Not what it seems?
Housing, China and Big Tech â all are regarded as âun-investableâ - ending last year the above three sectors were all under a cloud, but one broke free, why?
Plus, Powell scares the market by thinking too loudly.
HOUSE PRICES
Well letâs start with housing. UK residential property prices are holding up fairly well given the magnitude of rate rises, while UK housebuilder share prices look fairly awful. There is a confusing mix of income and capital issues to examine.
Housing itself holds up well â many reasons: demand of course, high levels of employment, heavy net migration and the normal new household formation provide a base demand level well above new build levels. At a time when it is unattractive to fund speculative new build (so units not pre-sold before commencement) because of finance charges, and with a planning system that is both over prescriptive and under resourced, supply will stay slow.
So, the logic of fairly steady prices for existing housing stock holds, buyers will need more cash, but with (in real terms) falling house prices, that can be done. It moves funds from (largely UK) borrowers to (largely UK) savers, but leaves total disposal income in the country (after HMRC takes a cut) largely unaltered.
While rising rentals, reflecting pent up demand and the pressure on debt funded landlords, adds to new build demand and provokes more supply at the institutional level, at least. So, we donât see a price crash (however desirable in some areas) at these levels.
So why then are housebuilders so disliked? Sales of houses will indeed slow, so reducing dividend cover, but the core business itself is fine and the capital value holds steady, albeit discounted by more.
CHINA TRAPS
China? Here we have almost the same issue, fundamentally sound, but politically hard to justify investment. That taint spreads to companies that sell into China too. It is very hard to ignore this vast market, and the undoubted speed of innovation and high productivity of a command economy. When so many other places fall back, China is tempting.
China has the size, finance skills and levers to deliberately act counter-cyclically, stepping out of sync with the global economy. So (on that narrative) it has ducked the blight of post COVID reopening inflation, by a deliberately slow exit, stockpiling commodities, and then stepping out of the market to defuse price spikes.
Arguably even with foreign capital, it was happy to load up when it was cheap with few restrictions, on both equity and debt, but equally happy to step back when prices and restrictions start to apply. Choice or circumstance? In an opaque system who really knows. . . But a China slowdown is not the same in type or duration as a free market one.
Like housebuilders it remains uninvestable, but for all that, there is value.
MEGA CAP VALUATIONS
So, to the third of the trinity, large cap tech. These are all US based, highly profitable, with not a lot of debt, but typically appear overvalued. In the old free money days, fast growing tech was enough, so the layer just below, also profitable, simply fed off the reflected glory of the mega caps, and so on all the way down to the start-ups and chronic loss makers. That link has broken, values are now about both size and sector. This is odd. Normally if you broke (say) Microsoft into ten equal parts the total value would go up. This year suggests it would now fall.
So, what are investors doing, if they are ignoring fundamentals? It seems the cash generating highly liquid stocks do enjoy excess market demand in tough times. Some of it is momentum following, some is a falling share count, but mainly it seems investors just really like the name recognition and deep liquidity, to trade the market.
From this website.
If so, it may be dangerous to write this group off. In a market going sideways they provide the price action, and it seems they are so big, so well entrenched and global, that the typical stock specific risk can almost be ignored. You need to be nimble; they fell hard in 2022, but their dominant recovery this year, providing nearly all of global equity performance might be the true reversion to the mean, rather than their sudden collapse when everything was being sold off last year. But that process does guarantee future volatility for them too, and history suggests it will not last.
DECLINE AND FAIL
We have nothing to add on what seems a be a new set of forever wars, beyond sadness and dismay. While whoever wins the 2024 elections on either side of the Atlantic, will be forced to do an âErdogan turnâ, or 360 spin. This could happen fairly soon after the polls close.
WHAT POWELL SAID
The markets seem not to like Jerome Powellâs musings on the vast range of things he does not know, at The Economic Club in New York this week. Does his calendar suddenly show his exit date, albeit over two years away? You could almost hear the soft polish of his resume to concede errors and some failed guesses. He even, twice, called US fiscal policy âunsustainableâ although he was careful to say that was not now, but only in the future (after heâs left office that is.)
But the long run neutral rate? No idea. The Philipps Curve? No idea. Interest rate transmission rates? No idea. Thatâs not new, though - it is pretty much what âData Dependentâ always has meant, and markets were previously fine with that.
We will know soon enough, if rates are still rising globally. It certainly makes markets jittery, especially on Friday afternoons.
