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Wildebeest investors and the dangers of the herd



You can learn a lot from observing animals in the wild — if you have time and patience. As a decidedly impatient sort, I find it easier to watch David Attenborough on television, where the distinguished naturalist compresses years of research and months of on-site filming into an hour or so.

Don’t get me wrong. I love a hike in the Scottish Highlands as much as anyone, especially now when the pandemic makes such trips impossible and therefore more tempting. However, even on the longest walk it’s hard to spot a fraction of the fascinating fauna shown in a single episode from Sir David.

Among his favourite themes is herd behaviour — the way animals stick together when it seems irrational — at least in the eyes of the rational human observer. For example, wildebeest plunging into a foaming river to get to the other side, even when they see those entering the water first dragged away by the current.

It’s an image that finance experts have often applied to the markets, especially at times when investors seem to be throwing logic aside in pursuit of a fast-flowing stock surge.

Wildebeest figure prominently in a report this week from Rothschild’s bank, which says that investors often exhibit the same “herding behaviour” as animals, seeking “the safety and comfort of the herd”. In a boom, they pile in together into overvalued markets; in a bust, they collectively panic and dump stock.

Rothschild’s timing is no accident, coming amid growing warnings of a global investment bubble, notably in US tech stocks. Veteran fund manager Jeremy Grantham, co-founder of the GMO investment company, warned this month of a “bubble that is beginning to look like a real humdinger”.

Mark Warner, senior portfolio manager at Rothschild, said: “People see their neighbours getting very rich and they want to do the same. It’s extremely difficult to restrain yourself from herd-like behaviour.”

The report includes some fascinating science, including a Leeds university study which tracked people who had been asked to walk about in a large hall. A few were given secret instructions to follow a specific route. Although participants were forbidden to communicate, the “uninformed” ended up following the “informed” in a snake around the floor. And they did that with no benefit in sight — the comfort of following others was enough reward.

Rothschild cautions that even professional investors fall for the lure of the herd, even when they know they are breaking their own investment rules. Some do so knowingly, buying overvalued stocks in a boom in the belief that others will drive prices even higher.

Now, professional investors are far from agreed that we actually have a market bubble today, even in high-priced US tech stocks. Howard Marks, founder of Oaktree Capital and just as experienced a fund manager as Mr Grantham, this week rejected suggestions that it was time to switch out of tech and into lower-priced, out-of-favour shares, such as financials and energy — the so-called value stocks.

Criticising traditional valuation models, which generally say value stocks are cheap now and tech is super-expensive, Mr Marks said: “Investing on the basis of rote formulas and readily available fundamental, quantitative metrics should not be particularly profitable.”

So what has all this to do with the retail investor? Clearly, if the professionals were 100 per cent sure that tech was in bubble land, those stocks would already be collapsing.

Instead, there is widespread uncertainty. For the moment, worries about high asset prices are offset by the confidence generated by the huge injection of ultra-cheap money by central banks into markets and, in tech, the sense that a entrepreneurial revolution is creating unmissable opportunities.

In a clear sign that the bulls aren’t ready to concede, Affirm, a US consumer finance start-up, saw its stock almost double on its stock market debut on Thursday, giving it a $23bn-plus valuation.

With so much cash around, many well-off households in the UK and other developed countries are well-placed to invest — having mostly seen their savings rise in the past year, as Covid-19 has led to cancelled holidays and entertainments. While the pandemic has left the poor worse off, the rich are in a stronger financial position.

As returns on bank deposits and safe bonds are negligible, the opportunity cost of holding equities is limited. So stocks remain in fashion, even when they trade at historically high price levels.

Moreover, even in equities there are still safety plays. The UK market, which has underperformed because of Brexit and because of a lack of tech stocks, is widely seen as ripe for recovery. Alexander Wright, a Fidelity fund manager, recently told an FT panel that the UK was “the best-value market globally”.

More generally, past precedent shows that investing in equities makes sense as a long-term strategy, as long as you are in a position to ride out a sell-off that might last a year or two. Tom Holmes, managing director of Salisbury House Wealth, a London-based wealth manager, says: “Equities . . . have outperformed all other asset classes”, returning 12.4 per cent a year in the UK since 1925, compared with 6.6 per cent for global bonds and 4.9 per cent for cash.

Rothschild recommends picking stocks on the basis of careful analysis of individual companies. It is currently backing Ryanair (on travel recovery hopes), US cable television companies (stay-at-home entertainment), and London-listed construction equipment rental group Ashtead (good management coping well with the pandemic).

Still, retail investors need to take care in today’s markets. If you think that global equities are near a likely peak, it may be a good time to break with the herd and take profits, especially with “risk-on” assets such as tech stocks — even if you believe prices may have a little further to climb.

