that control some of the largest levels of money flows in the investment landscape –
  3. This is interesting because of what actions investment managers take in response to their predictions – if they think markets will go down, they might be slightly more defensive in their allocation – or sell off some of their higher growth holdings – resulting in a decline of those shares – What happens to the price of assets on markets often occurs ahead of any event materialising – prices move at first due to the anticipation of an event materialising

Looking at the DB survey – One of the questions that the 600 participants were asked: “Which of the following do you think pose the biggest risks to the current relative market stability?” – where they had 13 answers in total to choose from – These are not in order – but I will list all 13 out and let you think about what you think the biggest threats are to financial markets and see how it stacks up against the predictions of wall street

  1. Domestic policies (such as tax or spending that governments make) – This partially relates to Fiscal policy – the policy that governments make, how much to tax people, what stimulus packages are taken, if business are to be shut down due to lockdown restrictions
  2. Worries about the debt burden – This is the risk to domestic governments, particularly in the US that the increase in the debt has on markets – can the government repay their debt obligations?
  3. Geopolitics – This is international politics which could affect markets – this ranges from hot wars, such as if a war between the US and China breaks out over Taiwan – which is very unlikely – all the way to a tariff policy on commodities
  4. Worries about longer term structural consequences of the covid shock – supply issues from government shut downs
  5. Waning vaccine efficacy – this can be a risk to markets as it can spell further government shutdowns and restrictions
  6. An uneven global vaccination campaign and economic recovery – this relates to countries having different policies to one another
  7. New variants that bypass vaccines
  8. Tech bubble busting – FANG shares and other large tech companies which make up a large portion of markets like the NYSE and Nasdaq collapsing – this is possible when looking at their PE ratios
  9. Strong economic growth failing to materialise or being very short lived – Policy makers have forecasted good growth of GDP coming out of a slump in GDP – this has been prices into the markets, so if it doesn’t materialise then markets can negatively react
  10. A Central bank policy error – For example – not increasing interest rates when they should – continuing QE longer than necessary – tightening too quickly
  11. Fiscal policy being tightened too quickly – the stimulus measures being reduced too quickly
  12. Higher than expected inflation/bond yields – inflation materialises at a higher rate than anticipate – and bond yields start to rise – which means their prices have collapsed
  13. Other – could be anything else

 

So what do you think? – No right or wrong answers – the results are simply the opinions of the 600 survey participants

  1. Is it Covid related – with vaccines not working as promised, or a new variant coming out?
  2. Is it due to geopolitics, or domestic policies, like a debt burden?
  3. Or is it central bank related, with policy errors or fiscal policy being tightened too quickly?
  4. Or is it inflation and bond yields being higher than expected

 

The poll shows that it appears that the fears from government responses to covid is officially over – According to the latest monthly survey of 600 global market participants conducted by DB – for the first time this year, the biggest perceived risk to markets is no longer government responses to covid. Instead, the top three risks are:

  1. higher than expected inflation and bond yields – This is the highest by any margin – 74%
  2. central bank policy error – where a CB may tighten too quickly – i.e. increasing interest rates rapidly to combat the number 1 perceived risk of higher than expected inflation
  3. strong growth failing to materialize or being very short lived (i.e. stagflation and/or recession).
  4. These three are rather related – in reality –
    1. Inflation materialises – with no growth – such as a stagflation event – then central banks may respond but make an error – then this exacerbates the issues

Overall – higher than expected inflation/bond yields are the biggest perceived risk by professional investment managers – but the flow on effects from this are really what matters