Sweet Dreams
Here we talk about the delights of the Conservative Party Conference in rainy Manchester, the failure of the in-built two-year time horizon in inflation models, and what may happen to interest rates.
FANTASY IN BLUE
At times in Manchester, it felt like everyone was looking for something. As government steps up spending initiatives, and empowers regional governance, and drives big spending on not achieving net zero, the chorus of demands for more taxpayersâ cash grew deafening.
There was utter silence on efficiency or capital allocation; it was all just âa good thingâ to spend more.
And oddly too, with so much lip service to the long term and reducing debt and halving inflation, the âhowâ of those was also ignored. Surely halving inflation is not even a government task? It was devolved to Bailey of the Bank - yet we heard not a word of criticism. If ever an eight-year commitment to a disastrously run project needed cancelling, his appointment looks to be just that.
This would spare him (and us) those endless letters on why heâs failing to control inflation.
For all that Conference was oddly cheerful - quite a bit of steel on show, from Suella of course, the only natural politician involved - some guts from Steve Barclay at Health, and Stride, a little less convincingly, at work and pensions - else, all rather wooden and on autocue. Although you could not help but notice that Farage still charms the fringe crowds.
COMPETENT DELIVERY?
The abiding issue remains competent delivery. It was odd to hear the government on HS2 arguing for accountability by sacking their own Euston delivery team. As if the failure of HS2 is not theirs, and theirs alone.
Instead of penny packet incrementalism, government needs a holistic delivery view - perhaps why France can build a TGV, and we simply cannot.
From this report of the Institute for Government
The Maude/Osborne âreformsâ destroyed half our domestic contractors, by a short-term focus and ceaselessly moving the goalposts. As a result, home grown firms are in the minority on the HS2 contractor list, and giant multinationals with more lawyers than bulldozers were the main bidders.
They want top dollar to take on the risk of a lazy, indecisive government machine - no wonder.
THE CHANGE PRIME MINISTER?
We have been very clear since 2019, that the Tories canât win another term, none of that changes, but the scale and composition of the anti-Tory majority next year is rather less clear.
In many ways, the best case for a Labour defeat, at the next election, is that the Tories have done it all already. They have blown the bank on out-of-control spending, splurged on unaffordable welfare, and raised taxes to unsustainable levels.
From this website
This government also crashed the pound, let inflation loose, let rhetoric overtake sense and has gone in hock to foreign debtors. I suppose they have yet to invade a sovereign country without a UN mandate, but they are working on that too.
So? Well oddly Starmer is still slightly boxed in, and in terms of polling data, not really getting much help from the weak Lib Dems, in those critical three-way marginals in the South. While Scotland clearly has had enough of the SNP running Scotland, it is less clear that they donât want the cause of independence to be heard in London. The Rutherglen by-election could be sending both messages, but in a general election voters only send one. I would not assume that genie is back in the bottle just yet.
JITTERBUG BLUES
We continue to see US rates above inflation, which is very different from UK rates which are still below.
So exactly what Powell (and Bailey) are doing with selling down the Central Banks balance sheets at a time of maximum new issuance, is not clear; it solidifies vast paper losses, creates new losses on the rest, so seems to be quite a pricey warning shot to politicians. But it is a plausible reason (along with super high levels of new issuance) for current bond market nerves.
We have always felt the Central Bank models, where whatever the question the answer is âit will be fine in two yearsâ are a fiction. The awareness that rates and inflation are staying high, is long overdue. But we have been in no doubt about it, for two years, nor have we ever flinched in our aversion to bonds, we were never being paid enough for the risk.
The jitters in the bond market feel more like a turning point, the sudden chop as the tide turns. The dollar has risen; people want to be there; if there is enough demand, that will lower bond yields again. So, I am not looking at US rates rising, so much as at the battle switching back to fiscal policy. Although in the end if Biden really wants 7% rates, I guess he can try to have them.
The UK and Europe are less contested, the labour market in Europe at least is not that tight, although still at record low unemployment levels, but with a lot of surplus workers in France, Spain, and Italy, and especially amongst the young. Euro interest rates are also really quite low still and are not yet looking restrictive.
So, it looks like another round of softening currencies, stagnant inflation and rate rise pressure. Central Banks still hope they have done enough. Even so it is quite odd that UK long rates are only just touching the level of a year ago, logically they should be two points higher. As for oil, we have seen this autumnal spike as a little surprising but transient, and as ever at this time of year, the short-term path is weather related.
