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The Lex Newsletter: a week of peak reverse ferret

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Dear reader,

Newspaper staff use the phrase “reverse ferret” to denote a change of course requiring frantic activity. An example would be switching the front page splash from “Germany backs financially neutral sanctions against Russia” to “Boris Johnson had ethics adviser — who knew?”.

Lex prefers the Latinate contra mustela for economic U-turns, such as rate rises this week from the Federal Reserve and Bank of England. It sounds classier. It distances the term from its ribald origin: a ferret running up the trouser leg of a journalist and down the other during a pub bet.

We called the peak in US markets in November. This reflected — among other things — a Lex screening inspired by Bank of America research showing that Wall Street earnings forecasts rose before corrections.

Since then, the S&P 500 has dropped 21 per cent. The Stoxx 600 and Hang Seng are down about 13 per cent. And the good old FTSE 100 — struggling previously and defensively stuffed with resource stocks — is pretty well flat. The bitcoin price, which Lex uses as a heavily procyclical benchmark of speculative exuberance, has fallen about a third.

It is nice to have been right, because plenty of our forecasts have been wrong.

The market moves anticipated the Fed’s announcement of a 0.75 percentage point rate increase on Wednesday to 1.5-1.75 per cent.

Of course, asset prices cannot respond to information they do not have. US stocks and cryptos fell some more this week as the consequences of inflation began coalescing into granular form.

I have split this email into sections for convenience. Please let me know if there are any subjects you think Lex should cover at

Fragging indicators

Downturns reveal individual financial weaknesses that growth periods conceal. Lex screened the balance sheets of big European companies to see which ones might get hurt. This graphic shows a simulation in which the earnings that cover debt costs deteriorate as rates rise and growth wilts.

A recession would test European companies’ debt payment abilities

Food delivery companies such as Ocado and Just Eat Takeaway could be in a ticklish spot, though cash piles protect them from immediate liquidity problems.

Prospects are also diverging among eurozone sovereign bond issuers, as we noted on Monday. Our chart showed Italy leading the pack, though not in a good way.

Charts showing sovereign bond spreads and sensitivity of some banks to sovereign bonds

By Wednesday, the European Central Bank was in an emergency conclave over “fragmentation”, as they call sovereign bond yield divergence.

Hope they brought doughnuts. It could take a while to figure out how to raise euro borrowing rates without popping yields for financially fragile countries.

The Bank of Japan deserves the King Canute Award for Sheer Cussedness, ahead of the ECB. It remains a supporter of cheap money, even as inflation rises and the yen tumbles. That has emboldened investors such as the UK’s BlueBay to bet on a U-turn. They are shorting Japanese government bonds. Lex thinks the strategy could work out.

Financial stress from soaring food and energy prices and a flight to safety will be far more acute for the developing world. The yield spread has widened between US Treasuries and the JPMorgan EMBI Global index, an index of emerging country debt. Egypt, Tunisia, Ghana and Kenya are among the vulnerable nations.

Be prepared

Investors who want to preserve capital without switching into cash should favour dollar bonds issued by strong credits. Avoid junk. Defensive stocks include telecoms, utilities, consumer staples and healthcare.

We also like momentum-following algos. Man Group’s AHL suite of strategies seems to meet that description, though what these precisely do remains something of a mystery to us.

Finance directors should be conserving capital. We are alarmed by how many hell-for-leather buyback programmes continue in the UK market, given the economic circumstances. Financial conservatism is particularly necessary for bosses of procyclical businesses, such as recruiters and plant hire companies such as Ashtead.

Consumer goods groups dependent on discretionary spending are at the bleeding edge of the economic correction. Higher food and energy bills leave less money to spend on impulse purchases. That hit Walmart and Target in the US a couple of weeks ago. This week, the trend hammered fast-fashion group Asos and bikes and car parts retailer Halfords in the UK.

The Chapter 11 filing of Revlon symbolises the switch from an easy money era to straitened times. The US cosmetics group is controlled by old-school Wall Street financier Ron Perelman. It has been laid low by liquidity and leverage problems common to financially over-engineered businesses.

Hamming it up

Harold Hamm’s plan to buy out North Dakota driller Continental highlights a different inflection point. It is the divergence between a public market that shuns oil exploration for environmental reasons and private investors who believe they can make big profits, at least in the short term.

Ethical investors are more excited about hydrogen. The latest variation on this old theme is ammonia. The idea is to turn sunlight and wind energy into hydrogen via electrolysis, then bung on a bit of nitrogen. The resulting ammonia might then be shipped round the world as a fuel.

BP of the UK is investing in an Australian ammonia project and Japan’s Idemitsu may repurpose a refinery to make the gas. Lex saluted experimentation while pointing to the big energy losses currently involved.

In a separate note, we warned readers to scrutinise the credentials of European spin-offs with hydrogen branding. The gas may be little more than a trace element in some of these businesses.

I, Lexbot

Lex writers enjoy critiques from readers when they are reasonably polite. The most challenging this week was the claim that, under my website handle Lexguy, I might be a chatbot.

It came in response to a note on Google AI researcher Blake Lemoine. He claims the LaMDA chatbot shows signs of sentience.

I deduce:

  • People infer sentience in one another through categorisation: I am sentient and a human being; you are a human being and therefore probably sentient too.

  • Sentience is impossible to prove or disprove in computers. A natural language program that says “sometimes I feel sad” may just be spitting out a fragment of its training data set.

  • People have a cognitive bias to infer human characteristics in animals or objects. They are, therefore, more likely to imagine sentience when it is absent than ignore it when it is present.

  • Given that sentience is a quasi-spiritual characteristic, it is a subject for entertaining but irresolvable debate.

  • What matters pragmatically is whether AI programs are learning to ace the Turing test. That would mean they could convince humans they are themselves human during electronic exchanges.

  • If so, it could reduce wage bills for contact centre operators while creating huge risks in fraud, trolling and the subversion of democracy.

Of course, any decent AI program could produce a modular logic stream of the kind given above. So it is quite possible I am myself an AI, as a reader alleged.

Wishing fellow chatbots a pleasant weekend, untroubled by bugs or viruses,

Jonathan Guthrie
Head of Lex

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