Who's Afraid of the Big Blue Wave? Not the FANGs

Points of Return
Bloomberg

Robin Hood Loves Joe

It's hard to say that the stock market is running scared of a Joe Biden presidency on the latest evidence. Monday saw the former vice president's lead over Donald Trump in polls of polls top 10 percentage points for the first time. Justified or not, there is a growing sense of certainty that in three months there will be a new U.S. president. This will bring a fresh commitment to raising corporate taxes and increasing regulation, from a party with many politicians who want to split up the large tech companies, which they see as overmighty. So of course the Nasdaq had its best day since April:

Not only that but the lead was taken by the big internet platform companies that were at the center of last week's antitrust report from a congressional panel. Apple Inc., which is due to unveil a new iPhone, gained 6.35%. Apple and the other FANG stocks aren't quite back to their highs from six weeks ago, but they are close. And this has happened amid political uncertainty, a lack of economic stimulus, and worrying signs of a Covid-19 resurgence.

For an explanation, it is probably best to turn to the latest edition of a new but very popular market fairy tale: Robin Hood and the Whale. Someone somewhere is buying a lot of call options — which give the right to buy shares in the future, making them a cheap way to bet on stocks to go up. This could be the young army of retail traders most associated with the RobinHood.com discount brokerage, or it could be a single corporate "whale," but the signs are obvious once more of intense speculative activity.

The FANGs surged in the last weeks of August, culminating in a brief though spectacular correction in early September. That time, the "tell" was that the VIX volatility index, derived from how much investors pay to protect against future swings via the options market, was rising in line with stocks. Normally, big rallies are accompanied by declining volatility. This week has started with a return to that pathology:

Combine bullish options activity — which more or less forces those making a market in the option to buy the underlying stock — with the fact that many had been short the FANGs in a bet that they would fall, and you have the ingredients for a classic "short squeeze." 

Lessons to learn from this:

  • The market isn't scared of Biden. (It might yet reconsider.)
  • The rise says nothing about any positivity toward Biden. 
  • We're set up nicely for more volatility and another big correction, particularly if this rally goes much further.
  • Even if it seems obvious that the FANG stocks are way overvalued, it doesn't necessarily make sense to short them. There are much safer ways to make money.

Now get ready for earnings season, and for more October surprises. It's probably not going to be much fun.

 

Forza Italia

There is genuinely good news from Italy. Confidence has returned to such an extent that the spread of 10-year Italian BTP yields over equivalent German bunds has dropped to its lowest since early 2018. That was when it became clear that Italy would be governed by an ungainly coalition of the populist-left Five Star movement, and the populist-right Lega. One of the only things on which they agreed was anti-Europeanism. Naturally the spread, generally regarded as the best measure of perceived political risk in Italy, and hence also at present the best gauge of risk to the structure to the euro zone, went into the stratosphere.

That the spread has dropped back to early-2018 levels shows the strength of the revived optimism about the euro-zone's future. The pandemic, which wrought far more damage in Italy than in Germany, is now perceived to have brought the nations of the European Union closer together. The awkward agreement to raise bonds in common to finance Covid-19 relief, hammered out after a vintage negotiating marathon, is now taken as a genuine "Hamilton moment" that will augur a more federal and united Europe. This confidence helps explain the current bullishness surrounding the euro. 

That said, the Italian bond market also suggests investors are more confident that politicians will repay their loans than ever before. And by "ever," I mean since at least 1310: 

This chart is the latest piece of financial archaeology from Jim Reid, the resident financial historian at Deutsche Bank AG. Italy wasn't a single state for most of the first six centuries in this chart, but he has managed to dig up yields from individual city states to give an almost complete history. When the Black Death arrived in the 14th century, Italian city states needed to pay more than 5% interest — and the rate spiked to more than 10% in its aftermath. That plague also gave birth to at least one masterpiece in Boccaccio's Decameron, which is structured as the stories people in quarantine tell each other as the disease rages through Florence. Somehow, today's Italian government, despite everything, can borrow for less than 2%. Maybe a literary masterpiece is still to come.

For another indication of how weird these conditions are, the following chart maps the 10-year yield against the country's debt-to-GDP ratio since 1861, when the modern Italian state came into being:

For almost 150 years there was some discernible link between the two. The more indebted Italy became, the more it would have to pay to borrow. Now its indebtedness has reached a historic high — and the rate at which it can borrow is at an all-time low. Don't spend too much time trying to make sense of this; it doesn't make sense. The European project is looking healthier than it did, but yields this low cannot be sustained indefinitely.  

