14th October 2022 / Anthony Cheung

Liz sacks Kwasi & what next for US stocks?

A busy end to the week, as UK Prime Minister Liz Truss sacked her Chancellor Kwasi Kwarteng and announced another U-turn in her government's tax cut plan. Find out exactly what happened and how markets reacted to the latest news.

We also tie in the latest developments in the UK bond market after Bank of England Governor Andrew Bailey told pension funds “You have three days to get out". A brave move or asking for trouble?

Finally, Thursday marked one of the largest intraday reversals in the US stock market on record. The initial move lower came after US Core CPI printed at a new 40-year high, but why did we rebound so quickly? Piers explains why the devil is always in detail!


In this week’s podcast, we went into detail on how the markets reacted to the sacking of Chancellor Kwasi Kwarteng by UK prime minister Liz Truss. We also went into detail on the UK bond market after Bank of England Governor Andrew Bailey told pension funds “You have three days to get out". We concluded the episode by discussing the latest ongoings of the US stock market where we saw one of the largest intraday reversals on record.

Here is how our conversation went -

The UK Prime Minister, Liz Trust, has just held an emergency press conference because the Chancellor was sacked earlier today. Before we delve into the details, what are your initial thoughts on what she said? 

Well, the emergency press conference finished about 20 minutes ago and  I've only just stopped laughing at just the ridiculousness of all of this. Well, she's thrown Kwasi under the bus but obviously, the big question is, well, why didn't she throw herself under that same bus? Because it's not like this plan was Kwasi;  It's not like he just came up with this master budget and then put it on Liz's desk just to sign off. I mean, we're led to believe this is entirely a joint endeavour. Joint almost like ideology which they masterminded it together. Saying that it's a disaster, would be a big understatement. Yes, someone's got to go but I don't understand how she can stay as well. Remember Boris a few months ago? The only way he got forced out was because of the en masse resignations. But unless that happens, she's just going to continue to wade on through this swamp that she's created. 

There's the technical process now that she can't technically be challenged because of the fact she's just come into leadership because of the time frame of the process of what that entails. However, I read one thing saying it only takes an afternoon meeting of the backbencher's committee to then flip that role and toss her out anyway. It's hard to really say anything concrete at this point, but one of the things from where I sit is I have lots of different news sources which gave me the initial wave of what the political correspondents thought. Former Chancellor Philip Hammond has already commented, saying he's basically just thrown the entire reputation of the Conservative Party saying that he's just torn it up because they're supposed to be the ones who are fiscally prudent of the political spectrum. A couple of other things that were said were that she didn't actually assign any blame to Kwasi and she did say that she has not changed her fundamental position that the economic priority is growth so she's like, holding on and there wasn't a great deal of information. The market has been waiting for this all day but she's just come out and talked about the 18 billion in corporation tax cuts being reversed, which goes against her own platform, which is what Rishi was pushing. She talked about the two things that they were saying from a market perspective;  She was referring to the down payment saying that perhaps there are more reversals to come, but they haven't really thought of what detail and context that's going to happen. The other thing was about how the spending will not grow as quickly as planned.

Yeah, all that's happened in terms of that mini-budget is that they've scrapped the idea of getting rid of the 45% tax band for the rich, and then now doing a U-turn on corporation tax. The corporation tax will rise from 19% to 25%. Right. So that's it. But certainly, the corporation tax on that is going to hurt Liz Truss because that's like a cornerstone piece of her campaign when she was campaigning to be the leader of the party. She's created her own downfall here by the spectacular sort of ill-thought-out way they went about that budget. And now she's having to just peel it all back just to stay alive. So she's entirely sacrificing her own political ethos just to cling to power.  So can the Conservative Party get her out? And the answer is probably no. So the only way to do it is for the Cabinet Ministers just resign. It's the only way. That's what happened to Boris in the end. So keep an eye out for Cabinet ministers resigning. But obviously, Liz Truss is hoping for a line to be drawn and that's incredibly naive because this definitely isn't a line drawn and we're all going to move on now.

