Tech Wreck or Much Ado
Talking Tech today - We think that market cycles are longer and far less repetitive than we like to assume.
Asset price ramps - the tech story
But each speculative ramp up and blow off in assets shares much the same features. Our view is the faster they go up, the less likely they are to recover having come back down. And a lot are pretty well back where they started, in price terms at least.
Yet the avarice of founders and sponsors in exploiting, seemingly without consequences, these destabilizing bubbles seems oddly popular, helped by the vast tax hauls they often create, themselves inflaming the process. The media of course delight in hyping them, somehow immune from the sin of market manipulation, which profits them mightily.
I suspect most investors have a āmarker stockā, to indicate where we are in the cycle, to me it has been the Amati AIM VCT. It has a fair range of stocks, competent fund managers, a reasonable yield. It topped out first in about April last year, had another go at the top in late August or so, and has been downhill all the way since. About Ā£200m of assets, a discount control in place, generally real companies, not concept stocks.
So not an obvious spoof.
This was unlike the SPACS, which we first highlighted in late 2020, and where they have been far more destructive, in most cases, even when containing a real business (and many did not).
Sometimes governments get pulled in too. All those profits make for flush lobbyists, generous donations. The London Stock Exchange, a quasi-regulator, bends easily to any wind that blows an irregular but ripe bounty to its coffers.
So, of all the myriad useful potential reforms and regulations, making SPACS easier was depressingly to the fore in ministerial recommendations. Likewise funny voting rights, which stop the founders getting hoofed out when it all goes south.
And what about crypto currencies?
We can debate whether crypto was the same, a lot of the crypto universe clearly was, and itself it was inflated by that same goldrush mentality. Indeed, plenty of market professionals tired of the chore of marketing real companies with real data are entranced by the lure of money for nothing.
Bitcoin is almost the perfect vehicle in this hyper speculative world, and yet we are ambivalent on it. It is very clean (once the dirty mining is done) and it produces carbon rather than arsenic (unlike gold) as a by-product. It canāt be tainted or doctored or indeed intercepted, so it is quite a pure asset. Of course, you can mislay it, and once lost it is rather elusive, it slips back into the great money sea and is lost quickly in the waves.
Some say it is too hard to turn into real money, dollars in the main, but nearly every investment is tough to realise, certainly most āalternativesā are and far too often the fees investors are charged are based on inflated values.Ā
Tech valuations
So, back in the tech wreck. We donāt believe the high valuations were ever anything but the flush through of extreme greed, created by an industry still able to sell duff product, to its heartās content, for colossal fees, along with skilled media manipulation. Or as a recent Hendersonās fund manager report said āinvestment bankers, greedy management teams and ruthless private equity vendorsā are to blame.
Judging the product in tech is always really hard. But judging what a reasonable value for the optionality of many of these shares is, should usually be far easier. A good rule of thumb is see how in ānormal timesā they are valued, both because that is when you will almost inevitably need to sell, but also it reflects the funderās ability to keep propping up losses. That is typically not measured in decades, but at most a few years.
COVID did not help, it closed the new issue pipeline, devasted large areas of the existing market and of course washed torrents of hot cash over everything. Less to buy, more to buy it with, a bit of a feeding frenzy and away we went. But thatās now over.
Nor do I really think this vast pump and dump enterprise was undone, as the market wisdom is, just by the threat of rising rates. The idea you can precisely discount some pie in the sky projection also feels slightly odd. The precision of diamond to cut the substance of weak custard, seldom produces a sharp, solid, edge.
How might we regard āconceptā tech stocks now?
Seen as driven by supply and demand, bulked up by liquidity and the āgreater foolā argument should you unload the stock, means you should beware of the belief that many of these stocks are anywhere near a bottom, until either they produce real cash flow, or a period of years allows them to de-risk their valuations. Ā
Seen in that light, and given the overhang of listing, taxation and scrutiny they now face, it should be more about how much should you discount their cash pile by, not what premium to NAV do they merit. Oh, and Iām talking about real Net Asset Value, not capitalized losses, (however you bottle it), a loss is not an asset, whatever the craven auditor says.
Nor is looking for a trade buyer sensible, buyers have to buy the whole thing, not a little slice where the value can easily be frothed up.
My preference is good active specialist tech managers. There are a few, at a nice discount, but pick your entry point with care, at this stage of the game.Ā
A lot of the late 2020 and 2021 excitement turns out to be Much Ado About Nothing, a startling production (above) of which closed recently at the RSC.
