Jerome K Wiley?

We do think Powell is running off a cliff, just not the one the market assumes. As we endured the wettest February since (at least) 1836, when William Lamb was prime minister, and the wettest Tory government since records began, is there any chance of dryer times?

But first the tiresome tango of rate rises, the market swept to and fro, nation by nation, until the firm stamp of a well-heeled bond whips the whole mass back round again.

Bailey of the BoE, and Powell of the Fed

So, this week it is to be Bailey first out the gate, FTSE up, bond yields down, next week who knows? That rates will fall this year is the only certainty and the big US markets have built a near vertical climb out of that snippet. But you will note, not in rate sensitive stocks, the Russell (small cap) is still pretty flat, weighed down by the regional banks that dominate it.

And Powell, he’s guessing or as he calls it is “data dependent”, but for all that he is pretty happy projecting those guesses forward. So, he has moved from three rate cuts this year, to a new position of ?  Well - three rate cuts this year. Not much data dependency there.

Before long he will run out of “this year”, because the inflation numbers are not behaving, nor critically is the oil price.  Like Bailey in the UK, he is desperate to cut and under heavy political pressure to do so, both have said 2% inflation is not now needed, just moves in the right direction.

I feel the only thing that can get us there is a sudden (and indeed overdue) drop in the energy price, which we do expect in the summer, but who knows? It has held up rather well so far.

So, at the moment, Powell is perhaps  running on thin air. Protectionism and vote buying fiscal measures mean he can’t get there without some other help.

Markets are supercharged – is it sustainable though?

And if rate cuts are what has supercharged markets in the US, I don’t see that as sustainable right through the year. It might instead be the possibility of a more market friendly, fiscally prudent, Trump, which would be more logical, in some ways; but that still feels implausible.

Nor do I see, as yet, many other markets joining in. Partly, why own anything else but the NASDAQ? Some markets have moved (Germany, Japan) but you could also argue that was after being oversold for too long. While the Swiss have cut rates, it is in part (as ever) to restrain their currency, I am less sure others will want to move ahead of the US.

They may be forced to, but there again their scope before European and UK elections looks limited. And some parts of the market, like UK smaller companies and many REITs (and some renewables) are not signalling anything but yet more damage and destruction, from suspect refinancing at high rates and over optimism on revenue.

Air Cushions

It was notable too how keen Powell is to slow the tightening imposed by reducing the Federal Reserve bond holdings, which has to date been done at a fairly brisk pace. He now talks of stabilising holdings, (in other words resuming bond buying, stopping the runoff of expired holdings) at what seems a high level, for fear of taking too much liquidity out of the system.

Periods of quantitative easing and quantitative tightening of the US federal reserve

From this explanatory article on the process by the Richmond Fed.

For a while rates and reserve sales were working as one against inflation, but not for much longer it seems. Which should be good for bitcoin and other liquidity consuming monsters, if nothing else.

Who is Next in the UK?

The interesting Tory battle is between the Official wing, now entrenched in power, and showing no sign of intelligent life, beyond wanting to “make a good fist of it” in the inevitable electoral defeat. Then there is the Rebel wing, keen to cause trouble, break things, get popular support, or be nasty, if it gets them attention. Although the Official wing regards this as disloyal, it follows an old pattern. It is not just about this particular bunch: see this paper.

Faced with a like quandary under Blair, the Tory party swung left, towards the centre and power, just as Gordon Brown started the decade long Labour march to irrelevance. The Official assumption is that will work again, although the alternative scenario is that Starmer settles down in the centre for the long haul, and the Rebel wing, kept securely away from power, withers for lack of a structure.

But all ruling parties were, by definition, rebels once.

Back in 1836, William Lamb was an unsuccessful politician, wrapped around by Peel, sent to the House of Lords, then brought back as a centrist Prime Minister, and being generally useless, was turfed out again, after naming an Australian city, en route. One must hope for no repeats from history.

William Lamb, Lord Melbourne – from this site

It does not feel time for compromise candidates, nor will a ‘safe pair of hands’ do. Rishi is in a fight.