A surprise shock could come from anywhere. Andrew Slimmon, of the investment management arm of US bank Morgan Stanley, says that the moment the US Federal Reserve hints at ending easy money policies, “sky-high valuations” will be hard to justify. He also warns in a report that investors don’t seem to be taking account of geopolitical risks. “When they do come to the surface, expect to see panic.”

Private investors are generally less well informed than professionals and, typically, in no position to move as quickly. Unless you are willing to sit in front of screens night and day, you will rarely have a good sense of market direction. You will be the wobbly-kneed weakling of the wildebeest herd, easily taken by the torrent.

Stefan Wagstyl is editor of FT Wealth and FT Money. Email: Twitter: @stefanwagstyl

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Coinbase: digital marketing | Financial Times




Coinbase will be a stock riding a runaway train. The US cryptocurrency platform wants investors to think long term about the prospects for a global “open financial system”. Most will be unable to tear their eyes away from wild, short-term price swings in bitcoin, the world’s largest digital asset. 

This has its benefits. Coinbase, which has filed for a US direct listing, makes most of its money from commissions on crypto trades. Sales more than doubled to $1.3bn last year. The company has swung from a loss to net income of $322m as crypto prices jumped.

But the company has given no detail on the financial impact of the 2018 bitcoin price crash. Will Coinbase’s 2.8m active retail users and 7,000 institutions hang on if there is another protracted price fall? 

Coinbase was valued at $8bn in a 2018 private funding round and $100bn in a recent private share sale, according to Axois. That rise looks remarkably similar to the increase in bitcoin’s price from less than $5,000 to more than $50,000 this year.

The rally is hard to justify. Bitcoin has not become a widely used currency — nor is the US ever likely to countenance that. It offers investors no yield. Volatility remains high. Elon Musk’s tweet this weekend that bitcoin prices “seem high lol” propelled a sharp fall that hit shares in crypto-related companies. Shares in bitcoin miner Riot Blockchain have lost a quarter of their value this week. 

Prospective investors in Coinbase should keep this in mind. Its listing will take cryptocurrencies further towards the financial mainstream. But risk factors are unusually numerous, including the volatility of crypto assets and regulatory enforcement. 

Both threats are widely known. Another risk factor in the listing document deserves more attention. Vaccination campaigns and the reopening of shuttered sectors of the economy is raising yields in safe assets such as Treasuries. Risky trades may become less attractive. Coinbase might be about to go public just as the incentive to trade cryptocurrencies is undermined. 

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This thread is closed to comments due to a history of posts on this subject that breach FT user guidelines

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US stocks make gains on Fed message of patience over monetary policy




Stocks on Wall Street reversed earlier losses after Jay Powell, the Federal Reserve chairman, reiterated the central bank’s desire to stick with accommodative policies during his second day of testimony to Congress.

The tech-heavy Nasdaq Composite ended the day up 1 per cent, having fallen almost 1 per cent at the opening bell. The S&P 500 climbed 1.1 per cent, marking the blue-chip benchmark’s second consecutive rise after five sessions of back-to-back losses.

A morning sell-off in US Treasuries also faded, with the yield on the 10-year note having climbed as much as 0.07 percentage points to slightly less than 1.43 per cent, its highest level since February last year, before settling back to 1.37 per cent.

Treasuries have been hit by expectations that US president Joe Biden’s $1.9tn stimulus plan will stoke inflation, which erodes the cash value of the debt instruments’ interest payments. However, the more recent rise in yields has also been accompanied by a rise in real rates, which are more indicative of the return investors make after inflation and signal an improving growth outlook for the economy.

Higher yields, which move inversely to the price of the security, also knock-on to equity valuations by affecting the price-to-earnings multiples investors are willing to pay for companies’ shares. A higher yield, analysts say, makes fast-growth companies whose earnings represent a slim proportion of their stock market value less attractive in comparison.

Shares in the 100 largest companies on the Nasdaq are valued at a multiple of 37 times current earnings, against 17 times for the global FTSE All-World index of developed market equities.

“When bonds yield close to zero, you are not losing out by investing in those companies whose cash flows could be years into the future,” said Nick Nelson, head of European equity strategy at UBS. “[But] as bond yields start to rise, that cost of waiting [for companies’ earnings growth] increases.”

Earlier on Wednesday, investors’ retreat from growth stocks rippled into Asia. Hong Kong’s Hang Seng index sank 3 per cent, its worst daily performance in nine months. Chinese investors using market link-ups with bourses in Shanghai and Shenzhen dumped Hong Kong-listed shares at a record pace, selling a net HK$20bn ($2.6bn) on Wednesday. China’s CSI 300 index fell 2.6 per cent. Japan’s Topix slipped 1.8 per cent, dragged down by tech stocks.

