The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

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THE DAILY EDGE: 13 SEPTEMBER 2019: Change to the Rule of 20 Strategy

ADVANCE MONTHLY SALES FOR RETAIL AND FOOD SERVICES, AUGUST 2019

Advance estimates of U.S. retail and food services sales for August 2019, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $526.1 billion, an increase of 0.4 percent (±0.5 percent)* from the previous month, and 4.1 percent (±0.7 percent) above August 2018.

Total sales for the June 2019 through August 2019 period were up 3.7 percent (±0.5 percent) from the same period a year ago. The June 2019 to July 2019 percent change was revised from up 0.7 percent (±0.5 percent) to up 0.8 percent (±0.1 percent).

Retail trade sales were up 0.6 percent (±0.5 percent) from June 2019, and 4.6 percent (±0.7 percent) above last year. (…)

Weak Energy Prices Held Down Overall Inflation In August Firm underlying inflation leaves Fed on track for rate cut next week

From a year earlier, the CPI increased 1.7% in August and core prices climbed 2.4%, the fastest annual pace since July 2018 when core prices also rose 2.4%.

Prices for an array of goods and services rose last month. Rent and medical prices were among the drivers behind stronger inflation in August.

The inflation figures leave the Federal Reserve on track to cut interest rates next week by a quarter-percentage point. (…)

On track to cut? Hmmm…Let’s see what the Fed’s preferred gauge of inflation does when it’s released in 2 weeks. In the meantime, core CPI says “mission accomplished” on the 2.0% target. Reminder: annualized core PCE inflation was 2.5% in the last 2 months, 2.2% in the last 3 and 3.0% in the last 4 months.

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Here’s the Cleveland Fed table: both median and 16% trimmed-mean inflation are comfortably above 2.0%. Excluding energy, inflation is ramping up widely.

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The Atlanta Fed’s sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 3.5 percent (on an annualized basis) in August, following a 3.4 percent increase in July. On a year-over-year basis, the series is up 2.7 percent.

On a core basis (excluding food and energy), the sticky-price index rose 3.6 percent (annualized) in August, and its 12-month percent change was 2.6 percent.

The flexible cut of the CPI—a weighted basket of items that change price relatively frequently—decreased -6.5 percent (annualized) in August, and is down -0.4 percent on a year-over-year basis.

The Atlanta Fed wage growth tracker shows wages well around the 4.0% mark and rising.

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And initial unemployment claims remain quiet at the low end of their historical low levels.

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These are conditions to …ease?

The ECB yesterday:

The Governing Council now expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2%.

Core inflation in the eurozone is stuck below 1.0% while Germany, Italy and the UK are in or close to recessions.

Who Can Go Lower? Japan Considers Deeper Negative Rates After ECB Cut The Bank of Japan is growing more open to cutting short-term interest rates deeper into negative territory, responding to global risks that are forcing other central banks to cut. The European Central Bank cut its rate target to minus 0.5% Thursday and reintroduced an asset-purchase program.

If the bank were to do so, however, it would look for ways to avoid sharp declines at the longer end of the yield curve, the people said. The goal is to keep an upward slope from low short-term rates to higher long-term rates, which makes it easier for life insurers and pension funds to make investment returns.

Amid concerns about a global slowdown and trade tensions, the European Central Bank on Thursday cut its rate target to minus 0.5% and reintroduced a program to buy eurozone debt. The Federal Reserve at its meeting Sept. 18 is poised to cut its key policy rate, currently set at a range between 2% and 2.25%. Investors widely expect a cut of a quarter-percentage point, but President Trump in a recent tweet called for cutting rates to zero or lower. (…)

The Bank of Japan’s policy board is leaning toward keeping policy steady at its own meeting next Wednesday and Thursday because the domestic economy looks relatively solid and the markets are stable, said the people familiar with the bank’s thinking.