Meanwhile the fields here feel like salt marshes, dark water lurking in deep cracks, the lips of which slide into clay and suck at the soles of your feet. We certainly could do with some heat.

I do expect this run in markets to go on, but the upside in the big US indices looks more limited and broader participation elsewhere will await those rate cuts. Both their size and speed have a capacity to disappoint, especially when they are so hotly anticipated.

The politics, a long time coming, may become more influential. It could get choppy.

We will take an Easter break, after what feels like a long spring.

And return with the sun (we hope) on 14th April.

 


a hand shuffling cards, with a background of a graph showing stock market movements

Sleight of Hand

This week, we speculate as to what the FCA is really after in their Practitioner Survey.  How closely do their actions follow their words, with the new Consumer Duty laws? And we also look at Hunt’s budget and the likely forthcoming non-impact on stock markets.

FED UP FEEDBACK

Periodically member firms get quizzed on how we see the FCA; this time they promised a shorter form. Well, if that’s shorter, I’d hate to see the long one. Take a look here. Thirty-nine questions, but so many cover multiple topics, it feels more like a hundred.

It is typical of such surveys designed by marketing advisors: a few soft questions, how are you today type guff, a few “have you stopped beating your wife” ones, just to check you are actually awake, then a lot of navel gazing on SICGO. They really despise it.

This is purportedly about promoting competition. Which actually makes the regulator’s job harder – encouraging more firms and lowering the barriers to entry for new firms.  The FCA does not like that idea much; so, note, it is a SECONDARY International Competitiveness and Growth OBJECTIVE, get the Secondary stress, minor, icing on the cake stuff. Objective, so just an aspiration, not real. Their minutes (above) even admit that.

Then we have more ‘are you happy questions’, then some tiresome back scratching ones, just how great are we at seminars? answering the phone? sending you flowers? You get the picture.

Then a few global ones, how good are we at promoting world peace and intergalactic harmony? By this stage you are probably wondering what this is, I am. And the idea creeps in that it is nothing to do with the poor regulated mugs, anyhow. So probably not much to do with the consumer either.

Meanwhile I see a landscape of poor consumer outcomes, vast sales driven peddlers of half-truths, a fair bit of market abuse, absurd barriers to entry, the insiders and regulators getting fat, the savers, investors and users of capital paying for it all.

NEW LAW OLD RULES

They also published “A new Consumer Duty Feedback to CP21/36 and final rules” more terribly exciting stuff, a mere 70 pages of it. They make much of the “Risk of Retrospection”, saying “we were clear that the Duty would not have retrospective effect and would not apply to past actions by firms”.

OK, this is a key political input; the industry has had enough of new rules, looking back. So, I take it that we won’t see big attacks on UK listed finance firms this time?

Not so, you guessed it, the entire financial sector is suddenly seeing bigger provisions, because, it seems, of the new rules. It looks very much like the damaging hits on SJP Close, Lloyds, are exactly this, retrospective application of laws, an action so vociferously foresworn by the regulator.

And this helps competition how? Well not at all. But do remember it is a secondary aim and applies only to “competition in the interests of consumers” so not real competition, but one where the mechanism (competition) and the outcome (interests of consumers) get muddled up.

So, for instance destroying UK financial services firms is fine if done “in the interests of consumer” and what could be more in their ‘interests’ than getting money back on a contract they willingly (and legally) signed ten years ago?

And that’s why choice and consumer outcomes are being lost in box ticking and adverts of fluffy kittens, sunsets on beaches and the like. Just look at the UK ISA advertisements, do they tell you anything? Beyond heavy hints at nirvana with no work.

HUNT’S LAST HURRAH

The budget? Well, it is so dull, you feel it is simply what the HMRC nerds wanted. More complexity, a few free hits (non doms), more CGT breaks for landlords, for the rentiers not the creators, less employee NI, but no change to employer NI, that actual tax on jobs remains as harsh as ever.

We are well into Q1 now, so I guess the intriguing thing is more this firm Treasury conviction, adopted by the OBR, that inflation will fall towards 2% in Q2. Given their prior errors, that is very bullish, and does not support base rates at 5.25%, frankly not even at 3.25%.