Overall if the start is any guide, October yet again could be rough for markets, but longer term still looks brighter.
By their works . . .
Well, the works this week: a pensive Jerome Powell does nothing, a reckless Andrew Bailey does nothing, Canada joins Biden in picking fights, and the bulk of most equity markets are stuck, going nowhere.
NO MORE US RISES
So, the apparently knowledgeable financial press said that Powell predicts rate rises? He said nothing of the sort of course. True the other members of the FOMC dot plots were in aggregate higher than the current rate, but by a fraction, it is like the average family being 2.4 children, meaning everyone, in the absence of King Solomon, has three children. No, it does not, it means on average there are no more rate rises.
So, Powell has stopped the runaway train, by lighting red flares in front of it and throwing railway sleepers across the track. Job done. Inflation is way below base rates. Bailey has asked nicely and tried to lasso the inflation express from half a mile down the track - wonât work. Inflation above base rates is misery, inflation below base rates is time to loosen.
Powell did start rambling, describing parts of the economy with âby their works ye shall know themâ but decided that was all a bit erudite, before he had even finished the thought. He then reverted to the old saw, âforecasters are a humble lot, (with much to be humble about)â. Presumably that is unlike Central Bankers? I still think that judging them by their works makes sense.
But Powell is happy: the Q&A session threw him a litany of gloom, government shut down, students having to repay debt, auto plant shut downs, but no, all is fine.
The core US consumer and therefore the US economy, is in a good place was his verdict.
BAILEY DITHERS
Bailey seems to like to crash the pound every October, which is not good for inflation, just as picking fights globally is not good for oil prices. And it is also bad for inflation.
And either the UK government will cave in to public sector strikes or productivity will keep falling due to said strikes. Neither are much good for the economy. Nor is it good for the markets: in performance terms, the UK remains the sick man of Europe, amongst major markets.
THE MAGNIFICENT SEVEN RIDE ON
I was at the annual Quality Growth conference in London again, a stock pickerâs feast as usual. It seems that if enough stock pickers can agree on the menu, as the dominant prevailing theory of investments, they will drive the prices of their favoured stocks ever higher. Which they do, it seems. This is helped by the âover the long run valuations donât matterâ line, pushed hard by Baillie Gifford (amongst others). You might recall my article on Scottish Mortgage a while back.
And of course, as we know from both index and momentum investing, once something starts to move in a flat market, it keeps moving.
But that leaves the vast bulk of quoted stocks flat or down on the year, which makes some sense. When rates rise, bonds are substituted for stocks. The last two quarters in particular have been flat to soft, and while some of these stocks may have hit a bottom, it is still very hard to tell.
The only good news for UK investors is that Andrew Bailey has ensured their overseas (especially US) stocks have a nice currency tailwind.
MADE IN JAPAN
Meanwhile from Comgest thereâs a radically different view of Japan. The equity rally there has been fantastic, but it is not the typical exporter boom of a weak yen, in their view, but more about bank stocks soaring on the expectation of the end of Central Bank rate control. This allows their vast balance sheets to earn a real return, at last. This is quite a departure from the general explanations about âthis is Japanâs timeâ. That one has caught me out far too often, but explains the horror show from respected funds like Baillie Gifford Shin Nippon - small and illiquid is just nasty everywhere.
So, although the global rally looks to be strong, it is terribly narrow, and built on different foundations in different places. Or more positively, a broad advance awaits the first rate cuts, either from triumph (US) having controlled inflation or disaster (Europe) having created a recession and left inflation out of control. Either route to rate cuts wins, it seems.
GLASSHOUSES AND THROWING STONES
Oddly, I feel the Canadian spat with India is really quite serious, the tendency of rich Northern countries to preach, in this case standing very carefully behind the only global superpowerâs shoulder, really annoys the global South. It has been going on for centuries and is at heart simply the old colonial mindset.
Indiaâs continuing reaction may well portray the accuracy (or otherwise) of the allegations, as on the face of it this is deeply insulting to the worldâs largest country, and one that has tiptoed down the line between offending the West and creating starvation and destitution for millions in the South.
I donât believe it - murdering virtuous plumbers in Canada over the Punjab, which has long ceased to be a primary source of domestic concern, is plain weird.