The markets are a definitive part of her fate. Yeah. What do markets do now? So what do the markets do now?

Right, so it's markets that have forced this whole episode because they reacted phenomenally badly to the budget. Talking about bond yields; that is. I'm looking at the 30-year government bond yield -. That's all that stuff around the pension funds and everything else, where the yield spiked above 5% last week, it then came off and came down this morning off the news that Kwasi is on a flight back from the States and is going to get sacked. Off that news, bond yields dropped and continued to drop from last week's peak. And so just today it dropped from 4.6% all the way down to about 4.25%, which is a big move, by the way, just in a few hours now, it's reversed a whole lot. Bond yields have reversed all of that downside from earlier on and back up above 4.6% new highs for the session. So bond yields are saying, Liz Truss “what the hell are you doing? Get out of office because you're not responsible to govern”. That's what bond yields are saying. I'm looking at the currency markets and if you look at the pound against the dollar and how that's been fluctuating and it's the same thing, but in reverse -the pound was strengthening this morning and now it's all come off and it's reversed. So the pound is now down on lows for the session. Still, I would point out quite a bit above where we were trading last week. We got down to below 104. That's the pound versus the dollar last week or a couple of weeks ago when the mini-budget was first announced and we're still up above the 111 handles as of now. But, yeah, a little bit of sterling weakness, but it's the bond yields that look to be more interesting in my mind. So, yeah, yields moving higher, the pound moving lower, the markets are saying that Truss has got to go. 

Do you think there's any connection to Jeremy Hunt? He was the former Health and Foreign Secretary. Probably not everyone's cup of tea in terms of his successes over the years.

Yeah,  I guess she's gone for him just because he's a hugely experienced politician and indeed Cabinet Minister and has held if you want to say that the two other big offices, which are Foreign Secretary and Health Secretary. He's probably just seen as thatsuper-experienced person who can come in and balance off her inexperience. I can only assume that's the strategy.

The only other person I heard tabled late morning was Sajid Javid but maybe he's too tight with Rishi?

Yeah, might have been asked, actually. Maybe he said no because he would not want to jump on the Truss trolley when the wheels have already come off.

Tell me about the bank of England, because I caught one of your posts on LinkedIn where I saw a comment saying that Andrew Bailey told pension funds  “you got three days to get out”. What's he talking about? And why is that such a powerful statement?

Well, this is the bank of England's emergency move following the budget, when bond markets just went into meltdown and UK government bond yields surged to crazy levels and this had this knock-on impact on pension funds and how they go about their business. There's this thing called liability-driven investments. It's ultimately resulting in pension funds having to essentially liquidate assets to raise cash to pay margin calls for the swap strategies that they're running. But the point is that obviously, a lot of the assets that pension funds own are government bonds, UK gilts, and so they're having to sell their gilts to raise the cash, but it's the gilts being sold drives prices down and drives yields up. So the selling of those gilts is that vicious cycle because it makes yields surge more, which means then their margin calls are even larger. So the bank of England stepped in and said, they will come in and provide some buy-side liquidity in this market because if you're in a market and everyone's selling well, the collapses, right? For every person selling, you can't sell unless there's a counterparty that's buying. But what happens if no one wants to buy? Well, then this is where markets just collapse, right? So the bank of England stepped in to avoid the collapse and said that they will buy. And normally they'd be expected to be what's called the buyer of last resort where they're stepping in to say “we are stopping this market falling, we're drawing a line, we're going to be the buyers and we got unlimited money”.  Or well, in this case, they said that they are going to use 65 billion. That's the case. And so everyone thought, “oh, thank God, relief. The pension funds aren't going to collapse the bank of England, they're coming to the rescue yet again.” But actually, that's not what's turned out to have happened, because the 65 billion that they've said they were going to spend to prop up this market, they haven't got anywhere near.  They're less than 10 billion, actually, all in all, of the 65, it's less than ten that they've spent. And everyone is wondering what's going on. And it's not like yields have dramatically reversed and what's going on here?  It's part of a much bigger thing, in my opinion. That bigger thing is the era of central banks just always coming to the rescue and bailing everyone out. And so this has been the case time and time again; quantitative easing programs, et cetera. And it's got to the point here in the UK now that they're bailing out governments, right? They're bailing out government incompetency. And this is where you get this slight conflict because the government wants to stay in power, they want to win votes, they want to be elected. So, sure, Truss’s mini-budget of tax cuts is populist and so fine, that's a good thing for the government if their objective is to get reelected. But of course, we just had a COVID crisis and debt levels are just through the roof. So in the end this is where, central banks, have just been propping it. So this is a stand from the Central Bank to say, “you know what, we're not going to continue to do this indefinitely just because the government's messed up here. We're not going to ride to the rescue just because pension funds have got these complicated investment strategies” When it comes to Pension funds, they're not stupid; they know the risks. They weren't expecting the yield moves we've seen, but it should be in their risk models. And if it's not, well, I'm sorry, whose fault is that? It's theirs. And it shouldn't be the Central Bank that just comes along and just bails them out all the time. So what the Central Bank has been doing for the last couple of weeks in this emergency window is saying  “yeah, we are buying, we are buyers, we are going to prevent this market from collapsing, but we're not just going to buy at crazy high prices and let you off the hook. We'll buy, but we'll buy at very low prices. You're going to have to wear a lot of pain if you want to use us as your exit point from this strategy”

