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September 24, 2018

2017 in the eyes of the markets

Christine Lagarde, Vimal Shah and Aly-Khan Satchu.
Christine Lagarde, Vimal Shah and Aly-Khan Satchu.

As we roll towards the end of the year, Tennyson's poem In Memoriam came to my mind

Ring out, wild bells, to the wild sky,

The flying cloud, the frosty light:

The year is dying in the night;

Ring out, wild bells, and let him die.

I thought we should first explore what happened this year in the markets and then in my next article try and predict what might happen in 2018. The developed world's central banks continued to expand their balance sheets which are super-sized from the Bank of Japan to the ECB, The FED and the Bank of England. Whilst these economies jaw-jawed about balance sheet normalisation, none actually effected a reduction in size. Interest rates remain at historical lows. Inflation has been strangely absent and many are now laying the blame for this presence of an inflationary absence at the door of the ''Amazon'' and ''Gig'' economy. In turn, this golden flood of [cheap] liquidity has lifted growth in the developed world and has spilled over into emerging and frontier markets as investors hunted for yield in all corners of the world.

Donald Rumsfeld said: ''There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.''

The big macro-known unknown is when and if inflation will rear its head and if these markets which have been doused with liquidity will exhibit some good old-fashioned vigilantism. In other words, will central banks have the mission console prised from their hands?

We remain deep in uncharted territory. Investors have chosen to focus on this ''Goldilocks'' scenario and have priced out a return to a more normal scenario. The CBOE Volatility Index has been at all time lows practically all year. The Dow Jones Index rose 5,000 points in 2017 and hit record highs practically every day. Stock markets in Europe and as far as Japan and Asia are all at multi-year highs. FANG stocks have been big outperformers in 2017 with Facebook shares up 56%, while Amazon is up 55%, Netflix 49% and Alphabet 32% as the digital economy becomes the operating platform for the world. Crypto currencies have moved from being some fringe thing to the point where my barista in my building in Nairobi knows the price. Even after correcting by over 30% this week, Bitcoin is up 14 fold with other cryptos like Ethereum and Ripple doing even better. Last week, long Island iced tea soared 625% in pre-market after changing its name to Long Blockchain. Company sells yes, iced tea, had a net loss of $11.6m this year. This is mania-type behaviour. Crypto was the fastest place to multiply your wealth in 2017. That's a fact, but whether it will be the place in 2018 is another thing altogether. I would be very very cautious. The Big Whales are hitting the exit button and pump and dump is something we have seen again and again.

Africa has had an excellent year in most cases. The best performing currency world-wide was the Mozambique Metical which delivered a 20% price appreciation and that return does not account for the positive carry. Equity indices from Lagos [The Nigeria All Share is +42.70% in 2017] to Accra [Ghana is +51.37%], from Nairobi [The All Share is +28.51%] to South Africa [which was at record highs before the Steinhoff scandal struck] have all served up some outstanding returns. Here in Kenya, the big beast Safaricom, was +42.00%, KenGen +48%, KCB +62.00% and others have all scored Fang-like returns.

African sovereign dollar-spreads are at 347 basis points [above US treasuries], the lowest in more than three years, according to Standard Bank Group Ltd. Madam Lagarde, the mercurial leader of the IMF sounded a note of caution in an interview with Quartz Africa.

Quartz: Let’s start with the “dark clouds” on the horizon that you made reference to in your speech, and specifically the debt burden. How worried are you about what some have called a ticking “debt bomb”?

Lagarde: I think there are a few things that are important. One is the usual ratio of debt to GDP which in about half of the sub-Saharan African countries now exceeds 50%, or a little less than half. The second thing I think is important is the debt service relative to budget and then for balance of payment purposes it’s the ratio of debt-to-export and debt service to export. So it’s all that taken into account which actually matters. And there are countries in Africa—I’m not going to point fingers at any of them—but some of them are seriously at risk.

Quartz: Do you think 2018 could be the year that the debt problem finally explodes?

Lagarde: It could very well.

2017 was an incredibly benign year for investors. We are in the final innings of this expansion and investors will need to keep their wits around or as Thomas Pynchon said:

“What goes around may come around, but it never ends up exactly the same place, you ever notice? Like a record on a turntable, all it takes is one groove's difference and the universe can be on into a whole 'nother song.”

I will seek to explore the contours of 2018 in my next article.

Happy holidays.

 

 

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