It is all circular, despite commentators’ child-like obsession with margins for error. If inflation stays high, tax raised stays higher, covering higher public sector spend. So low inflation is (oddly) a cautious model prediction.

The market does not believe it. Nor do we. Not quite chapeau consumption time, but I don’t see 2% this year. I am not sure where this recession is, but not in any of the streets I walk down.

If interest rates are really about to fall off a cliff, the FTSE looks oddly stuck, miles behind the US indices, and sterling also looks curiously strong. If saving rates are about to be pummelled, the yield stocks that fill the FTSE will suddenly look very cheap. Which suggests the markets are not buying it, not yet.

A 500-point rally might even be plausible, if the OBR is right, but it is not, and talk of headroom is nonsense. This remains an expansionist fiscal mind set, but of quite limited duration, hence the market caution.

Elsewhere we are in ‘riding-the-tiger’ time: if you are onboard, how and when do you get off it?


DREAMERS

What would Trump’s high tariff isolationist world look like? What would the mirror image be in Xi’s China? Not now, not next week, but rolling into the next decade.

And whatever portfolio theory says, and whatever the optimistic investor believes, 80% of my own portfolio is flotsam, drifting up and down on Pacific tides. Stocks I both like and which have compounded over decades are remarkably few. Oh, and a brief word on African housing.

GOING IT ALONE

But first, to give it the grand name, autarchy, or self-sufficiency. A bit of a joke - the Soviet Union tried it, Iran tries it, China famously only revived after ditching it.

But it is back in fashion, and not just in strange places. The EU industrial and agricultural policy is starting to look like a version; beyond their four walls they need carbon and chemicals, but within them they don’t, nor will they allow imports of them (or products including them). Quite fantastic.

Trump is on his 60% tariffs line. Xi clearly wants to cut off foreign capital, as it arrives infected with democracy and transparency, and the associated foreign reporting or verification.

So, could they? Yes, the US could - it is big enough, can do most things, and largely trades internally. While at least in Trump’s imagination the commercial borders are sealed, and so enforceable.

What goes wrong? Well at some, quite distant, point people stop expecting to trade with the US. So, at its most extreme, if China can’t sell to the US, it won’t buy from them either. But that is decades away, most Chinese production can probably take a 300% tariff, and still sell at a profit.

The flip side of the tariff is the huge salary for a barista, or a trucker. The latter is not so far away. Prices of domestic US production must rise, to allow the blue-collar Mid-West to rejuvenate. US consumers of course (including that barista) will pay vastly more for US goods, or will get hit with the import tariff; this of course is a tax on them.

Source: Statista

What about Xi? Well again it is possible - that’s how China ran for much of his life, with a lot of new infrastructure, industrialization, since installed. He can do it all again. There, unlike in the US, the issue is capital. As a big net exporter, an area that will itself be under pressure, money will be harder to find; it already is.

 

THE NIGHTMARE

Countries that go through this closing cycle typically also do default (as the Soviets did, as US (and UK) railways did,). Folly, but it can be done.

The US has been going down this route since Obama, Trump talked a lot about it, but Biden too sees the resulting wage inflation as a good thing. So, it is the next US President’s policy either way.

Obama was keen on hitting capital markets (FATCA was and remains both a non-tariff barrier (I am being polite here) and a tariff on external capital) and I suspect a Biden administration must do the same, to balance the books.

While Xi never really left protectionism, WTO and GATT were mainly honoured in the breach.

And Europe? There is quite a strong strategic need to expand to the East, although as that goes through (and we are talking the mid 2030’s here) Ukrainian farmers, like Polish farmers today, will buckle under the rules; it barely matters about the Donbas, the EU will shut those heavy industries down too.

So, I think autarchy can work for all three, it will support a large uncompetitive labour force, and consumer choice will vanish. In many cases there will be lower quality and high prices. All three will attack (or in some cases keep attacking) capital flows.

And in the end, the entrepots will survive, those not in any such block, like the UAE or Singapore today, Amsterdam in the 17th Century, Yemen under the Romans and Victorian Britain.