You've seen, hardly anybody sold. So what does that tell you? That tells you that, okay, there isn't a pension fund meltdown crisis here because if there was, they'd be selling to the Central Bank even at their low prices. But they've chosen not to and that speaks volumes in my opinion.

Yeah, that's so interesting and you're absolutely right. I agree with that conclusion.  An on Andrew Bailey then, I know you’ve never really been a big fan?

The default with Bailey is from the press and from myself, I would definitely say, is always, “what the hell is he doing? Lack of credibility, making mistakes, not believable etc” And so the press, jumped on it again when he said on Tuesday, “pension funds, we're not extending this emergency window. You've got three days, get out.” And then the press was all over it like “ My God. What's he doing? Is this going to be a disaster? Bond market is going to collapse. The whole thing is going to implode” But in my opinion, if he pulls this off,  he'll go from zero to hero. In my mind, this could be and I don't know yet whether it will work, but it could be one of the most dramatic monetary policy stands the.

If I was thinking about it from a PR perspective, I didn't see the live conference with Bailey, but given the language that was adopted, I can imagine it was delivered in a very authoritative way. And it's almost the opposite of what we've just seen from Liz Truss, which is there's a heightened degree of uncertainty. Will the bond market freak out? Obviously, there's a tangible risk of that happening because you don't know until you say it and you find out pretty quickly, hence the way markets react. But this is one of the things that is so important about that leadership role, is even if you're unsure, even if you're scared if you're anxious, it's not your job as the point man to show those types of feelings. Because that was exactly what one of the journalists was talking about from some of the initial WhatsApps that were firing in the background when she came on stage which is not good enough.

I've never seen someone exit stage left so fast after that press conference; she was sprinting to get out of there. It was the most uncomfortable thing I've seen in a while and that's not what you want from your leader. You have got to be confident and assertive.

The thing is, right, that markets are so powerful and they tell you what to do based on how they behave, and that's really what's been happening for years. Central banks and governments, if you make a mistake, markets will tell you, and then you need to reverse and change. If central banks say, “right, we're going to start hiking rates” and markets freak out and they go, “oh God, all right, fine, we won't” But this is Bailey trying to just reverse the tables and to say, “Markets, you're not going to dictate to me what we're going to do. We're going to dictate the terms to you”  And it worked in so much as bond yields dropped. It's only now Truss has flipped in it's on the way back up again. But, from Bailey's point of view that's the best thing he's ever done, in my opinion.