LOCATING THE ELUSIVE BASE
the investment impact of recent events
CRANES
I spent last Sunday in the elusive pursuit of grus grus, in the upper Marne basin, East of Paris. For some reason the Common Crane had already left in a bid to cross Central Europe, heading for the Artic, weeks earlier than in most seasons. Clearly, they knew something about the airspace ahead of them.
While the largely empty Lac du Der, also had lessons on levelling up; here was a vast and disruptive engineering scheme, it seemed executed without too much controversy, operating well and with the surrounding villages wealthy, quietly prosperous and largely content. Or so it looked in the February sunshine. It was all in pretty harmonious concord with nature too.
THE FRENCH MODEL
It seems the French can see the grand scope of government, the need to provide top class infrastructure. Here is their France Relance plan up to 2030. Up to 3-4 billion Euro is likely to be spent in 2022 alone.
The issue is perhaps not just politics, but the unspeakably low quality and lack of vision of the UK governing class. The French cities have retained their great buildings, the administration is a high profile and visible force, not something to park in the burbs, having ejected them from city centres to grab their assets for still more rentier housing. Nor does the state foolishly aim to do everything, the peage (and TGV) enable high class fast communication, but certainly not always for the lowest price. Nor is health care completely and absurdly free, irrespective of demand. But it is effective.
Power is cheap and plentiful, no hysteria about nuclear there, and the military proud and visible, even the transport police are packing heat. So, watch that off peak ticket schedule.
Of course, not all is rosy. COVID hysteria still ruled, masks and vaccine passes were required for everyone, for everything.
Yet if any UK government is serious about leveling up, (as in the recent White Paper) here is both a lesson, and an indication that Goveās piffling attempts are a mockery; he needs more like Ā£48 billion to start it, not Ā£4.8 billion.
You feel they just picked up the easy option from the choices their tired civil servants had suggested. Perhaps it was the one that said, āNo real impact, but sounds OK for nowā.
UKRAINE - Did Putin miscalculate the Westās indifference?
Ukraine? Not a lot to add to that. We were wrong that Putin was not stupid enough to do it. Wrong too that it would be over in hours. So, treat our topical ignorance with care. Also, wrong that the West would shilly-shally over piecemeal sanctions. Whether we are wrong yet again in assuming that without a quick win, the sanctions will now damage the global economy quite badly, remains to be seen. I also suspect seizing Central Bank assets can only be done once and once done, global finance and investment will become far more fractured, forever.
But in truth, it was going that way already.
However, this blind market panic seems absurd. I really doubt if Putin, at this point, wants to line his battalions up on a border to provoke NATO, who are I suspect closer to an aerial counter strike than he thinks, and would indeed now love the excuse of any incursion on NATO soil.
He has made it into a popular potential war for the West, the most dangerous sort.
War Tactics
It looks to me as if Russia wants a pincer movement, to isolate Ukraineās forces in the Donbass, plus a threat to Kiev to topple the government, but has he the muscle to take and hold all of the vast country? Even if he does, that does not suggest he will go further than Ukraine, just now.
While his aims are so blatantly false, success can be easily claimed for almost any outcome.Ā So, a collapse in currencies, and stock markets across Eastern Europe, looks an exaggerated response. True, this is Germanyās worst nightmare come true, no competent military and a gun-shy US, so they must now realign fast, and where Germany goes, so goes the EU. It is not going to fold or fissure in the face of this explicit threat. Although Germany at heart is much more like the UK than France; rapid execution will not be quite as easy as simple announcements. Remember the farce over moving Tempelhof airport?
As yet, the final step of directly locking in Russian energy supplies, large parts of which go to German consumers, has not been taken, but that would, in the short term, be very costly.
Although high taxes on energy give governments a great incentive to let prices rip, (and demand destruction is great for the climate lobby too), but they are rather less popular at the ballot box.
Interest Rates
Meanwhile Powell remains determined to stay behind the curve on rate rises, it is as if the received wisdom on rates, indeed on Central Bank power, has been quietly ditched, and instead he is hoping inflation burns itself out through demand destruction/supply creation. Well, an interesting experiment, but if thatās the game, as we have predicted for a while, inflation will remain gently smouldering, but rate rises will still be very gradual.
