Skipping along
Skipping is the weekâs theme, following the inadvertent use of the term by the Fed Chairman, along with the rather weird behaviour of Jeremy Hunt.
Although any skipping seems unlikely soon, on this side of the Atlantic.
The dear old ârecessionâ still lingers, unseen but feared, like an ex Prime Minister. We are convinced it will arrive, but as a âtechnicalâ recession only. It should be hard for anyone to be surprised. Labour markets are much stickier and far more fragmented. Supply is short, so any systemic shock feels unlikely. While as old hands keep noting, single figure mortgage rates, well below inflation rates, are hardly restrictive.
Chair Powell (almost) mentions âskippingâ.
Jerome Powell was bowling along contentedly, when he suddenly described the Reserve Boardâs June inactivity as âskippingâ. Although it actually was just a âskipâ, before he realised the error and with a guilty look speedily reverted to the far more passive âpausingâ. Â But we knew how he was thinking. He was going to keep his foot on the neck of borrowers for a bit longer â interestingly, he refers to real rates of interest, as somehow unjust and injurious. Odd that when asked anything about fiscal policy he instantly plays the neutral, technical banker, no good and evil there.
Moves in the real economy.
So, what has really happened?
Not a lot, energy prices have climbed all the way up, and now slid all the way down. Aggressive fiscal stimulus continues, any chance Biden has to bribe the electorate with their own money, he still takes. Employment remains strong, although there is some tightening in hours worked, but it is still pretty hard to see how the Fed gets down to 2% inflation for a year or two.
And yet, markets by a mix of that unseen recession and faith in so called base effects, do think inflation by the autumn, will justify a real pause. No skipping.
UK Chancellorâs odd statements
Here in the UK Jeremy Hunt is in quite a different place. Inflation still looks high and embedded, but he has carefully outlined how he would keep going with substantial hand outs to offset inflation (aka fiscal stimulus).
However, inflation control was all for the Bank to sort out.
This is nonsense, of course. The UK Government is yet again stoking inflation while taking no responsibility for stopping it. He then gave a tortuous explanation as to why his policies have now produced exactly the same interest rates as the Truss typhoon, created by his reckless predecessor, but somehow, not at all the same.
Rate rises â a global feature.
Funny that, as we noted at the time, there was little odd about the October rate spike, and much that the Bank could have done (but refused to) by a prompt rate rise (matching the US) to stabilise the currency and inflation.
Rate rises are a global feature, with not a lot one small country could do about it.
2021 chart produced by the UK Institute of Chartered Accountants
So quite where the virtue of the Truss toppling quarter point rise is now, is rather unclear.
As sterling shows, the prize for that autumnal sloth will be higher rates (and inflation) than elsewhere for longer. The thing about fire fighting is the sooner you start the less you have to do.
So how did Monogramâs methodology work?
Our in-house model switched into Japan in December 2022 and Europe in March 2023. As we only ever deal in half a dozen big global index Exchange Traded Funds, this is not a tickle, but 25% of the total equity position in (or out) at once.
Brutal and scary, but effective.
We look at the signal, kick the tyres, thump the bonnet, turn it off and on again, look for reasons to ignore it, and then six months later look back in wonder and say, âoh yes, that was rightâ. These signals are delicate enough to very seldom feel right at the time, but after almost a decade of running the model, we have learnt to obey.
So, our Momentum performance discussion, yet again, is about how much we made, not about in which direction the money went. While the GBP version, seeing similar signals, has also never come out of the S&P 500, which for a good while also felt wrong, but it seems was right, taking a long view. The USD model was more skittish but is back in both (S&P and NASDAQ) US indices now.
So, we do know where momentum has been, and it is quite strong.
Markets in the political timeline
The rational thinkers say the market is (still) too expensive, but the trend followers donât agree, who is right?
We tend to feel just as Central Bankers were very slow to spot inflation, they are possibly being too slow to see it has now been contained, and the US skip may be a pause and then a snooze. Which would be very convenient for the Fed during the US Primaries, allowing for cuts into the US election?
Related to that, we watch with amusement a dialogue about the attractiveness of stock exchanges, in particular in London, couched entirely in terms of what potential listing companies say they want. Not a mention of what investors want, as if they just donât matter. Quite absurd, as what all listings need is a deep market, good liquidity, stable tax regimes, and an attractive base currency.