Let’s talk about Thursday's move in the US equity market because all week we've been waiting for one official data point to hit, a very important one, because it's the greatest weightless factor basically that builds the perception of what the Fed is going to do. And a rate hike from the Fed come early November of the magnitude of 75 basis points. That was priced in before, it's priced in now. It's not about the November meeting. It's about that terminal rate which we've talked about before in a previous episode, which is about where do rate rates go beyond this, how high do they go and where's the resting point when we get to the top?The Consumer Price Index report from the US came in at 8.2% on the headline, which was down from the previous 8.3, which was 0.1 above expectations. But let's just park that because the one I'm sure that you can give some more colour on is what's under the bonnet of the inflation reports when you start taking out some of the more volatile components; so typically food, energy, people look at the core reading and that rose to a 40 year high - 6.6%, up from 6.3% and above street expectations. So stocks are down, gold down, and bonds down. The only thing moving up really in that scenario is the US dollar, of course

If I talk about the Nasdaq, [you can swap that in for any other stock market,] basically because they all did the same thing. So the Nasdaq, the inflation numbers hit and the Nasdaq sold off from 10,450. I'm rounding things up and down here, but basically, a 400-point sell-off bank in pretty much a straight line straight away. And that initial reaction was because of the core CPI reading. And the core CPI reading;  6.6%  - 40 year high. But more importantly, was higher than the March peak. So for Core CPI, we had a big surge higher at the start of the year to six and a half percent in March. Then it tracked lower for the next few months, which is what led to the stock market rally in the summer. And now in the last couple of months, it's just gone s above the spring high. And so the first reaction in markets is, “oh my God, this is a disaster. This inflation crisis is definitely not over. The Fed is going to have to carry on hiking rates at 75 basis points per meeting till God knows when? The terminal rate that you were talking about is now going to be higher and is our doom and gloom and stock markets collapse”

The devil's in the detail. And it is difficult with inflation because there are so many elements to it and there are so many different components. And there's headline inflation and there's core and then there are goods and there are services. It is difficult to delve into the data, but what happened in markets after that 400-point sell-off and the Nasdaq sell-off paused, then it started to push back higher and bounce and not only did it rebound the whole lot, so a 400 point sell off, 400 point rally, then into the close it then added another like 200 points on top of that. So basically 400 point sell off, 600 point rally, and finishing on the highs for the session. No other news So when I delved into the inflation situation, it became a little bit more clear . So if you look at that, if we just take core inflation, that's taking out food and energy. So what you got left and in core inflation, you can split it into goods or services. Okay, two things on the goods side, and this is probably the most powerful catalyst for that rebound if you look at the goods side. So stuff like what we saw was shipping costs have now started to fall. Commodity prices are falling. We've had them what we call a real build-up in inventories. This is where companies are stockpiling products, so that's where their manufacturing products and then maybe they're sticking it in the warehouse that's ready for goods to be sold and shipped or the inventory levels of components or whatever.. They've been building and building for super high levels, which is normally a sign that sales are starting to weaken. And so it's perhaps a lead indicator that companies are going to start to buy less. So the demand side of the inflation situation; there are signals that it's going to weaken. And what we saw with the goods inflation element of the core inflation reading, we now have goods disinflation. So actually net over all goods in the basket - the price has now dropped. And that's the first time that's happened since 2020. So goods inflation is now negative so that's a clear sign that maybe this inflation crisis has peaked or is peaking. But hang on, then if goods prices went down, why was the inflation print so high and why was it higher than expected? It's all about the services side Services inflation definitely did not go down. Now the biggest component of the services side of inflation is shelter. So everything to do with your house and you living in a house. And that came in super hot. And that's been one of the elements of the inflation basket that's been really driving this inflation spike. So the shelter portion of the inflation basket was up 0.7%, both in August and September actually. Now that shelter portion, makes up half of the core services. Medical care, makes up 12% of the core services. That went up big time, weirdly, mostly because of the surging costs of eye appointments. So looking ahead now, what's inflation going to be next month? So what's driving it up now? And are those factors sustainable? So medical care probably not going to continue to be a factor that's pushing inflation higher. Transportation services, that's 10% of the core services side of the basket, that shot up 1.9%. That was a lot bigger jump than we saw in August, when it was only 0.5%. And again, it's a bit tricky as to why or to judge why that's happened and there's no evidence to suggest it will continue to happen. So if you've got goods prices now declining if you've got medical care and transportation services spiking, but for no good reason, so probably won't again going forward, then really all it comes down to is shelter.