The Fed should have turned off the monetary stimulus and reset to ānormalā six months ago, by the time they finally move, it will be a full twelve months late. Real rates are deeply negative, levels not seen in decades, and moving fast, this is really not quarter point stuff.
All of the above implies on-going nominal economic growth, ongoing share price appreciation (at least in nominal terms) and an ongoing reward for borrowing to excess.
But despite the rush to safety currently supporting the US dollar (and US assets) the danger to markets is not just from the noisy, tragic, East but also from experimental monetary policy in the US. Ā
DETONATION OR ROTATION
Two big market forces are at work just now, one is rotation out of the low interest rate winners, to wherever we go next, the other might be something more spectacular.
Enough of the market still sits in the ādonāt knowā category, to make everyone uneasy. The VIX is high.
So, what would cause the more explosive outcome? Traditionally higher rates divert more of the profits of indebted companies to banks and bondholders, so the theory goes, reducing dividends. Or at the more extreme level, this also makes refinancing debt harder.
This comes with a āsecond orderā impact, in that consumers or buyers also shovel more towards the banks, less towards the producers.
But none of this seems remotely likely yet, the world is awash with cash, and savings levels and interest rates have barely stirred from their COVID slumber.
Markets seem to be just talking about normalising, not slamming the brakes on.
Will we grow regardless of inflation?
The other big risk would be a failure of non-inflationary growth, which also seems unlikely. There are few practical signs of governments enacting the type of supply side restraint needed, we know. We still look for some self-restraint on how much governments seize in taxation; with high inflation taxes should be being cut, or thresholds systematically raised, but thatās also not happening.
The āidiot populaceā as curated by the media, constantly wants more supply side restrictions, greater consumption and lower prices, as if this was all somehow available; it is not. The worry here is that governments having messed up the big issues, give way to yet more populist demands for the impossible. At the same time, markets are also getting a little less keen to finance such nonsense or, being markets, raising the price at which they do so.
Well, all that is possibly true and has been happening for a while, but the old theory was that innovation was too fleet footed for any of that stuff to matter much. This is getting a bit tired, but broadly still seems to hold.
What if Ukraine does erupt?
So, the third detonator is in Vladās hands. Is a reverse Barbarossa coming down an autobahn near you? Well letās assume yes, because heās finally lost it. It is still fairly clear that if he steps onto NATO territory his army is in trouble, US and NATO airpower will rapidly outgun him. So, I discount that. But perhaps Ukraine does indeed end up like Belarus. China will support Putin, so the UN is irrelevant.Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā Ā
Then what? Well, a nation the size of Spain gets locked out of European commerce. Not important. Defence spend goes up? Well, some would say āabout timeā. Germany can decide to burn coal or nuclear or freeze, see previous answer. Come to that, so can we.
Given Russian gas must go somewhere, a bit like Iranian oil, it probably goes to China, which then trades it or cuts back its own Far East imports. Gas as we all know, canāt be stored for any useful length of time. Russia needs the earnings from it, so it will emerge on the market somewhere, at pretty much the current price.
It will be messy, it will create hard choices, but Russia is well on its way to autarky already, it can certainly live without dollars. Is this really a detonator? On its own, I doubt it.
Where is the rotation?
So, we still conclude all this market reaction is rotation, and it is out of overpriced US equities, where Biden created the biggest inflation bubble by far, and where interest rates are rising faster than elsewhere in the OECD. Hence, we see the hazard as mainly still on Wall Street, and to a lesser degree to the US economy. Weāre looking at rising rates, a strong dollar, increased detachment from the global economy, and none of it helps earnings, but nothing is catastrophic either. The US (unlike the UK) wisely seized the chance to be energy independent.
But even so, we are not yet that concerned, valuations in the US are still extreme, as many sets of earnings seem to show, once the market looks at forward guidance, it shudders, and prices fall. A lot of built-in growth is needed to get price earnings ratios back down to earth, and thatās whatās being hit just now. To use a forty or fifty times earnings multiple, needs a lot of confidence about the future. That stretched temporal certainty is now lacking.
This is not that unusual for a rotation, but in that case, markets will bounce, and that will suddenly move a lot of funds off the side lines and back in. Where is that process now? Well going back to the Jan 27th low is causing some excitement. But we are not sure even thatās a disaster. Overall, the taking out of that and the October 2021 S&P low, wonāt be fun, but the market still had a heck of a run up last year.