The winners will be flexible, a tad amoral, assertive, in fluid alliances, but reliant on gold not steel to survive. And they will suck in entrepreneurial talent too. At a strategic level, that feels the place to be looking. Although buying uncompetitive heavy industries before their brief period of tariff induced profitability, has a short-term allure.

 

DOGS OR GREYHOUNDS ?

The ludicrous halving of CGT allowances, based on some fantasy “yield” number from the equally ludicrous HMRC, via the OBR, means once again the tiresome process of harvesting losses is upon us. No longer can they sit unloved at the back, snoozing; out they must come.

And what a tale of dross they reveal, and scattered amongst them so many once “good ideas” and busted yield stocks. Well, it sticks in the throat, but perhaps sticking it in a US wonder stock for six months is better?

Of course, if I knew when I acquired them that the FTSE was moribund for two decades, I would never have bothered. Seems it is time to simplify.

 

COLLATERAL

And lastly African housing. It was one of Gordon Brown’s (and the PRA’s) great achievements to get UK banks out of overseas assets, far too volatile, currency? foreigners?- Who needs them? Bring it all home and inflate the UK housing market with safe, cheap, mortgages.

So, Citizens went, Barclays were hounded out of South Africa, and so on – although their post-sale performance has really not been great either. Africa now just does not have proper mortgage financing for the vast bulk of the population. This is at a level I had failed to fully comprehend.

You think that despite everything, Africa must have got better. But no housing, so less health, less stability, no financial security. Safe recycling of profits in the continent is still hard. Aid can’t create institutional reform, but that’s the need.

If you look for the breakout into developed status, it starts there.

 

 

 

 


The Glass Bead Game

We look today at a domestic version of a complex, rulebound meaningless pursuit that too many of our brightest and best waste their lives pursuing, and whose twists and spirals ultimately signify nothing.  I mean the UK Office of Budget Responsibility (OBR), of which I took a tour this week. Almost nothing there is as it seems.

Meanwhile markets reprise 2023, with tech or bust once more. Although tech and bust is the market fear, as fiscal stimulus and services inflation hold rates too high for some to survive.

 

UK OBR

The OBR was an explicitly political creation of the coalition government in 2010, with a remit to somehow restrain the ever-increasing debt governments take on, to bribe electors. They were also keeping half an eye on the much older ‘debt ceiling’ style US legislation. It failed; so now the OBR just thrives on telling the government how much more it can spend or not collect, with spurious accuracy; purportedly managing public money.

It doesn’t forecast anything as a forecast is an expected outturn. All it does is crank the handle on the old, discredited Treasury model, creating projections. A projection is 1) a ‘what if’ assuming all other things are equal and 2) only as good as its underlying model.

One clear flaw is the requirement to take government spending plans as viable when they are usually not. They also have no idea where public sector productivity is heading. It has no remit to look at how productivity might be helped and no capacity to look back at how wrong its old ‘forecasts’ were. That is the job of the National Audit Office, it seems.

It also won’t talk to the Bank of England, as that organization has executive powers (to raise or lower rates) and the OBR apparently must just be a commentator: more glass bead rules.

So, it fiddles with the model and its six hundred inputs and countless equations to give precise answers to pointless questions, because each answer sits in its own vacuum.

There’s a heavy focus too on tax revenue, but with quite a thin staff, this results in excessive reliance on HMRC, who can be hopelessly wrong (and typically over optimistic on tax yields). But again, if the tax bods claim some complex, job destroying, arcane nonsense will raise income, in it goes. The side effects of such decisions must also be ignored.

It has no remit to assess how taxes impact productivity, which partly explains many of Hunt’s blatantly anti-growth measures. As a result, the economy is locked into low productivity, getting steadily worse.

From the ONS flash report here

 

For all that the financial press will be full of the OBR cogitations on the forthcoming budget (March 6th). One little bit of power they do have involves a requirement for the Chancellor to give ten days’ notice of the budget contents (hence no doubt the usual leakage levels) and for two months before that, they sift through proposals and indicate how each, in isolation, would work. The economy is an interconnected entity, they know, yet there is no attempt to give us an overall view.

