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.
Reserve in Reverse
Fallen Emperor?
With almost two thirds of global equity markets represented by the US, the fall in the dollar so far this year is quite dramatic, and for many investments, more important than the underlying asset.
UK retail investors are especially exposed to this, as although Jeremy Hunt (UK Chancellor) may not notice it, the US is where most UK investors went, when his partyâs policies ensured the twenty-year stagnation in UK equity prices.
While Sunak continues to pump up wage inflation, which he claims, âwonât cause inflation, raise taxes or increase borrowingsâ Has he ever sounded more transparently daft? Sterling, knowing bare faced lies well enough, then simply drifts higher. Markets know such folly in wage negotiation can only lead to inflation and higher interest rates.
We noted back in the spring, in our reference to âdollar dangerâ that this trade (sell dollar, buy sterling) had started to matter, and we began looking for those hedged options, and to reduce dollar exposure. To a degree this turned out to be the right call, but in reality, the rate of climb of the NASDAQ, far exceeded the rate of the fall in the dollar.
While sadly the other way round, a lot of resource and energy positions fell because of weaker demand and the extra supply and stockpile drawdowns, which high prices will always produce. But that decline was then amplified by the falling dollar, as most commodities are priced in dollars. So, a lot of âsafeâ havens (with high yields) turn out to have been unsafe again.
The impact of currency on inflation
Currency also has inflation impacts. Traditionally if the pound strengthens by 20%, then UK input prices fall 20%. The latest twelve-month range is from USD1.03 to USD1.31 now, a 28% rise in sterling.
In a lot of the inflation data, this is amplified by a similar 30% fall in energy, from $116 to $74 a barrel for crude over a year. In short, a massive reversal in the double price shock of last year. In fairness this is what Sunak had been banking on, and why the âgreedflationâ meme is able to spread. But while that effect is indeed there, other policy errors clearly override and mask it.
A Barrier to the Fed.
In the US we expect the converse, rising inflation from the falling currency, maybe that is creeping through, but not identified as such, just yet, as price falls from supply chains clearing lead the way, but it is in there.
Finally, of course, this time, the dire performance of the FTSE is probably related to the same FX effect on overseas earnings assumptions. Plus, the odd mix of forecast data and historic numbers that we see increasingly and idiosyncratically used just in the UK. If the banks forecast a recession, regardless of that recessionâs absence, they will raise loan loss reserves, and cut profits, even if the reserves never get used.
Meanwhile, UK property companies are now doing the same, valuing collapsing asset values on the basis of the expected recession, and not on actual trades. So, if you have an index with heavy exposures to stocks, that half look back, half reflect forward fears, it will usually be cheaper than the one based on reality.
Why so Insipid?
OK, so why is the dollar weak? Well, if we knew that, we would be FX traders. But funk and the Fedâs âfront footâ posture are the best answers we have, and both seem likely to be transient too.
If the world is saying donât buy dollars, either from fear of the pandemic or Russian tank attacks or bank failures, thatâs the funk. As confidence resumes and US equity valuations look more grotesque, the sheep venture further up the hill and out to sea. To buy in Europe or Japan, they must sell dollars.
The VIX, in case you were not watching, has Smaug like, resumed its long-tailed slumber, amidst a pile of lucre.
From Yahoo Finance CBOE Volatility Index
So as the four horsemen head back to the stables, the dollar suffers a loss.
The Fed was also into inflation fighting early; it revived the moribund bond markets, enticed European savers with positive nominal rates, (a pretty low-down trick, to grab market share) and announced the end of collective regal garment denial policies. But having started and then had muscular policies, it must end sooner, and perhaps at a lower level. So that too leads to a sell off in the dollar.
Where do we go instead?
So where do investors go instead?
In general, it is either to corporate debt, or other sovereigns. Japan is not playing, the Euro maybe fun, but not so much if Germany is getting back to normal sanity and balancing the books again. So, the cluster of highly indebted Western European issuers are next.
Sterling now ticks those boxes, plenty of debt, liquid market, no fear of rate cuts for a while, irresponsible borrowing, what is not to like?
For How Long
When does that end? Well, the funk has ended. You can see how the SVB failure caused a dip in the spring, but now the curve looks upward again. Although fear can come back at any time, as could some good news for the UK on inflation. However even the sharp drop the energy/exchange rate effects will cause soon, leave UK base rates well south of UK inflation rates.
So, every bit of good news for the Fed, is bad news if you hold US stocks here.
How high and how fast does sterling go?
Well, it has a bit of a tailwind, moves like any other market in fits and starts, but could well go a bit more in our view. Oddly the FTSE would be a hedge (of sorts).