Have a look at where our MonograM investment model allocates funds based on momentum, over the last three decades, the US is absent for significant stretches. We rebalance monthly, the next one will be most interesting.
And inevitably, we do feel cautious too, but it is about levels, not wipe outs. Rotation not detonation.
Charles A R Gillams
Monogram Capital Management Ltd
First Principles
Principles may be lacking in certain quarters, but we will start with the economics of inflation rather than Boris.
How much inflation and for how long?
Inflation is simply too much demand for the available supply, nothing more complex than that. So, you tame it by either less demand or more supply. So, unlike it seems most Central Bank economists, who it turns out are just statisticians, for ever looking back, we must project forward.
That tells us quite clearly that the inflationary imbalance will persist as long as demand stays artificially high and supply is artificially constrained. It is that simple. Forget the rest.
So as long as governments have fiscal laxity, along with negative real interest rates, they are pushing up demand. As long as workers wonāt or canāt work, it will reduce supply, as long as economic activity is made less efficient by government action and diktat, it will reduce supply; end of.
So, at the very least Central Bank balance sheets must start reducing, which is not happening, stimulus must be fully withdrawn, which is not happening, and the old workers and their old ways of working must resume, which is not happening. Fresh capital can certainly change some of that, but it takes time.
Putin, Oil, and Geopolitics
What about oil?
This is the one item that alone might distort the picture. Which is positive, as we see oil prices falling in the summer. We also donāt see the West has really grasped what Putin is up to; in all the cold war style hysteria, he is possibly just after what he says. This is for the West to stop fomenting rebellion in Russiaās sphere of influence, and to be clear about NATO expansion plans, where there are indeed none in existence. He might have higher hopes, perhaps of a deal on Crimea in exchange for the Donbas, but we doubt it (or his chances of getting it are low). As might we, less interference in our politics would be nice; but see previous answer.
Nor is it that clear he is actually rationing energy; it is telling that Russia is reported as not able to meet its OPEC + quota, which at these prices is crazy. His oil industry will have been hit by sanctions, and the loss of Western expertise, and the Russian economy will also have suffered under COVID. A loosening of sanctions would really help him, for all his bravado.
If that reading is correct, as the situation winds down and OPEC+ winds up production, oil prices will fall, I would expect quite substantially. Much of the energy spike is self-inflicted, with nuclear plant closing or offline in France and Germany, and reckless price controls, having made using UK gas storage unattractive. All of these things can be sorted out.
Any possible good outcomes on inflation?
So, to inflation, well it wonāt care much about the pinpricks inflicted by the likely interest rate rises now under discussion, especially if they creep up so slowly no one notices. It needs a unified 1% OECD jump to cool this lot down, and the ending of stimulus. Neither is likely. Closing the US printing presses, were it to happen, does also have interesting global impacts, as Andrew Hunt notes.
We see it all turning rather glacially, with a bigger slump in inflation, if energy prices fall, but then being generally persistent in the 3% area for the rest of the year. We expect to have both higher rates and inflation for a while.
All of this is mighty tricky for investors, but I donāt sense that just bailing out is right, nor that the actual interest rate rise will cause an enduring slump in all asset prices. Investors have to own something, or they will sit and be mauled by inflation.
And what of Johnson?
It is easy to read the current level of confusion from either sideās viewpoint. Yet to me, I see the normal factional infighting, the usual media exaggeration, some political mischief making, but still no reason to depose a Prime Minister with a very clear mandate and a large majority. Like any large party the Tories have the embittered and passed over, the Remainers and fans of state intervention and a volatile and raw body of new recruits in seats no one ever expected to win. Plus, no doubt a few opportunists who sense that the heavy lifting on COVID and BREXIT is done, and they can now seize all the prizes.
The Tories do need a reset; it would be nice if Downing Street left Ministers to govern and simply acted as a cheerleader. Not that I see that happening, leaders and their hangers on always lust after more and more centralization, more control. But until a compelling, unifying, plausible Tory opponent appears, I foresee no change.
And in a way with reform all but dead, with Goveās last hurrah on āLevelling Upā a damp squib, it may not matter who leads the Tories, they have very little real power.
It is quite odd how big majorities do so little good, and how poor party discipline is, when they have them.
Charles Gillams
Sea change
A trio of influential knaves to worry about this week, united by a belief that āthis time is differentā. Well pantomime season is behind us, however we can still all shout āoh no it isnātā.