Column chart of Hang Seng index, daily % change showing worst day for Hong Kong stocks in 9 months

European equity markets closed higher, with the Stoxx 600 regional index rising 0.5 per cent and London’s FTSE 100 index up 0.5 per cent. UBS’s Nelson said European equities were less vulnerable to rising yields because European stocks generally traded at lower valuations than in Asia and the US. “We have fewer big technology companies here.”

While the bond market ructions have unsettled many equity investors, some believe this should not affect stock markets because the inflation expectations that have driven the Treasury sell-off are linked to bets of a global recovery.

“Rising bond yields and rising inflation from low levels provide a historically attractive environment for equities,” said Patrik Lang, head of equity strategy and research at Julius Baer. Traditional businesses whose fortunes are linked to economic growth, such as “industrials, materials and especially financials”, should do better in a reflationary environment than tech stocks, added Lang.

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Fed needs to ignore ‘taper tantrums’ and let longer rates rise




The writer is chief executive officer and chief investment officer of Richard Bernstein Advisors 

The Ferber Method, a sleep training technique, teaches babies to self-soothe and fall asleep on their own. It’s as much a training technique for new parents to ignore their baby’s crying as it is for the child to learn to cope by themself. 

The US Federal Reserve should consider Ferberising bond investors and ignore future “taper tantrums” like the market disruption that occurred when the central bank signalled tighter monetary policy in 2013. The long-term health and competitiveness of the US economy may depend on bond investors’ self-soothing ability to cope with reality.

The slope of the yield curve is a simple model of the profitability of lending. Banks pay short-term rates on deposits and other sources of funds and receive longer-term rates by issuing mortgages, corporate loans, and other lending agreements.

A steeper curve, therefore, is a simple measure of better bank profit margins, and has in past cycles spurred greater willingness to lend. Historically, the Fed’s Survey of Senior Bank Lending Officers shows banks have been more willing to make loans to the real economy when the yield curve has been steeper.

A chart showing how banks have been more willing to lend with a steep yield curve. As the slope on the US treasuries  10-year-less-2-year yield curve has steepened, so the net percentage of banks reporting tighter lending standards has fallen

With that simple model of bank profits in mind, textbooks highlight the Fed’s control of short-term interest rates as a tool to control lending. The Fed reduces banks’ cost of funding and stimulates lending when it lowers interest rates. But it increases funding rates and curtails lending when it raises short-term rates. Coupling lower short-term rates with a steeper yield curve can be a powerful fillip to bank lending. 

However, policies in this cycle have been unique. As US short-term interest rates are near zero, the Fed has attempted to further stimulate the economy by buying longer-dated bonds and lowering long-term interest rates. Those actions have indeed lowered long-term borrowing costs in the economy, but banks’ willingness to lend has been constrained because lending margins have been narrow and risk premiums small.

Banks in past cycles might have been willing to lend despite a relatively flat yield curve because they could enhance narrow lending margins by using leverage. However, regulations after the financial crisis now limit their ability to use leverage.

This policy and regulatory mix has fuelled some of the growth in private lending. Private lenders are not subject to regulated leverage constraints and can accordingly lend profitably despite a flat curve. The growth in private lending effectively reflects an unintended disintermediation of the traditional banking system. This has meant liquidity destined for the real economy has largely been trapped in the financial economy.

The yield curve has started to steepen, and the Fed should freely allow long-term interest rates to increase for monetary policies to benefit the real economy more fully. Allowing long-term rates to increase would not only begin to restrain financial speculation as risk-free rates rise, but could simultaneously foster bank lending to the real economy. 

Thus, the need for the Fed to Ferberise bond investors. Banks’ willingness to lend is starting to improve as the curve begins to steepen, but some economists are suggesting the central bank should continue its current strategy of lower long-term interest rates because of the potential for a disruptive “taper tantrum” by bond investors. The Fed needs to ignore investors’ tantrums and allow them to self-soothe.

The investment implications of the Fed allowing longer-term interest rates to rise seem clear. Much of the speculation within the US markets is in assets such as venture capital, special purpose acquisition vehicles, technology stocks and cryptocurrencies. These are “long-duration” investments that have longer-time horizons factored into their valuations. They underperform when longer-term rates rise because investors demand higher returns over time. Capital would be likely to be redistributed to more tangible productive assets.

Investors and policymakers should be concerned that monetary policy is fuelling speculation rather than supporting the lending facilities needed to rebuild the US’s capital stock and keep the country’s economy competitive.

Like a new parent to a baby, the Fed should not rush to coddle bond investors’ tantrums and should let the financial markets soothe themselves. Short-term financial market volatility might cause some sleepless nights, but the Fed could unleash the lending capacity of the traditional banking system by letting the yield curve steepen further.

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