The central bank also wants to see the impact of a sales tax increase, which will be introduced Oct. 1, and the results of its quarterly corporate sentiment survey, released the same day. The policy board meets again in late October. (…)

World central banks are totally aligned fighting the manufacturing slump caused by the trade war:

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@topdowncharts

Speaking of the trade war, soybean stems are the modern olive branches:

China to Exclude U.S. Soybeans and Pork From Additional Tariffs The move by Beijing follows President Trump’s two-week postponement of higher tariffs on some Chinese goods.

The official Xinhua News Agency said Friday that China would buy “a certain amount” of agricultural products from the U.S., and that the government would exempt such purchases from punitive tariffs. The Commerce Ministry and China’s economic development agency decided on the measures, the report said. (…)

As Trump says: “We’ll see what happens”.

Pointing up But Trump also said, smelling the ballot boxes:

“It’s something we would consider, I guess,” Trump told reporters at the White House on Thursday, referring to an interim agreement.

Trump administration officials have discussed offering a limited trade agreement to China that would delay and even roll back some U.S. tariffs for the first time in exchange for Chinese commitments on intellectual property and agricultural purchases, according to five people familiar with the matter.

Here’s one scenario: a truce is declared, tariffs are lifted, trade resumes, no hard Brexit, manufacturing revives, capex rise. What then happens to already rising inflation, tight labor markets and already accelerating wages? Fed up?

We’ll see what happens.

47,000 grocery workers in California avert a strike with new contracts

After six months of talks, the deal avoids what would have been the largest private-sector strike since 74,000 General Motors employees walked off the job in 2007 and the second major work stoppage in the supermarket industry this year. In April, 31,000 Stop & Shop workers at 240 stores in New England walked out of their jobs for 10 days. That campaign drew support from Democratic presidential candidates Elizabeth Warren, Joe Biden and Bernie Sanders.

The union representing California cashiers, stockers and clerks at more than 500 stores declared victory on Thursday. (…)

The new Ralphs and Albertson contracts met a list of union demands. They include wage increases between $1.55 and $1.65 an hour for workers over the course of the three-year contract, the union said. They also include provisions for pension funds, provide additional guaranteed hours for veteran workers and expand health care access to workers’ family members. (…)

U.S. Deficit Tops $1 Trillion for First Time in Seven Years

(…) “It will be a very substantial tax cut,” Trump told congressional Republicans at a retreat in Baltimore. He said the tax cut would be “very, very inspirational” without providing details. (…)

The administration has also put off the idea of a possible cut in payroll taxes, Treasury Secretary Steven Mnuchin told CNBC earlier Thursday. Mnuchin said that Trump was focused instead on a second round of proposed tax cuts. (…)

Last fall, ahead of the midterms where Republicans ultimately lost their majority in the House, Trump suggested he would cut taxes for middle-earners by 10%. (…)

The tax cut announcement came as a surprise to administration officials and Trump’s allies in Congress. That plan was never released. (…)

Mnuchin Says U.S. Looking Closely at Issuing 50-Year Bond The Treasury Department is “very seriously considering” issuing a 50-year bond next year, Treasury Secretary Steven Mnuchin said, as the Trump administration looks to take greater advantage of low interest rates to slow soaring borrowing costs.
Falling Yields Unleash Flood of Muni ‘Century Bonds’ State and local governments, along with universities, are joining companies in a dash to issue debt and lock in low rates, sometimes for up to 100 years.
US junk bond inflows signal investor optimism More money put into high-yield funds this week than in any since February

FYI:

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SENTIMENT WATCH
Stocks have ‘sufficient tailwind’ to climb higher — keep buying: Credit Suisse

Going against the wary crowd is our call of the day from Credit Suisse’s global equity strategist Michael Strobaek, who thinks the S&P 500 can climb higher and now’s the time to buy more stocks.

“Recent weeks have seen political risks in Europe diminish and the U.S.A. and China make renewed efforts to resume talks. Accommodative central banks should further underpin investor sentiment,” Strobaek told clients in a note. He’s boosting equity exposure to overweight — meaning they see better value for money in stocks — with an emphasis on the U.S.