 

THE LOST RALLY

I have few rational reasons why anyone would lend the UK Government at under 4% for ten years, were it not for some foolish faith in the OBR projections, without reading the small print.

Which brings us to markets: back in November the UK ten-year gilt yielded 4.5%, by about Christmas falling to 3.5%, and now it is back over 4% and headed higher.

Chart from this website

Quite a spin in ten weeks for a ten-year duration instrument. This is why that Christmas rally in value stocks was ignited, and indeed started to push out into Real Estate, various Alternatives and certain smaller stocks.

Although it didn’t move those stocks most sensitive to the credit markets, who will need to rollover/refinance current debt. This affects for example, the renewables, private equity, and office property. The problem there is of both rates and availability. With the scale of asset mark downs, whether interest is 6% or 8% is not the issue; there is no funding appetite even at 20%.

The year-end rally moved a wide group of stocks, from extremely cheap to still very cheap. We then realized that it was not yet safe to go back in, so buyers evaporated, and prices faded. With state debt at 4%, against persistent inflation, fixed income is also oddly unenticing. So, the market default has been to pile back into the biggest, most liquid, US tech stocks and similar easy-in/easy-out momentum trades, like bitcoin.

There is little sign of deflation in services, no evidence of it in housing, where supply issues dominate, and little in financial services; indeed, all the supply side mess of COVID and excess regulation, is simply getting worse. Public sector pay inflation is also high and going higher (don’t tell the OBR).

This does not dent the 2024 story of cutting rates and hence higher stock markets, but it may require some patience, and that delay may itself create more pain.

 

The Glass Bead Game and the ‘lost marbles’ qualification for office

Our games of self deception are not to be confused with lost marbles of course; it turns out that the onset of senility is now a bar to being prosecuted for storing secret state papers and also, somehow, a recommendation for re-election for four more years, to the most powerful post in the world.

If that ends up giving us Trump again, by default, presumably he will at least have a defense in future years, against those same crimes? He does not have the “Biden defense” available at present, perhaps thankfully.

As the OBR shows, very clever institutions can come up with very silly solutions.

 

 


Good intentions

Two quite technical topics this week, hinged on the persistence of old viewpoints on current markets: pricing in UK stock markets, and China, and how we might look into emerging market funds. Plenty of good regulatory intentions, but rather less than welcome outcomes.

 

FIXED ODDS

Little in the debate on UK markets has looked at the major role played by an increasingly poorly performing small UK bank, Close Bros. Even when it was doing well, it felt odd to have a vital market role being undertaken in a backwater, but as its capitalisation dwindles, the core task of equity market maker, which it provides, seems oddly misplaced.

In smaller UK stocks, we therefore still have a ring holder who, it is said aligns buyers and sellers’ interests. Not mine.

Given the fortunes at the disposal of state banks or indeed the London Stock Exchange, why is Winterflood (a part of Close Brothers) still trying to provide this vital service in the style of an old-fashioned bookie?

It matters greatly, because in many UK stocks and investment trusts, the wide bid offer spreads make dealing almost impossible. If you are eking out a high single figure return, and in these markets not doing badly to do so, Close Brothers scooping 10% off a single trade, in the bid offer spread, is pretty lethal.

With them restricting trade, liquidity disappears, without liquidity so does price discovery, and it is not a stock market any more.

Close has itself also suffered a number of hits lately. It is a hotch potch of old merchant banking activities, along with an expensively acquired asset management business, plus a shocking venture into litigation funding that might ultimately (it is itself a matter for litigation) cost almost as much as they paid for it.

While just lately the FCA has been asking (dear CEO
) about insurance premium finance, oh, and Close has a lot of motor finance too, an area of recent expansion, but also another hot spot for the FCA, after issues on commission. The latter Close has known about for a while, it was a disclosed risk in their last accounts.

All places where margins are quite high, perhaps in the view of the FCA too high.

 

A screenshot of a section of Close Brother's website

From: Close brothers website – section on ‘who we are’ - their business model.

Given the lack of any announcements, the 40% share price decline in Close (CBG) over six months, to levels seen just after the GFC, is remarkable. Perhaps this benign graphic is not quite the whole picture?

