James Athey of Marlborough Group gives us the low-down on AI stocks, addressing valuation, recent falls and earnings; a look at the inflation picture for major European economies and the effect that has on debt markets; and the liquidity picture in markets at year end, as banks face increased scrutiny of capital positions.
Interview Transcript
Jo Gallagher: Welcome to Chair TV this week. Your insight and co trading desk. Prepare for the week ahead. I’m Jo Gallagher. Today I’m joined by James Athey of Marlborough Group to discuss the main topics and events leading this week. James welcome to the show.
James Athey: Thanks for having me.
Jo Gallagher: So equities have had an exceptional run since the US election. How have you been navigating market reaction in fixed income and how are you positioned going into this week?
James Athey: Big picture. We very much consider that we are end of cycle. We see lots of signs of the sort of exuberance in markets that one tends to see at the end of cycles. Equity valuations are rich, credit spreads are very tight. But fundamentally speaking, we also see signs that we are coming to the end of this rapid cycle after the Covid pandemic. So rising unemployment is obviously a key one, slowing employment growth in general. And there are many other signs under the hood that tell us that the economic future maybe isn’t as bright as is being suggested. When you look at equity markets. So that leads us to take a more defensive posture. Of course, in the weeks leading up to the election and the days since the election, we’ve really seen a continuation of these pro risk trends. Yields have continued to rise. But we have some skepticism, really, about these so-called Trump trades. Of course, the potential for fiscally irresponsible growth and inflation boosting policies is real. But we consider in many ways those risks might be overstated. We consider that there are likely to be some offsets in terms of fiscal policy, and we also think the timelines have been somewhat exaggerated. It’s going to take time to pass legislation through Congress, even with Republican control of the Senate and the House. So we’ve used that rise in yields to add core duration, and we continue to use the strong bids to reduce our exposure to credit markets.
Jo Gallagher: We saw a lot of volatility in the air space following Nvidia’s earnings last week. What is your take on AI and its trajectory?
James Athey: Yeah, I mean it was interesting. Obviously the AMD Nvidia results really there wasn’t a lot to say. They were very close to consensus, but we did still see some volatility in the stock price as much as anything that just reflects how rich valuations are, how high expectations are with respect to earnings. And of course, a lot of the so-called hype around AI is to some degree justified. There are companies which essentially have monopolies. ASML is the only advanced lithography machine manufacturer. Taiwan Semiconductor really is the only foundry that is able to make these most advanced chips. And so there are good investment cases for those stocks. But we started to see just a little divergence. ASML is 40% off its highs in spite of still having that dominant industry position. TSMC now over 10% off its highs really Nvidia just stands alone. And actually we think invidious competitive position is probably not as strong as the other two. So going forward, I think it’s going to be difficult for some of these stocks to live up to their valuations. And that is really before you discuss the fact that as yet there really aren’t any killer use cases. There is also the potential that these large language models become commoditized very quickly. Open source becomes the dominant source. And in that respect, it could be very similar to the gold rush, where lots of gold is found. But not many prospectors made money.
Jo Gallagher: And then how does your investment outlook translate to the European and UK markets and where are you seeing opportunities and risks emerge?
James Athey: The better run of economic data that’s really driven the rise in yields that we’ve seen over the last two months or so is very much a US phenomenon and that really is why we’ve seen such strength in the US dollar. When you look at economic data this side of the pond in northern Europe and Germany in particular, you see that the story is very different. Germany really does face secular challenges at this stage. China has gone from being a strategic source of demand for German exports to being a strategic competitor in some of Germany’s key industries. Obviously automobiles being top of that list. And that really has resulted in several years of negative growth for Germany, and we expect that to continue. And that’s a significant weight on the eurozone economy. When you look further afield within the eurozone, you see that excessive deficit procedures are now being implemented on countries like Italy and France, which by definition will slow their economies. And so with the exception of Spain, we see really considerable cyclical and secular challenges to the economy. So ultimately, that’s likely to lead to much more dovish policy from the ECB. So Germany actually is our favorite market to own duration at the moment. The UK story is somewhere between the two. Ultimately, we do have concerns about the outlook for economic growth in the UK. We have concerns about the incentives that may have been created by the most recent budget, and indeed we have concerns about the potential for the investment that the Government has talked about to materialize or to materially push growth higher. But it is difficult to argue with the fact that at the moment inflation remains sticky. So we do like duration in the UK because we think it offers good value. But the economic story sits somewhere between the US and Europe.
Jo Gallagher: And how do you expect liquidity to fare across assets as we come into year end?
James Athey: Year end is known as a tricky period for liquidity. What happens is that banking regulation really is only adhered to at period ends, where regulators take snapshots of bank balance sheets in order to judge various criteria relative to regulation, things like liquidity, things like leverage ratios. And so banks behave exactly as they wish to between quarterly earnings, and then they tidy up or window dress their balance sheets at those period ends when these snapshots are taken. Year end is a particularly big one. But first, the globally systemically important bank regulation, so-called sips. They happen once a year at year end. And so there’s even greater pressure on banks to tidy up their balance sheets, which generally means less liquidity provision. If you look at, for example, financing costs within equity futures, they have risen considerably in recent weeks. This starts to hint to us that liquidity pressures are already emerging. That being said, in terms of trading liquidity within fixed income markets, liquidity conditions currently are still good. Naturally, in general, liquidity conditions within credit markets have actually been particularly good for a long period of time. And this possibly relates to the entrance of some of these more modern, technologically driven market makers, the likes of James Street, who potentially have improved liquidity conditions in credit markets during normal times. We would have some concerns, however, that those business models may not be battle hardened in environments where volatility increases, particularly when we have dramatic risk off type scenarios. It’s likely that some of the algorithms, some of the machines which are used to make those markets provide that liquidity and that price discovery might be turned off during those volatile conditions. And so we could find that liquidity conditions deteriorate much more dramatically than we might expect during periods of excess volatility. So we do have concerns looking to year end. We do have some concerns in general about the modern structure of markets. But as we sit here today, really, we would observe that liquidity conditions look good.
Jo Gallagher: Thank you, James, for your insight and of course, you for watching this having Trader TV this week.
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