Is London aiming to provide these? We seem to favour founders â so, tweaks to voting rights, smaller free floats, fewer shareholder rights. But then oops! No buyers.
This is worse than nonsense, it damages what little is left of Londonâs reputation. In this market you start with the buyers. The price performance of many a recent IPO spells out the problem, the sellers are finding it too easy to deceive people â a call is needed for greater transparency, longer lock-ins, and less pandering to insiders and their advisers (not more).
The Long Recessional
English local elections, and US regional banks
The English local elections saw the Tories lose 1,058 seats, dropping to 2,299 in the wards contested on Thursday, Labour gained 536 rising to 2,674, while the minor parties saw the Liberal Democrats rise by 405 to 1,626, Independents dropped by 104 to 962, Greens rose by 241 to 481.
What does all that mean for next year? Well, we called the next General Election for Labour the day after the results of the last one, and nothing has changed that view. Nor do we believe talk of falling short of an absolute majority is anything but wishful thinking by bored commentators. Rishi is largely in office, but not in government: a fairly weak cipher for the mandarins behind the throne. When they tell him to abandon core Tory principles, he obeys. This divides his party even further.
So, investors really should focus on the âwhatâ; not the âifâ. The Tories as we noted last time, had most to lose, and will take some heart at the spread of their defeats amongst the opposition parties. Although given the locations contested, both official Labour, and the Corbynite rump voting Green, did well.
This was an anti-Tory vote, rather than pro anything in particular.
We will still see a solid Labour governing majority next year. The Lib Dems will likely be back over fifty seats; as ever un-representative of their larger vote share.
So, what of Starmer?
His big offer is that he will stop party infighting and provide stable competent government. It will be Blair redux. The core five aims are currently crime, education, NHS, climate change and growth. Who would have guessed. No doubt apple pie is next.
The method it seems is Blairite targeting, with a bit of management mumbo-jumbo about breaking down silos, overarching aims etc. With the one area of large-scale Soviet style planning in the energy sector, with a state-run organisation, with what sounds like loads of money, but in truth (for the task) is not. Anyway, the big issue is not power generation but transmission.
I guess we do know from Wes Streeting, (the next health minister) that Labour knows the real problem is the public sector unions, part of why Starmer was so keen not to rely on their funding or support. But while âsilo breakingâ is neat code for curing chronic demarcation fights, again, how does he propose to tackle it? Breaking ossified crusts needs steel. We know soft soap and water wonât do it.
But to tackle that, means splitting up some giant empires and even if Labour wanted to, I doubt if it has the means. At the same time public sector reform requires exiting vast areas where mission creep has expanded a thin film of under-funded interference and sub-par delivery. True Blair did cut loose Scotland and Wales, to wreck their own patches, raise their own taxes, maybe we will see more of that?
So, we should not hope for too much, we will get another well-meaning ambitious left-wing lawyer, but he is not Blair, and Blair despite fond memories, still gave us the GFC and Iraq.
We fear that the hostility to business and enterprise shown by Sunak will persist, it is probably embedded in the Treasury and Whitehall.
The slew of rate rises, and the slow sacrifice of the US Regional Banks
Somehow Wall Street keeps looking for rate cuts, and collapsing inflation, when it is simply not visible in the data. They are so hidebound by their models, that they see inflation as a pile of bricks. You count the bricks; you know what inflation is. But it has never been that, it is like the water table, it is a level, not discrete pieces, and like water it spreads, dampness pervades all. Sure, you can remove bricks, even big pieces of wall, but the water table needs everything to dry up for it to subside.
Taken from this article by IMF staff writers, Agarwal and Kimball in 2022.
You can see the flaws, factors 1, 2 and 5 look like classic bricks, or transitory bricks we should call them now. As for 4 that has been entrenched by regulations, especially on minimum wages, by tax hikes, health fears and support payments, which leaves 3 as the real solvable problem, and it endures. True they rightly noticed it, but by relying too much on the bricks falling, institutional economics just keeps getting it wrong.
You canât lower the level, while demand remains too strong to be drained away. While the idea you can disperse inflation while piping liquidity in to offset the cost-of-living crisis, is simply daft. Until excess fiscal stimulus stops, inflation will quietly shift, steam away, reform, and then drip back on us; clammy and damp as an English spring.
It helps a bit that vacancies per job seeker are falling in the US, but it is all pretty glacial, the job market is still very tight and wage inflation still embedded. We are awfully short of swallows to be declaring summerâs arrival.