Basically, shelter is the last portion of this basket that's driving prices higher.  That's why markets rebounded yesterday because a lot of the elements in the basket are really flashing that in the future inflation is going to start to come back down, but it does leave shelter and will that continue to rise?

The last point about shelter - shelter CPI is calculated using rental data. How much does it cost to rent? Now in the CPI basket, that shelter component is looking at existing rental amounts and their new rental contracts. Now if you took out the existing, there are other readings that aren't used in the CPI inflation basket, but you can find them elsewhere. There are other measures that get rid of existing. It's just what are the new rental contracts, and how are they being priced? Because that's obviously a much better lead indicator.  If you've signed up for a two-year rent agreement, well, then you can't change the price.  So the price isn't going to go anywhere, but it's the new deals that are getting signed now. The prices are starting to come down. So the lead indicator by looking at new rental costs is showing that the lag is about nine months. The lag between CPI shelter measures and actual rental costs in new deals being done, it's about nine months. So basically the long and the short, it looks like the shelter market is turning as well. Now, if you just look at new rent deals and therefore we're nine months away from the whole shelter CPI component starting to come all the way back down. So we've still got nine months. But the point in the way markets operate is we don't wait for nine months to see if it actually happens. We look into the finer detail and the more lead indicators to see if it's beginning to happen and if we're happy it's beginning to happen start pricing it in. So this is why markets rebounded yesterday. 

Yeah, I was looking at another rationale that was trying to be pinned to the move. Perhaps there are a couple of other elements that exist in an intraday environment that can exacerbate these types of wild price movements. There are four other things that were tabled - Chart support option hedges. So unwinding short positions. Earnings season. And then rule-based strategies just exacerbate some of the moves. The only thing I can think of by that reference is that perhaps there are short term intraday participants running automated systems on momentum-based trading. The main thing to the people listening; there are a couple of different types -Some will be traders. When you get a situation, if you're looking at intraday markets  I can say it's as tempting as it can be to jump in and just ride the reversal,  I'd say that's a highly risky strategy, more broadly speaking, because what you described about the CPI report all makes complete, crystal clear sense. The ability for you to really make that assessment in real-time is impossible. Certainly in very, very tight time frames. And your initial rationale is based on then buying into a market that fundamentally doesn't make sense to the initial interpretation, which is never a good thing, If you are trading intraday, then probably the best course of action is if you see the types of volatility probably your best served not trading, because even though you mentioned a 600 point move in a market, which sounds very appetizing, you could be 600 points on the wrong side of that move, and you want to pick opportunities where the probabilities hopefully are leaning in your favour. You're not rolling the dice here, trying to just chase markets. So that's pretty intraday.  Beyond that, for anyone who's more interested in the mechanics, both from a long term investment point of view for a fund manager point of view and for a student to understand about these things; t's a good explanation because now when you look at the market, actually, I'm looking at the Nasdaq and I just noticed that it's gone nowhere. 

One of my favourite things is that when you get a market episode like yesterday, it doesn't happen often. I read the mainstream financial press and just for entertainment, comedy value. Just read some of the attempts that they are making at trying to explain what happened. It's super hard to explain and blatantly unless you've been a trader and you've been right in amongst it for years, then it almost just seems impossible to explain. But their job, that's what they've got to do. And I love some of the things they come out with to try and explain it, I find them hilarious.