  1. So lets break these three down further – looking at what wall street anticipates from here
    1. The most likely catalyst for the coming correction is in the form of higher interest rates – higher than expected at least – coming from a shock to interest rate rises that are out of cycle or not foreshadowed in the forward guidance
      1. Or at least that’s what this survey suggests – when asked “with regards to 10 year US treasuries, will the next full 25bps move be higher or lower than current levels?” – the vast majority, or 84% of survey respondents expect the next 25bps move in 10Y yields to be higher, and just 11% lower.
      2. In reality though – only 5% of the respondents were honest saying that they don’t really know –
    2. DB then asked respondents if they believe the policy error for major central banks – Fed, ECB, BOE – is going to be too dovish or hawkish
      1. Dovish refers to keeping policy too loose for too long – such as what has happened for the last 11 years in the USA – and may other countries in the world
      2. Hawkish refers to being too hard in a short period of time with policy – such as tightening too quickly
  • The risks were seen as high everywhere but the Fed/ECB were seen more likely to keep policy too loose with the BoE expected to err on the hawkish side.
    1. Dovish – 42% for the Fed, 46% for the ECB and 20% for the BOE
    2. That they will get it right – 24% for the Fed, 26% for the ECB and 20% for the BOE
    3. Hawkish – 33% for the Fed, 21% for the ECB and 45% for the BOE
  1. So overall the consensus is that the US and EU is likely to continue to have low rates when compared to the BoE –
  1. When combining two of the top three results – that is Looking at the combination of higher inflation and lower real growth – i.e. stagflation – the next question is “what are the risks of stagflation over the next 12 months according to your definition?” the concept of your definition is an interesting one – as technically there is a fluid definition of stagflation – where there is no overwhelming consensus definition for “stagflation” based around the levels of growth and inflation –
    1. I.e. does a 3% inflation with 2.5% GDP growth equal stagflation? Technically yes – but this is pretty normal for some western nations and wouldn’t be of concern
  2. For now – lets look at three simple categories – all of which can technically meet some definition of stagflation
    1. A strong slowdown in growth and a strong pickup in inflation – 25% of participants agreed with this definition – with most expecting a very high or high chance of this occurring in the UK – not as much in Asia or the US – but 40% chance in EU
    2. Growth around zero or negative and inflation well above target – 45% of participants agreed with this definition – again with the higher chances in the UK But very low chances of around 15% in Asia and 20% in the USA –
  • Growth below trend and inflation comfortably above target – 30% of participants agreed with this definition – again the UK was the stand out with 75% of the respondents believed that that this was very high or highly likely
  1. When looking at inflation expectation – the survey asked “the fed currently believes the recent increases in inflation are largely transitionary. Which of the following statements most accurately reflects your view?”
    1. Virtually all transitionary – 2% – Mostly transitionary – 62% – Mostly permanent – 31% – Virtually all permanent – 3% – Don’t know – 2%
    2. This is an interesting result – as the answer to this question all depends on how you view inflation – the fact that we get 5% inflation this month – but then inflation goes back to 2% next still means that whatever inflation has been incurred is still permanent – unless we get deflation the following month – therefore – 100% of respondents should respond with ‘virtually all permanent” – but what they are referring to is the % increase over time – is 5% permanent or will this go back to 2.5%? This is what the respondents are answering

The final question of relevance – and what is most important to investors – the end result of market prices – “in your opinion, do you think there will be an equity correction before the end of the year?”

  1. When asked if there will be an equity correction before year-end, only 29% said no, while solid majority, or 63%, expect a drop between 5 and 10% before year end.
  2. Just 8% expect the coming drop to be bigger than 10%.
  3. Then 29% think there will be no correction of magnitude – However market sentiment has changes slightly over the past month since September – Going from 58% to 63% for those that market will decline by 5-10% – but then those that think more than 10% has gone down, -10-8%

So in summary – did your views line up with wall street?

  1. Wall street think the biggest risk to markets are
    1. higher than expected inflation and bond yields – This is the highest by any margin – 74%
    2. central bank policy error – where a CB may tighten too quickly – i.e. increasing interest rates rapidly to combat the number 1 perceived risk of higher than expected inflation
    3. strong growth failing to materialize or being very short lived (i.e. stagflation and/or recession).
  2. Most think that the biggest risk is increasing interest rates – with transitionary inflation
  3. And that markets will have some mild declines between now and the end of the year – dropping by 10% at max, given markets have already dropped by 5%

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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