All things are possible, and India cares far more about Kashmiri terrorism (for instance), but if it is false, expect a sizable slap to Canadian interests, and more accommodation for Putin.
After all, if you are treated as if you are behaving like Putin, why would you ostracize him?
JENSEITS VON GUT UND BOSE
We ponder the point of the UK markets, ignore clashing BRICs, set up for the slow fall in interest rates in 2024, yes, long lags are long.
There are two investor markets, one akin to gambling and speculation, one allocating capital efficiently to invest capital or fund governments. But like weeds in a nutrient rich field, spare liquidity attracts the rankest growth of useless vegetation. Thereâs no clear way of knowing which is which. Money famously does not smell, and clients donât really care much about how they earn a return, whatever they may say.
From: The FT Adviser Website
Fads and fashions in investing fuel some success at first - then they can no longer conquer new lands, and deflate, dragging down asset values as they go.
ARE INDIVIDUAL UK STOCKS WORTHWHILE?
I look back, as all investors should from time to time, at my successes and failures. Luckily out and out failures are pretty rare, and in some measure, so are successes, as I quickly milk the wins (usually from takeover bids), so they disappear from the record.
This leaves me a pretty solid mass of fairly dull UK equity holdings, I slightly favour value over growth. So, I know a simple snapshot wonât reveal the steady benefit of, at times, decades of good dividends.
But at the end of it all, for a UK investor, what remains is a mass of general mediocrity. Resource stocks have been good to me, still are, but the mass of industrials? Not really.
Or property companies?
Well big dividends from REITS, but again not really. Of financials? Again, long years of high dividends, but capital values stay scarred by the GFC. Chemicals, retailers, distributors, tech, utilities: well, all fascinating, with some good runs, often good yields. But in the end?
I could ignore such perennial plodders when their yields were far above base rate, but they are now surpassed, by a simple savings account.
So, I do wonder at times like this, why I hold them. Doubtless we will get rallies, but the tone feels a tad discouraging just now. And I sense the politicians of all hues, who seem to be eager to relieve me of anything that looks like a nominal gain, or enforce their often extreme views on my assets.
PERHAPS OTHERS DO IT BETTER
My long-term winners by and large stack up in investment companies, with specialist fund managers, and almost entirely overseas, or at the very least global. Not that is much of a surprise, we have mentioned before how the FTSE100 has not moved much in twenty, going on twenty-five years. Yet again it has flattered to deceive this year, yet again it has that slumping dinosaur feel to the graph.
The UK is not alone in that. Most of Western Europe shares that fate, and Eastern European investing has been a good way to create losses. Somehow Europeâs governments have done just enough to keep investing alive - and somehow the stock markets have had just enough liquidity to avoid collapse.
It is partly why so many investors love small companies, but they are savagely cyclical, as we are seeing just now.
I could blame management, and their apparently limitless greed, but while many quoted boards maybe have rogues or knaves, but nigh on all of them? No, I wonât accept that.
Globalization has freed capital to move easily and fast. Far faster than any real business can adjust, and in this world the ability to attract capital is vital. True many attract it, to waste it, like a meme stock, or Peloton, but it would be wrong to see that as a line of tricksters repeatedly finding ways to con the market (although many have) more about the power of liquidity to inflate prices, attract buyers, inflate prices once more, in an unending climb. That is until the last buyer has paid up, and the tipping point is reached.
Taken from this website
Then the whole thing unwinds downwards, down to a true value, or less.
WHERE NOW?
On the one hand, as interest rates fall, and they will do soon, even if that one last hike is much discussed and may well happen, the path looking forward is downwards.
FED rates in the last 5 years
This should benefit value stocks, as more and more dividends emerge once more above the high-water line of cash deposits. Rates wonât go all the way back to zero, that is gone, but should start on the way down.
On the other hand, the liquidity trade is here to stay, money attracts money until the thermal tops out and the vultures glide along to the next spiral, or indeed back to the last one.
And looking over decades, as fund managers must, that is all that happens in most markets globally, one or two have true secular growth that also gets returned to investors (a key caveat), most seem not to. Investors become either hobbyists in love with a stock or short-term traders. It is notable how many of the new breed of big company directors spurn the shares of their own companies, bar a token few thousand.
Markets seem to have progressively been made easier for momentum, versus âtrueâ investors, allocating capital to create real jobs. The capital allocation bit is worthy but dull, and arguably governments and regulators seem to have strangled it into stasis.