Stocks simply have more return to offer than bonds right now, he said. “Moreover, throughout the strong year for equities to date, many investors have proven reluctant to jump on the bandwagon, leaving many with cash to deploy. This as well as still depressed investor sentiment suggest that this rally still has legs,” added Strobaek.

Gundlach sees 75% recession chance, has a warning about the corporate bond market

(…) Gundlach, to a London audience, outlined a number of worrying signs, including declines in purchasing indexes, which peaked at right about the same time the U.S. and global stock markets SPX, +0.29% did.

Gundlach said neither Trump nor China would be willing to agree to a trade deal, with the Chinese side waiting for the possible electoral defeat of the White House incumbent.

He also pointed to a New York Fed model showing a rising likelihood of a U.S. recession but did concede that jobless-claims data have been indicative of a strong labor market, even if jobs growth has slowed.

A bear on the U.S. dollar DXY, -0.31%  , Gundlach expects more interest-rate cuts from the Federal Reserve, with the bond market having priced in four. (…)

In corporate bonds, Gundlach does foresee crisis, noting one piece of Morgan Stanley research concluding that a third of investment-grade debt should really be rated high-yield.

He said the corporate bond market has surged in size and is highly leveraged, with weak covenants. “So when you have the recession, there won’t be an ability to address these issues,” he said. (…)

CHANGE TO THE RULE OF 20 STRATEGY

The Rule of 20 Strategy makes no forecast, no scenario and only uses known trailing EPS and inflation.

The Q2’19 earnings season closed on trailing EPS of $164.44, practically unchanged from the end of June ($163.99). This metric will not change much in September.

Yesterday, we got CPI data for August and core CPI is now +2.4% YoY. This metric will also not change this month.

As a result, we know that the Rule of 20 Fair Value is 2894 on the S&P 500 Index (20 – 2.4 * 164.44). This value will not change any more in September.

Because of the rise in core inflation, the Rule of 20 P/E reached 20.73 at yesterday’s close (3014) which triggers a boost in cash from 20%, set on August 6, to 30%.

However, because the Rule of 20 Fair Value is down 3 consecutive months and its moving average is also declining, cash is doubled to 60%.

These charts plot the S&P 500 Index with the Rule of 20 Fair Value moving average for 3 periods since 1957. Equity markets tend to move in sync with earnings amplified by oscillation from under to over valuation. A cheap equity market can withstand a weakening Fair Value like in the late 1970s, in 1985-86, in 1990-91 and 2012-13. An overvalued market can get even more overvalued like in 1961, 1968, 1971, 1987 and 1998 until they succumb to the lack of genuine fuel.

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The Rule of 20 Strategy aims at maximizing equity exposure when valuation is attractive and protecting capital when equity valuation becomes excessive. It also seeks to add another layer of protection when the Rule of Fair Value, based on profits and inflation, is in a downtrend which happens in recessions but also during “profit recessions” and/or when inflation rises faster than profits, the condition we are currently in.

The Credit Suisse strategist quoted earlier sees “tailwinds” in political and monetary events or scenarios. The only winds the Rule of 20 Strategy would consider come from trailing profits and inflation.

These provided steady tailwinds from mid-2009 to mid-2015 and since the end of 2016. But investors are now facing headwinds from stalled profits and rising inflation.

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Huawei’s Ren Zhengfei ready to sell 5G tech to a Western buyer to help create rival, level playing field

Ren Zhengfei, the billionaire founder and chief executive of Huawei Technologies, said he is ready to share its 5G technology with potential western buyers.

Ren said Huawei is willing to give buyers perpetual access to Huawei’s existing 5G patents, licences, code, technical blueprints and production know-how for a one-time fee, according to a two-hour interview with The Economist on September 10, the contents of which were confirmed by Huawei.

