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This “daft” market is on the verge of collapse, warns Toogood

07 February 2016

Following the move to negative rates in Japan, City Financial’s Peter Toogood warns a financial crash is very much on the horizon – though other market commentators are more constructive.

By Alex Paget,

News Editor, FE Trustnet

The Bank of Japan’s decision to implement negative interest rates is the final straw in terms of increasingly “daft” monetary policies, according to City Financial’s Peter Toogood, who warns that that while there may be room for one “final consumer boom”, QE-fuelled financial markets are on the verge of collapse.

The Bank of Japan (BoJ) shocked markets this week by slashing rates into negative territory in an attempt to weaken the yen further and spark inflation within the economy.

Toogood, who is investment director at the group, says this decision – like similar policies elsewhere in the world – will do nothing but delay an inevitable market crash as companies in areas such as the US and emerging markets are up to their eyes in debt at a time when competitive pressures are intense and revenue lines under stress.

While some believe the BoJ’s surprise announcement to be positive for risk assets – which have endured a torrid start to the year thanks to China’s growth concerns, fears of US recession and oil prices falls – Toogood says it is a signal for investors to significantly de-risk their portfolios.

Performance of indices over six months

 

Source: FE Analytics

“Negative interest rates represent the final straw in terms of increasingly daft monetary policies. QE provides politicians with an excuse to do nothing,” Toogood said.

“The world is increasingly unproductive and false profits have been built on the free money party. Corporations in the US and emerging markets are up to their eyes in debt at a time when competitive pressures are intense and revenue lines under stress.”

“This year was always going to be challenging and will remain so. It may well be that we can squeeze out one final consumer boom in the developed world: sub-prime mortgages started exploding in 2007, not 2008 after all. However, credit markets have rung the bell and you just have to decide how long you want to stay at the party.”

He added: “Personally, I ordered the cab and have gone home.”  


 

Bearish sentiment has increased significantly over recent months as investors have become fearful that the rally in equities (which started in March 2009 and has been helped by extremely loose monetary policies) is beginning to tire in the face of growing macroeconomic headwinds.

Performance of index since the global financial crisis

 

Source: FE Analytics 

Of course, given most of the major sources of bad news for markets – such as China and falling oil prices – have rumbled on for some time several managers say now is a perfect contrarian buying opportunity, such as FE Alpha Manager James Thomson.

“Earnings estimates have come down already, economic and growth estimates have come down already," Thomson said.

"Any upside to that would be a very positive sign for markets and investors aren’t positioned for it, so I think if anything, there’s the potential for a positive surprise coming through as a result of that.”

However, Toogood says the main worry is, using Japan as an example, that central banks around the world are running out of firepower to improve economic conditions.

“Japan is emblematic of the issues that the world faces. Japanese equity managers may be bullish on the prospects for Japan, but that is because Japanese corporates have adjusted to a world of deflation,” he said.

“They have net cash on their balance sheets, are mostly unlevered and are now focusing on return on equity. Great news for shareholders, not so great for the real economy.”

“It is worth remembering that the rest of the world has similar challenges. The eternal bulls will cite full employment and rising wage growth as bullish signals. Unfortunately, the new savvy shopping set doesn’t overpay and thanks to the free money option provided by ZIRP and QE, there is growing competition for those same shoppers.”

Toogood says this disruption will be very intense for companies as technological developments are causing management teams to spend more to compete which, in turn, is causing rising costs in a world where revenue lines are stretched.

“In the case of the US, this is all occurring at a time when the US has never had more gross debt on its balance sheet than it does at present.”


 

He also warns that while the major financial stresses has so far been limited to commodity-related companies, investors shouldn’t think they are safe by avoiding those areas within their portfolios.

“The rise in the high yield spread is the best barometer of corporate health, which is sharply deteriorating,” he said.

Performance of indices over 1yr

  Source: FE Analytics

“For those inclined to buy high yield, remember that previous bulls told you that in 2000 the problem was limited to telecoms, in 2008 it was just about financials and today, it will just be an energy and mining story. Well, for the record, that is utter nonsense – the distress will infect everything, period.”

“Oil is a supply issue primarily, but it is also parlous for economic growth. Impoverishing the likes of Brazil is at best unhelpful, as we need the emerging markets to be strong. Arab nations can no longer recycle their oil windfalls into the risk assets.”

“The gift of cheaper energy has been passed to nations that are greying (Japan) or are wasting the opportunity (Turkey). All in all, not helpful.”

Alex Scott, deputy chief investment officer at Seven Investment Management, completely disagrees with Toogood, however.

Scott says that a low oil price is still a very good sign for the developed world and that while certain energy related companies may go under over the short-term due to falling prices, the strength of banking systems in the likes of the US and UK mean there is little chance of contagion.

“After a painful period in markets, it’s very tempting to succumb to the pessimistic narrative swirling around markets, but our process demands a clear analysis of the real risks and the opportunities, versus what is priced into market valuations,” Scott said.

“If we thought the world was going into recession, our portfolios would look very different – but we don’t. It seems to us that markets are wrong: isn’t it time we stopped worrying and learned to love cheap oil?”

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