The endless, joyful, mindless dance of momentum, is simpler, prettier, easier to tax, cheaper to trade; quite wonderful really. But is it much else besides that, or is it substance without meaning?
It is odd how governments moan about the lack of growth and yet cripple capital allocation. In a market system, the best capital allocator wins. It is really quite simple.
Once the tightening stops, there should be more currency stability (of sorts) as all the Central Banks realign their rate patterns again. In (to us) an unresolved month, the dollarâs strength has been notable, when not a lot else was.
All mimsy were the âborrowgovesâ
Away from all the shenanigans with base rates and currencies, earnings seem to be showing a pattern. We look at the possibility of an unshackled NatWest and Indiaâs renaissance after the Hindenburg disaster.
START OF EARNINGS SEASON
In so far as reported earnings have a pattern, it reflects the actual position, not the fears of a hidebound analyst community imprisoned by useless economic models. Statistics are not predictive.
There is no recession, whatever all those clever models predicted, never could be one with the extreme fiscal stimulus (quite unlike the private sector fuelled inflationary blow outs of previous downturns), high employment and plenty of liquidity. So, real life earnings are in a purple patch, high and in cases rising demand, with falling or stable costs.
Meanwhile wage costs are perhaps stabilising and the labour supply position seems less frenetic.
In-house graph from published UK Government statistics – real time statistics
But dividends are generally ticking up, a nice bonus to collect when interest rates do start to fall next year, and valuations based on yields look low again.
FLAVEL OF THE MONTH
Nat West really is a sorry tale. The government stupidly sold off the crown jewels at give-away prices, and it now seems to be clinging on to the chaff for no good reason. The dead hand of the state permeates the place, and given the huge interest being paid on the vast national debt, surely a sale of all the government holding is long overdue.
You read the voluminous annual accounts and somewhere about page 180 the PR guff gives way to the reality of declining business lending, a worsening net promoter score and that ultimate civil service fudge, of combining two corporate departments to obfuscate.
Does NatWest actually dislike its customers?
I speak from experience – NatWest seems to dislike small business: we moved the last of our corporate accounts from there this year. Why? In striking contrast to the PR flim-flam that dominates the annual accounts, it seems that making life easy for us, is nowhere on their agenda.
At some point, it was just easier to go than fight – somewhere around the twentieth demand for the same details, and the endless Orwellian (âdoes not agree with other dataâ), even after the written confirmation that they were now content; so we quit. Always there was that threat to close the account, but not release our funds, for some arcane procedural reason.
I found the bloated pay packet for the CEO (and CFO) pretty hard to swallow for that performance. It just seems that they donât attract good staff, and like the slow pacing of caged animals wearing their lives away, those that remain pick away at the residue of their customers.
As for valuation? Nat West would still be cheap, but I felt if it broke above ÂŁ3.00 (as it did earlier this year) again, on present form – thatâs not a terrible exit.
Letâs hope this starts a basic rethink and some real value creation.
RISING IN THE EAST
We noted when the Hindenburg short-selling started in India, and we doubted that it was much more than a clever speculator, despite the sad sight of the neo-colonial British press (and a few Americans) lining up to say âI told you soâ.
Fridayâs FT was discussing India and still called it âlow-growth⊠dependent on commodities⊠hampered by political dysfunction and corruptionâ. Extraordinary – stale, lazy, stereotypical.
The reality is as we predicted: after a pause while stock markets looked for a systemic problem, and the short sellers booked their profits, the Indian market strode on to a new height.
From Tradingeconomics
Not that the biased UK financial press would ever mention that story. Far from the mud hut image they seemingly seek to portray, plenty of IPO (and deal making activity) is showing that India, not Europe is becoming the true challenger in high tech.
The SENSEX started this century at 5,209, the FTSE 100 started at 6,540. The FTSE 100 has made it to 7,694, and the SENSEX? It has powered past to 66,160. One is up some 18% in 23 years, (not enough to even cover advisor and custody costs), the other 1250% in the same time.
No sensible portfolio can have omitted India this century, but the UK press will have worked hard to ensure most UK ones still do.
Well, thatâs the half year done, we will resume on the 10th September, expecting markets to be drifting sideways, but that gives plenty of time for the traditional summer bursts of excess or despair.
Although if it is performance you want, getting the big moves right, and the right markets, is far superior to the timing of most individual stocks.