The most important thing for you to know this morning is that Italy’s prime minister Matteo Renzi resigned overnight, after decisively losing a referendum he’d called.
Before the vote it’d been called “Italy’s Brexit”. I’m not so sure. The vote centred around the workings of Italian domestic politics. But it’s certainly another example of anti-establishment sentiment: the PM called the vote, put his own job on the line and lost clearly. In that sense, it’s another data point in the trend we’ve been following all year, starting with Brexit, moving on to Trump and now Italy.
Precisely what it means for Italy, financial markets and your money will take a while to become clear. I’ll be talking to Tim Price later about what this means for Italian banks. Tim’s been warning they could become the flashpoint in a new European banking crisis. I’ll report back on that as soon as I can.
But I’m virtually certain this is going to result in one thing you need to prepare for: volatility.
Again it’s part of a wider trend
We’re living through a period of sweeping political change. We’ve seen anti-establishment movements and anti-status quo votes take hold all year. That could be the defining trend of next year.
That leads to volatility. Much higher volatility. Political instability leads to uncertainty. Markets hate uncertainty. And as Tim Price put it recently, markets aren’t very good at “solving for” politics: working out what a new political landscape means. That’s what creates big moves up and down in the stock, currency and bond markets.
I mentioned a few weeks ago that it’s important you understand how to measure and manage volatility in order to make better, less emotional and more rational decisions. It’s a key component in risk management. That just became even more urgent.
Which is why on Thursday Dan Denning and I are holding a special online webinar entirely focused on how to manage volatility. It’s something everyone should attend. It’s free. And in it, we’ll show you how you can understand what is and isn’t normal volatility for each of your stocks.
We’ll show you how to make better decisions in whipsawing market, how to set your stop losses at precisely the right level for each stock, and how to know exactly when the right time to buy any given stock is.
To be clear, this event isn’t connected to any particular newsletter we publish. And it doesn’t matter what kind of stocks you invest in – you’ll learn something useful and valuable nonetheless.
All you need to do to sign up to view the webinar is register ahead of time for free. There’s also a free report on volatility management I’ve put together, which you’ll receive when you do so.
I’ll be in touch again later with the link you need to register for the webinar. Look out for that.
Bond smash continues
Moving on. If a $1.7 trillion loss in the bond market doesn’t make you sit up and think about your money, I’m not sure what will.
That’s what happened last month to the Bloomberg Barclays Global Aggregate Total Return Index. It fell 4%, or $1.7 trillion. It was the largest fall on record since the inception of the index in 1990.
Ignoring a move like that without considering what it means for your money is a huge mistake.
A research note from RBC’s head of US cross-asset strategy, Charlie McElligott, last week put this in blunt terms. He wanted to “bang you over the head in order to expose the tectonic shift being experienced in markets on the narrative/regime shift.”
It is indeed a tectonic shift. Short term, we’ve seen a sharp reversal. It was only over the summer that more than $10 trillion worth of bonds were trading at negative yields. That led to the upside-down situation where people chased yield in the stockmarket and capital gains in the bond market.
McElligott called that “max-bizarro”. It was. So perhaps short term what we’re seeing is a reversion to the mean – a normalisation.
But what is normal?
Bond yields have been falling for 30 years. For most people that is normal. Unless you’ve been investing for longer than that, your entire experience of the financial world will be fundamentally based on falling bond yields. That could be changing. It’s like living through a 30-year summer, then waking up to find winter has come. What do you do?
I have an answer to that. A pretty comprehensive plan for what to do with your money to take advantage of the step change in the market. More on that in a second.
First, as I showed you last week, the bond market is bigger and in many ways more important than the stockmarket. But lots of private investors either don’t understand its significance, or just ignore it. Maybe you’re one of them. If so you need to rethink that position.
What’s going on in the bond market affects the rest of the economy. When prices are falling (which means yields are rising), that changes what companies have to pay to borrow. It feeds through to things like mortgage rates, with a knock-on effect to the housing market.
They’re also a key component in pricing annuities. If you’ve retired recently – or wanted to and been unable – you’ll know annuity rates are less than half what they were a decade or so ago. A big part of that is bond yields – falling yields have crushed annuity income.
Perhaps most importantly, the bond market – like all markets – gives us signals about the economy.
2017 Wealth Summit
Charlie Morris explained this very succinctly in our 2017 Wealth Summit last week. Here’s how he put it.
Without getting into the macroeconomics, quite simply, bonds were massively overpriced, and when yields are at nothing for ten years, that really doesn’t make a lot of sense. So at some point, investors are going to reject.
And you’ve got to think why bond yields would go up. And there were three main reasons. One of the reasons is inflation. You need to be protected against future inflation, to lend money to a government. The second is it causes economic growth, so there are exiting things to do with money, rather than park it in safe havens.
And a third is creditworthiness, whether you believe or not that the government can pay back that money in the future. And I think that we’re not at the point of credit worthiness, as much as the internet would like you to believe that that’s the case. I don’t think that’s the case in the Western world quiet yet; it may come in the future.
So I think we’ve really got two things here. One is the fact that inflation expectations are rising. They’re probably not going to rise as much as people think, and I think that a lot of the expectation is already in the price.
But the other side of it is the economy recovering. Now, I do believe this part of the equation is real because in 2009, we had this very, very strong recovery after the crisis in financial markets, and yet the man on the street didn’t really feel it. And here we are, seven or eight years later, the stockmarket hasn’t got so much to look forward to, the bond market’s really got nothing to look forward to, but the man on the street has.
Those are the three key reasons bond yields would be rising: inflation expectations going up, economic growth recovering, or a loss of confidence in government finances.
Charlie doesn’t think we’re at the point of a loss of confidence in the government yet. But the first two reasons are completely valid. Inflation expectations are picking up – just look at what’s happening in commodities markets like copper. And Charlie sees signs that the economy is picking up too.
That means we’re likely moving into a world where inflation and bond yields are rising at the same time. That’s a tectonic shift in the markets. And you need to shift with it.
With that in mind, you need to look at the plan Charlie has put together. Remember that Charlie has clobbered the market this year already. And he’d seen these moves in inflation and the bond market coming months ago. That’s when Dan and I started working on his “Money Map” with him.
We published it for the first time last week. If you haven’t read it yet I recommend you do so immediately. You need a plan for the new trends emerging in the markets.
Best,
Nick O’Connor
Associate Publisher, Capital & Conflict
Category: Geopolitics