The acquirer would be allowed to modify the source code, meaning that neither Huawei nor the Chinese government would even have hypothetical control of any telecoms infrastructure built using equipment produced by the new company. Huawei would likewise be free to develop its technology in whatever direction it pleases. (…)

According to the interview, Ren’s stated aim is to create a rival that could compete in 5G with Huawei (which would keep its existing contracts and continue to sell its own 5G kit). To his mind, this would help level the playing field at a time when many in the West have grown alarmed at the prospect of a Chinese company supplying the gear for most of the world’s new mobile-phone networks. (…)

THE DAILY EDGE (20 September 2018)

U.S. Housing Starts Rebound After Two Months of Decline

Total housing starts rose 9.2% during August (9.4% y/y) to 1.282 million (AR) from 1.174 million in July, revised from 1.168 million. That followed an 11.4% June decline to 1.177 million, revised from 1.158 million. A rise to 1.240 million starts had been expected in the Action Economics Forecast Survey.

Starts of single-family homes increased 1.9% (-0.2% y/y) last month to 876,000 units following a 1.1% July rise to 860,000. Starts of multi-family units surged 29.3% (38.1% y/y) to 406,000, the highest level since March. (…)

Building permits declined 5.7% last month (-5.5% y/y) to 1.229 million units following a 0.9% July rise. It was the lowest level of permits since May 2017. Single-family permits were off 6.1% (+2.1% y/y) to 820,000, the lowest level in twelve months. Permits to build multi-family homes dropped 4.9% (-17.7% y/y) to 409,000, the lowest level since March 2016.

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Given the weakness in permits, nothing to write home about.

ATA Truck Tonnage Index Fell 1.8% in August

Thanks Craig.

American Trucking Associations’ advanced seasonally adjusted (SA) For-Hire Truck Tonnage Index decreased 1.8% in August after increasing 1.9% in July. In August, the index equaled 112.9 (2015=100), down from 115 in July. (…)

Compared with August 2017, the SA index rose 4.5%, down from July’s 8.6% year-over-year increase. Year-to-date, compared with the same period last year, tonnage increased 7.6%, far outpacing the annual gain of 3.8% in 2017. (…)

Ed Yardeni plots the 3-m m.a. in YoY against GDP. Momentum has peaked out.

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But another burst may be coming:

BOOM-BUST
China Races to Get Goods to the U.S. Before Tariffs Hit

At sea and in the sky, the U.S. president’s trade war with China has ignited a freight frenzy. Hyundai Merchant Marine Co.’s vessels leaving China for the U.S. are full, deliveries to California ports are surging, and cargo rates for journeys across the Pacific are at a four-year high.

The levies that kick in Monday have amplified the busy pre-holiday season as Chinese manufacturers rush everything from toys to bikes to car parts into American stores before tariffs hit. At Air China Ltd., freight to the U.S. is booming.

Starting Monday, a 10 percent duty applies to $200 billion of Chinese imports — Trump’s biggest salvo yet in a trade war between the world’s largest economies that now directly hits U.S. consumers. After that, American importers have until the end of the year to stockpile Chinese products before the tariff leaps to 25 percent. (…)

China Plans Broad Import Tax Cut as Soon as October

China is planning to cut the average tariff rates on imports from the majority of its trading partners as soon as next month, two people familiar with the matter said, in a move that will lower costs for consumers as a trade war with the U.S. deepens. (…)

The move comes as the nation is trying to stimulate domestic consumption to support a slowing economy, and follows similar cuts to tariffs in July on a wide range of consumer goods. (…)

Wages Are Growing: Should Investors Worry?

(…) The August [payroll] report, however, raises the possibility that Goldilocks is leaving the building.

“The current pace of job gains, coupled with a multi-decade low in unemployment claims, is more than sufficient to keep the unemployment rate trending down—which means wage pressures should intensify,” says Schwab chief investment strategist Liz Ann Sonders.

Evidence of the upward pressure on wages can be found in the National Federation of Independent Business (NFIB) survey for August. It showed that a large chunk of small businesses are reporting higher worker compensation, and the share of small businesses planning to boost pay in the next three months is at a historically strong 21%. (…)

The jury is still out on wages in spite of the continued strength in the labor market and increasingly widespread shortages. The NFIB survey covers mainly very small businesses. The various Fed districts do their own surveys summed up in the monthly Fed Beige Book. Here’s what came out of the recent Being Book covering the month of August. I also include salient comments on prices and tariffs.