Boris seems to be the least of our problems, if the greatest of villains, for the scurrilous crime of enjoying himself, what a rat. While Powell is providing an increasing threat to the poor and exploited across the globe by generating financial instability, and the lamest of the lot, Lagarde is just repeating a political line. The Euro zone debt figures look like this. A sharp rise from an already overstretched position, but still benefiting from falling rates, so when that rate line turns, the problem will really bite.
Will markets ever trust the Fed (if they did this time, outside the gilded denizens of Wall Street) again? Hopefully not, the trouble with putting administrators in charge of Central Banks is they rely only on historic facts, it is in the job description, thatās what they polish, hone and serve up.
But the economy is dynamic
The mismatch is that the economy is dynamic, and has no printed rule book, beyond that of the rocket; what goes up, must come down, immutable like gravity. And you simply canāt wish gravity away.
So, this Fed is programmed to repeat what it can see looking backwards, and all the obedient commentators on Wall Street who simply echo its nonsense, are of little use, except to fleece the gullible and to signal false comfort to one another.
Having said for most of last year āthere is no inflationā they have turned on a sixpence, to say inflation is now out of control. Talking of six or seven rate hikes; they wish, just bankerās fantasies. Although markets, not surprisingly, are now suddenly jittery.
Investment implications
This week we went from feeling over 20% cash was too cautious, to feeling we had missed the boat on value stocks, back to feeling 20% cash was really just fine, all in the space of four short days.
So, because that sea change in inflation expectations was so abrupt, this is a genuine dislocation, we do see the NASDAQ and both the concept stocks on infinite multiples and the mega tech stocks on thirty- or forty-times earnings, as in some trouble, in a process that does not feel over yet.
There is a ton of selling, and the spoofing assets, including crypto, will be heading down, in a dip that feels likely to be around for a little while. But two things stand out, firstly until rates start to top out, this excess money simply canāt go into bonds, so what happens to it? Secondly if the market assumptions about Powell and Lagarde are both right, you are going to be paid handsomely to hold dollars, while simultaneously being charged to hold Euros. We donāt see that as sustainable either. One must be wrong.
Looking ahead
This is why Lagardeās confidence in no rate hikes, feels like a lawyerās bluff, as if currencies move, it wonāt be her choice for long. While uninvested money, on which fund management fees are still charged, always makes asset gatherers nervous; it will all go somewhere.
That also leaves the question of how much growth we will actually see, as if it is below expectations, then inflation will be choked off, labour force participation will fall, US rate rises will run out of steam. There are already signs of that. While given the scale of market movements, the ending of bond buying by the Fed (long overdue) and even a modest run off of the balance sheet, will be pretty irrelevant, both are really drops in the financial ocean.Ā
The froth blown off
So, the good news is we will see normal investment conditions, the froth blown off, bonds producing a yield, along with slower growth and moderating inflation, which we do feel will be backing off by mid-year. All of course will rather depend on the progress of COVID, because we still see (and have done for nigh on two years) this inflation is directly caused by COVID responses.
Reducing the output capacity of the economy, with no cut in demand, has to cause price rises. These price rises will exist everywhere COVID does, so trying to pin them to a single cause or location is not easy. They will persist until the demand/capacity equations correct, which with COVID is a multi-year task.
The FTSE finally gets a look in
So, a sea change yes, a market dislocation yes, but if it is as bad as is currently feared, with some big winners resulting in the financials, real assets and energy. All of which, on those fundamentals, still look to us good value, hence the visible support for the FTSE 100.
While if it is not that bad, sufficient money will flow into US Treasury stock, from low interest areas, forcing the dollar to rise, and rates down, until other areas are simply pulled along. So no, we wonāt then be getting seven rises on this data and equity markets can start to relax.
And what of Boris?
Finally, Boris, now degenerating into farce, but much as we hate what he has become, we recognize one wing of the Tory party feels he is too right wing, while another feels he is too left wing. Both dream of replacing him with their own, but in so far as he splits the difference, the risk that the other faction wins, should keep him in office.
Either faction will demand more of his replacement than they can ever deliver, given that core fundamental split, so such a divide simply hands Downing Street to Keir Starmer. For now, I still feel he survives, and given his nature he will remain impervious to change, but remarkably adept at promising it.
Sterling seems notably unfazed by it all.
Charles Gillams
Monogram Capital Management Limited