Premium financing is ironically a good business, because the FCA’s wide and unpredictable view of its own remit makes financial services insurance premiums rather high, but that’s another story.

And market making is run as a bookie, not as a market utility. Winterflood itself can be taking a long or short position. So, investors must fathom both the share price, and which way their market maker is facing. In big stocks with lots of choices that’s all fine and pretty transparent. But in small ones, they can look (and behave) like the only game in town.

And it looks as if last year, they possibly went too short in the autumn. So, when the market turned on a dime in November, a fair bit of short covering took place, prices leapt, in places by over 20% and spreads opened out. And market size dwindled to penny packets.

It matters how? Well, you can get ripped off to deal in smaller UK stocks, where smaller is up to about £300m, and the price can be “wrong”, volatility increases, and liquidity goes. Do companies or investors like any of that? Nope.

It is notable that their trading profits in this area seem to far exceed both their gross (long and short) and net (long less short) positions.

Every big company was small once, and if you choke off the supply you get an ossified market, like the current moribund main FTSE index.

Perhaps the FCA could start to look more at best execution and market depth, and less at arcane ways to double count costs, or ‘protect’ those trying to enter the primary market from strict rules. This interview with Witan makes a reasonable case for looking after the secondary market first, not just the big IPO’s, with their juicy listing fees.

Investor protection is about investors making money, not about them losing it as cheaply as possible.

CHINESE BURNS

After our piece last time, we have been looking at Emerging Market funds ex China, because far from being the great hope of EM investors, China (and not just the PRC, but also Hong Kong) has become the rock that shatters fragile performance.

The role of benchmarking

There are several structural problems in EM funds, one is the role of benchmarking. A good idea at one time, it allows investors to compare performance to something specific. But it has become quite expensive (guess who pays?), as benchmarks don’t come cheap, if you now have to have them.

It also rather neatly points out to investors, when an index fund might do a better job than active managers, and worst of all, especially with the oddly amateur directors of most UK investment companies, leaves them ‘hugging’ or enslaved, to the benchmark. For good reasons in one sense (you don’t get fired for just about beating the benchmark) but for bad in others (all the funds are boringly similar). They just make the same mistakes together. And a beaten benchmark, that is itself falling, means the investor still suffers losses. I have yet to meet an investor that liked those.

The impact is both direct, so you can’t find India funds without Reliance Industries (the biggest stock), for example, and indirectly so as to “generate alpha” funds take bigger risks within a market, rather than have a below benchmark position in that market, even if all their analysis says they should just quit that particular town. Which is why funds find reasons to linger in bad neighbourhoods.

Another bias that hits the EM sector (which for a decade now has flattered to deceive) is that their stock analysis is focused on stocks they have held, while the investor wants to hear about stocks they should hold.

So, a fund manager typically gives a detailed list of analysts and companies followed by their firm, and it is full of what looked sensible when all those analysts were hired. So, in EM, there are stacks of China analysts, of organisations based in Singapore (the preferred offshore China centre, after Hong Kong got too hot), hundreds (if not thousands) of Chinese stocks covered, but all the buying is now into India. With quite nominal stock coverage; and hardly anyone based in the country.

Just as to a hammer, every problem is a nail, so to those EM analysts every opportunity is in China. Until outfits like Janus Henderson and Templeton stop having toolkits full of hammers, they won’t be able to stop breaking investors’ hearts with China. Nor will investors realise quite how much this infects their performance.

This will slowly correct, but small funds that can exit China totally in a week, and have a global remit, with no equity benchmark, dare I say it, have quite an edge.

It is a vast and nuanced space, Lazards provides a good overview.

And it is not just EM specialists, we looked at Ruffer of late, it has got broken China littered amongst its portfolios.

So, we worry that the Christmas rally looked broad based, because of a bear squeeze over a range of stocks, that then reversed with early January selling, based rather more on fundamentals. In which case 2024, so far, is in danger of looking more like 2023, less like the cyclical turning point many hope for. We do see earnings falling, of course and then ultimately rate cuts rescuing valuations. But ultimately may be quite a while.