BOSTON
  • wage increases were mixed
  • Prices were reported to be unchanged or up slightly
  • Most contacts noted the tariff issue but said that, so far, the effects have been small and they did not expect too much damage if they are expanded.
NEW YORK
  • wage pressures remain fairly widespread, though they have not intensified. Fewer businesses indicated planned wage increases than had been the case in recent months.
  • tariffs were driving up costs, particularly in the manufacturing sector.
  • As for selling prices, however, fewer businesses than in recent months said they were raising their prices—particularly in the wholesale trade sector. A number of wholesale trade and transportation contacts said they planned to hike prices in the months ahead.
PHILADELPHIA
  • wage growth continued at a moderate pace. Once again, over half of the nonmanufacturing contacts reported increases in wage and benefit costs. Staffing firms reported no dramatic changes in wage trends; even in labor markets with the District’s lowest unemployment rates, wages were said to “continue to inch up.”
  • Price increases remained modest for most firms but were stronger for prices faced by manufacturers. Among nonmanufacturing firms, less than one-third reported
    increases for prices paid and for prices received – somewhat lower than in the prior period. One-third of the manufacturing firms continued to report increases in
    prices received for their own goods; however, more manufacturers paid higher prices this period, with nearly two-thirds noting increases. Bankers and other contacts
    cited labor shortages, wage pressures, and tariffs as concerns for spurring inflation, but none reported evidence of current inflation.
  • For those firms already impacted, contacts often cited double-digit price increases; some typical responses were that tariffs “have put us out of business” on certain products and “are a cloud on every facet of our business planning.”
CLEVELAND
  • Staffing levels and wages rose moderately during the reporting period in a similar fashion to rises in recent survey periods. Overall wage pressures were in line with the moderate trends seen so far in 2018
  • Both input prices and final selling prices continued to rise and anecdotes suggest price pressures were similar to those of the previous two survey periods. One retailer pointed out that the firm was beginning to see an increase in the firm’s costs because of import tariffs.
  • Final selling prices trended higher. Construction firms aggressively raised their prices to pass along higher materials costs. More than half of manufacturing contacts raised their prices for a fourth consecutive reporting period. Service-sector industries reported relatively more modest price increases as firms attempted to cover rising worker compensation costs.
RICHMOND
  • Wage increases remained modest, overall.
  • On balance, prices grew at a moderate rate since our previous report. According to our latest surveys, manufacturing input prices rose moderately and continued to
    outpace selling prices. Meanwhile, service sector firms indicated that both their prices paid and prices received grew at a moderate rate.
ATLANTA
  • Contacts continued to report that wage pressure was growing; however, increases greater than 2 to 3 percent remained targeted, rather than broad-based. In response,
    firms continued to approach compensation creatively (e.g., offer enhanced flexibility, use bonuses and other incentive pay, and offer profit sharing or other forms of temporary compensation that can be discontinued if necessary).
  • more ability to pass along these price increases than in the previous report. Anticipation of rising costs related to tariffs continued to contribute to vendor price increases for commodities. The Atlanta Fed’s Business Inflation Expectations (BIE) survey showed year-over-year unit costs were up 2.0 percent in August. Survey respondents indicated they expect unit costs to rise 2.1 percent over the next twelve months.
CHICAGO
  • Wage growth remained modest overall, with wage increases most likely to be reported for managerial, professional and technical, and production workers. Most firms reported rising benefits costs.
  • Prices rose modestly in July and early August, and contacts expected prices to continue to increase at that rate over the next 6 to 12 months.
ST LOUIS
  • Small business contacts highlighted the tight labor market as their main challenge, citing difficulties matching compensation and benefits that larger employers offer.
    Wages have increased modestly since the previous report. On net, 40 percent of survey respondents indicated that wages were higher or slightly higher than a year
    ago, and 39 percent reported increases in labor costs.
  • Prices have continued to increase modestly since the previous report. On net, 32 percent of business contacts reported that prices charged to consumers increased
    relative to a year ago, about the same share as three months prior.
  • On net, 33 percent of survey respondents indicated that costs were higher than the same time last year.
MINNEAPOLIS
  • Wage growth was moderate to strong since the last report. An ad hoc survey of Minnesota staffing firms found average wage growth of 3 percent to 5 percent, with similar expectations for the coming year.
  • Increasing entry-level wages from $11 to $13 “hasn’t had much of an impact in recruiting, but moving to over $15 has.” A North Dakota contact said wages for entry-level office jobs have risen from $12 to $14 over the past year, while those for entry-level forklift operators have gone from $14 to $16 or more
  • Price pressures increased moderately relative to the previous report.
KANSAS CITY
  • Wages rose modestly in most sectors, and moderate wage growth was expected in the coming months.
  • Input and selling prices rose in most sectors in late July and August, and additional increases were anticipated moving forward. Selling prices in the retail sector increased
    moderately compared to the previous survey period, while input prices rose robustly.
DALLAS
  • Wage pressures remained elevated, with more than 60 percent of firms saying they were increasing wages and/or benefits to recruit and retain employees. Upstream
    energy firms reported significant pressure to raise wages in the Permian Basin despite flattening of the rig count, and midstream and downstream energy companies also
    cited rising wage pressures, particularly for personnel with less than five years of experience. A transportation services firm was offering up to $15,000 in multi-year
    sign-on bonuses in some areas. Retailers noted difficulty filling lower-level positions, with several contacts reporting starting wages of $15-$16 per hour to remain competitive.
  • Nearly 60 percent of firms said they were unable to pass higher labor costs to customers through price increases.
  • Price pressures remained elevated in part due to tariffs, although they did ease slightly over the reporting period in manufacturing and retail. Price pressures were little
    changed in the service sector. Firms’ ability to pass on higher costs to customers was limited, although a few did mention plans to raise prices in the near term.
SAN FRANCISCO
  • Wage growth ticked up broadly, and some businesses increased benefits in response to more labor retention challenges.
  • Price inflation increased moderately over the reporting period.