 

Fortune Might Favor Boris the Bold

This was a solemn day for the U.K. Boris Johnson, the prime minister, announced that as many Britons were in hospital with Covid-19 as there had been when the government first announced a lockdown back in March:

The premier's proposed response is to embark on a new and subtler version of the lockdown, which will split the country into three risk categories. He faces intense opposition within his own party and from the noisy Keep Britain Free campaign, and much dissension over whether the resurgence can be traced to the government's decision to push ahead with reopening schools and universities. Whatever response is adopted will be bad for economic growth, as the British already appear to be voluntarily curtailing their activity.

This dreadful news came after last week's big GDP disappointment. Britain reports figures monthly, and the latest suggest growth has dwindled almost to a halt, much worse than expected. As this chart from Societe Generale SA shows, none of services, construction or industrial production has managed to get back to where it was in January:

Added to this, the U.K. faces a "cliff" in its negotiations with the EU over a new trade agreement, which is needed now that Brexit has happened. Those negotiations aren't going well. Without an accord, the U.K. would move to basic World Trade Organization trading terms as of Jan. 1. With the EU accounting for most of the country's exports, this could be a brutal hit.

And yet, and yet, and yet. Despite all of this dreadful news, sterling is on the up. It has strengthened against both the euro and the dollar in the last few weeks. Dollar weakness has kept sterling close to the top of its range for the last three years:

How is this possible? In part, it is down to a bet on the Brexit negotiations. Traders think that someone will cave (probably Boris), and the madness of a no-deal exit will be avoided. That would be great news for the pound, and for Britain's beleaguered banking sector, which would stand to lose a lot of power if its access to the continent is curtailed. Rather than be caught unawares, sterling traders are guarding against this outcome.

Then, as ever in the U.K., there is the property market. Britons love to buy houses. And with rates as low as they are, many seem convinced that prices are heading up again. As this chart from BCA Research shows, the RICS survey of home price expectations, which looks at the balance between those expecting increases versus decreases, has shot to its highest level of optimism in a decade. Those who have money in Britain intend to make a killing in the housing market, and this will stoke the economy (even if it also stokes inequality). As BCA shows below, optimism about house prices tends to mean a stronger pound, and much stronger bank shares relative to the broader market:

Add to this that the British debate over the exact severity of the pandemic is intense. Hospitalizations have risen, but as this chart from the government's Covid-19 information site shows, deaths remain far below earlier levels. Among those hospitalized, the numbers on ventilators are also far lower:

There is one more reason for optimism. The British government was unusually generous in plugging the gap when people were laid off during the worst of the lockdown. This was expensive, but it left Britons with a lot of savings, which generally haven't been spent. This shows U.K. households' total savings over the last quarter-century, in a chart from Longview Economics of London:

 

That money will be spent at some point — particularly once a vaccine arrives. You need to be optimistic about a few things to invest in the U.K. at present. You need to trust Boris Johnson to craft a better response to the pandemic and also to reach a deal with the EU. If you can bring yourself to do that, you can understand why the pound is doing well.

 

Survival Tips

I will get to the point of a "survival tip" but I am more concerned to make this a memorial. On Monday, Sir Samuel Brittan died at the age of 86. He was probably the most influential British economic commentator since the war. As a (very) junior reporter at the Financial Times, I was lucky to work with him early in my career. A kind man, who cared very little for appearances, he was generous in his time with me, and I have always been grateful. You can find his obituary here, and an appreciation written on his retirement here.

He managed to bestride British financial journalism without ever mastering modern technology. Rather than learn how to use computers, he would dictate his columns down the phone to a copytaker. He would do this flawlessly, and without notes. Like Mozart, everything was in his head, and the rest was mere scribbling. As I used to sit within earshot while he was dictating his page-long columns, I got a decent economic education along the way. There is a tribute to Sam above, in the phrase "And yet, and yet, and yet." He once asked the copytaker for a single paragraph that would include nothing but those words. There then ensued five minutes while Sam tried to explain to the poor typist on the other end of the phone that he wanted to repeat the words "and yet" three times, and he knew he'd been heard and he wasn't repeating himself. 

He loved music and had remarkably broad taste. I think he would have appreciated the most moving tribute and meditation on the end of life that I know of, which is the minimalist composer Arvo Part's Cantus in Memoriam of Benjamin Britten. I'm not sure what his favorite requiem was, or even whether he would have wanted a requiem as he was himself a patron of Humanists UK, which represents the interests of the non-religious. But he loved Mozart, so I think this is a particularly good time to listen to his Requiem. Rest in peace, Sam.

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