It is Not a Pipe
A long view this time : Has the price of capital changed for good? How bad is the UK position? Oh, and the unusual universality of colonialism.
A Far Off Galaxy
Letâs start with colonialism. I have been reading about the benighted past of Bulgaria (R.J. Crampton, 2nd Ed, CUP). A Bulgarian I know said that the country âhas a knack for picking the wrong sideâ - a little harsh, I thought. However, it has always existed as a colony, aside from a brief imperial phase around the last millennium but one, and before that when it equated to Thrace, almost as far back again.
Given the option, Bulgaria recently opted to join the Western European empiresâ current formulation as the EU and NATO - the latter being the armed wing of Western thought. Bulgaria had suffered horribly under the Soviets, with a steady and ruthless coercion of an existing multiparty democracy, at a speed just enough to keep outsiders ignorant, or if not, passive.
That history gives me a whole new viewpoint, on the string of broadly similar states. The Balkans and The Middle East all appear in a new light, and indeed I start to comprehend the bitter sideshows (as they seem now) in both World Wars, over that same terrain.
The collapsing empires (Russian, Ottoman, Roman,) seem more influential than the current rulers in so many former colonial states. They are really not, as we think now, a series of nations fighting for âindependenceâ. In most cases that independence is fragile to the point of being mythical, while the internal fissures are enduring. The cracks of nations within empires, not of states within a world.
Now You See It
One passage in Cramptonâs work stood out âby mid-summer social and industrial unrest were widespread with strikes by civil servants. On transport networks, and despite the provisions of the law, in the ports and medical services. The government was forced to grant a 26% wage increase to all state employees, an action which weakened its attempts to control the budget deficit and inflation and which did little to impress the international financial organisations.â
Written about conditions just before another wrenching Balkan realignment last century, this rather made me stop and reflect.
A parallel with the UK?
Just how close are we in the UK to that edge? Lost in a warm feeling for individual strikers and their causes, and a very British willingness just to plough on, there still seems to be a real danger.
I am well aware of our great national strengths, in the arts, our language, higher education, science, heritage, even logistics and retailing - they are enduring causes for optimism. But long-term investors need to weigh up the recent damage, especially the loss of political capital by the âresponsibleâ right, the high levels of debt and taxation, which coupled with low productivity, could also spell trouble, the certainty of ongoing nationalism and the unhealed rift of Brexit.
There is danger too in the probability of a Labour government, which however centrist the leader is, will have left wing factions to assuage. It is equally dangerous to continue our recent experience of minimal ministerial experience. I hope the change wonât be as bad as I fear, but it will probably be worse than I hope.
This remains a reason for the FTSE to be anchored to late 20th Century levels, despite almost every stock I research looking cheap. The fear of being still cheaper tomorrow rules.
Do Markets Care?
On the other hand, re-pricing capitalism after the decade of populist nonsense by central bankers does feel pretty good. If you have no cost of money and no reward for savers, financial gambling prevails.
All of this raises a key issue: is the apparent resurgence of speculation (the greater fool theory of investing) permanent? In which case investors should probably just watch momentum. Or is this most recent re-run of the last decadeâs speculative phase, really transient?
For a better view, see this page on Statista
As long as inflation exceeds the cost of money, assets will likely rise; the widespread return of real interest rates (a point we are almost at) should slow that down.
After that point what matters is cash flow, and whereas gambling will favour growth stocks, real returns come about when interest rates are high, but inflation is also falling. The gap matters and we are not there yet.
This is probably the crux of the next two years, and we doubt that having had a serene and slow drift towards recession, there is any reason either to expect a suddenly faster descent now, or really to expect the corollary, a sudden fall in interest rates, to offset a deep recession.
If rates stay high, but have indeed peaked and inflation declines, value investors should be in a better place. If they get it wrong, they are at least paid to wait.
As we have seen in the last twelve months, growth investors fuelled by borrowed money really do need a rising market, they get hit twice if it falls: both through a loss of capital and then the need to fund loss-making assets at real rates.
The Monogram View
Overall, our position has been that fundamentals should win, but we suspect momentum will win. Spotting the next momentum shift early, therefore remains a powerful driver of returns.
One narrative of 2023 (so far) is that the SVB crisis and stronger growth combined led to far more liquidity than markets expected. This fed into the gambling stocks, giving them momentum.
So, although the first half was not what we expected, the second half might still be. But it is just one narrative, and it may still be the wrong one.
Note : Further reading, for those interested in Bulgaria :
See also, The Bogomils: A Study in Balkan Neo-Manichaeism, Obolensky, Dmitri.