With the exception of the Dallas and SF Feds’ surveys, indications are that wages and labor costs are not taking off, nor are selling prices. However, input costs are rising in manufacturing with limited pass through so far. Tariffs were not broadly cited as adversely impacting with the exceptions of steel and aluminum users.

Overall, the August Beige Book raises no loud bells on wages, inflation and profit margins. Same with recent PMI surveys.

So, why this?

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Here’s a clue:

Source: Deutsche Bank Research (via The Daily Shot)

Another factor may be that we have just passed the date when corporations could contribute to their pension fund and tax deduct at their 2017 tax rate.

30’s are now 3.20%. Jeff Gundlach says a close above 3.25% is “a game changer”.

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Julien Brigden: Since 1985 the 100 month moving average has held the bull trend. We have NEVER closed above. It’s now at 3.2169%.

Trump: “The OPEC Monopoly Must Get Prices Down Now!”
OECD Sees Trade Tensions Hindering Global Growth “It’s not the end of the recovery, but the risks are piling up,” says chief economist

The Paris-based research body slightly lowered its targets for global growth Thursday, saying it now expects output to rise by 3.7% in each of 2018 and 2019. In May, it had expected output to grow by 3.8% this year and 3.9% next. (…)

Alibaba’s Ma Recants Promise to Create One Million U.S. Jobs Chinese technology tycoon Jack Ma is recanting his promise to create one million jobs in the U.S., citing the trade spat between the world’s two biggest economies.
Calpers Looks to China for a New Chief of Investment An official with China’s foreign-exchange regulator is the lead candidate to become next investment chief of the largest U.S. public pension fund.
Oaktree’s Marks says Brexit makes UK too risky to invest in ‘So far no good’, says billionaire investor on progress for a deal on leaving the EU

(…) “We don’t tend to play where the probability distribution is extremely wide, or where the left hand tail goes way, way, way down” because dreadful outcomes cannot be ruled out, he said. “And Britain is that place.” (…)