If the market can't sell off on the back of more bad inflation data, well, maybe that's it. Maybe we're at the bottom, there just aren't any sellers left. If anybody did want to sell, they've already sold even more bad inflation data and the market doesn't go down. So is that a signal? Well, okay, maybe this is a bottom. What do you think about that? 

Yeah, but after 37 38,000 got smashed in the S and P, I'm a little bit less inclined to be talking it up. But put it this way, a lot of the bank stuff I've been reading. Bank of America was basically saying along the lines of, there's more pain to come. And a lot of them, like Morgan Sandy, are the same. They're talking about corporate valuations that are still too rich and need to come down. And  we're just about to begin earning season. We got an important couple of weeks ahead, but we could probably sell off into we then got the midterms coming in the first week of November. So from a timing wise and just given the usual market reactions that we get post-midterms as well now with this UK debacle coming. There's a lot of bad stuff that's happened and that's had its impact now. Yeah, I'm more of the mind of we sell off short term next three weeks, month. I still think that then there's a little bit of time when the dust will settle on this. I just had so a comment here from one of the Fed officials talking about four and a half to 5%, likely the top of the Fed funds rate cycle, which is in keeping with their guidance. But we hit forts the second week of November. - we sell off till then and that's when the bottom because then as well, those corporate valuations got time to come down, be a bit more depressed and the more depressed they become with this greater sell-off that still might emerge,  then you'll start to see.

I do agree with the earnings season that's about to start. I mean, that's definitely going to be pretty significant.  And it's not just their earnings for quarter three, which is probably going to come in weak, but it's really about what are these companies guiding for 2023, what's their guidance for 2023? And how bearish are they and how worried are they, especially in the US with the dollar being so uber strong? So for these massive giant organizations that generate a lot of international revenues, that's really hurting. It's interesting to see what they say about that  2023 guidance. And that may be the most powerful force. And if it's doom and gloom, then, yeah,  you're right, we may get another leg down over the next two, three weeks. But on that earnings front, so it's some of the banks reporting today, right, which is really just kicking off the season and then what?

Yeah, without going into all of the numbers,  I've put out the press releases of every large financial institution reported in the last 48 hours on my LinkedIn; JPMorgan. Morgan Stanley City wells,  Fargo. And BlackRock was on Thursday. So the reason why this is super important; is if you're a student listening and you're in the midst of the application season, which I know is very much well underway right now, either applying, writing cover letters, or at this point of the year, typically in an interview or looming assessment centres. If you read one of these investor relation documents around corporate earnings from a JPMorgan, for example, or a Morgan Stanley, then essentially it gives you not just the top-level performance of that business. It allows you to understand in a more granular fashion how each division is performing, of which these specific divisions that you are applying to. It also allows you to do a competitive landscape assessment of, okay, so how big is MS in this space compared to GS, right? Or why isn't a classic investment bank so different to a city or Wells Fargo, for example? What's the commercial banking aspect of them? How big it is in context? I always try to say to students is that if you were an employer and you are employing someone to work in your company, let's say you owned your own small company, right, and you asked that famous question, what do you know about my company? You should be able to tell me. Particularly, I'm giving you public documentation of facts and figures of what exactly we do, what services we provide, what's our best product, and how are you positioned in the market. If you are listening to this podcast and you can't answer those questions about the bank you're applying to, you're probably not going to get that job. But look, I can only take a horse to water.  This is all to help. It doesn't take more than, I would say, 15 minutes to just have a little look over the document because generally people are concentrated on a specific division and you're going to be, like, much more educated and you'll feel much more confident and you'll have that special differentiator from the other candidates then.

But yeah, earning season will pick up a bit of pace next week. Usually, it's still a bit slow, you'll get the other financial names amongst some other firms, but then it's the week after it's, then the busiest week of all of the season, and then probably the week after that is when we'll start. So we're probably talking like late October. The Apples, Amazon's, Alphabets, and Metas of the world will probably come in about two weeks or so. We’ll cover that when the time comes. The world might be a different place by then.


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