Yet, we do accept Central Banks have largely given up on rate rises, we think too soon, and their main mechanism will now be leaving rates elevated for longer. Along with quantitative tightening, which as few politicians really understand it, they can get away with. Well, it may slowly work.
Looking ahead
We (still) see inflation as higher for longer, rates likewise, and over time the big users of debt, mortgage borrowers and national Treasuries, are going to get used to paying more for it.
Although expect some other fiddle to try to stop this too, which will, naturally, embed inflation and stagnate productivity.
Markets? Well, with plenty of liquidity still and indeed (unjustified) rate cut optimism and many cash flow yields staying attractive, they remain skittish, but with no panic.
So, we are not that gloomy. Although perhaps a sideways summer is ahead.
If your base case is rapid rate cuts and mean reversion, we still have our doubts.
Charles Gillams
Monogram Capital Management Ltd
The Recessional is a great poem by Rudyard Kipling. And the Long Recessional, the title of David Gilmourâs book on RK.
While Shonibareâs trademark mannequins rely on implausible inflation to prevent disaster too.
First as Tragedy, then as Farce
This is turning into another unloved bull market, we look at why, and wonder if Chou En Lai was right about the French revolution. Lets start with inflation.
I chanced upon Paul Krugmanâs The Return of Depression Economics, written in 2008. Krugman is very much an establishment man, Keynesian to his socks and seeing the great failure of late 20th Century economics being the sudden lack of demand. He has other work and more recent books, but I will focus on this one.
IMF Remedies
He has particular vitriol for the way the IMF repeatedly used austerity in its many forms, as the antidote to all and any of the chaos created by a deflating bubble. So, taxes up, spending down and crush demand to stabilise a currency, to avoid the extremes of bank collapses.
In Krugmanâs world, it was more important to regulate banks, and it seems hedge funds, thereby stopping the sources of instability in the credit markets, and to then prop up demand.
Well, the echoes are there, current policy remains both IMF applauded austerity to save the currency, which is just what Hunt inflicted on the UK last year, and a desperate search for ways to pump up demand, to stop stagflation. Much as Biden is doing with the US and the amusingly called Inflation Reduction Act, and indeed the MAGA type, neo-Trumpian, protectionism now evident in the CHIPS Act. The rush to global rearmament should be just as effective.
All in the end versions of Keynesian demand creation â digging holes in highways to refill.
Echoes of Old Bubbles
Krugman is not indifferent to the bubbles this creates in the US stock market and US housing prices but would seem, like Senator Warren, to suggest whatever the question, more bank (and shadow bank) regulation is the answer.
It is odd as you piece together many establishment views, how this policy of âcreate bubbles, and then carefully regulate their deflationâ, but never cut demand too hard, is now the undeclared reality of mainstream economic policy at Western Central Banks.
Krugman is blistering on some old tropes, the Schumpeterian theory of creative destruction gets short shrift, which still lingers in the financial press in complaints about âzombieâ companies (which I have always found weird). Likewise, that global development is all about rigging resource prices, which haunts the walls of a million coffee shops and a fair few churches and is also (sadly) tosh.
So, he is not all bad.
The New Bernanke Put
Nor when you understand how deep his influence is, does this financial market seem so strange, because the Central Banks hope inflation is external (weather, politics, madmen fighting etc) so this will âmean revertâ in time. Alongside this sits a very wary take on destabilising currencies by interest rate differentials. The old guard real world elements break through occasionally (and have supporters, like the splendidly lucid El-Erian) especially with double figure inflation on the rampage, but they are not heeded for long.
Seen like that, while the stock market hates bubbles and inflation, it canât shake the belief that in some form the âBernanke Putâ is still in play.
In which case âhigher for longerâ on interest rates is a paper tiger, as rates donât cause recessions, regulatory failure and hot money flows do. In that world buying an overpriced but liquid US market and buying the dollar looks, to many, like low risk. Not to us.
Inflation control?
And yes, as we have long argued, this wonât control inflation, but it seems who cares? We donât need to fear the stock and housing bubbles deflating abruptly, as the Central Banks wonât allow that. Nor should we worry about rates, as Central Banks canât let them rise much more, without jeopardising their over-indebted host governments.
So yes, old hands may hate a rising market into an economic  slow-down, but they are it seems, just part of history.
What then to buy? Arms companies are not significant post ESG, the China trade is (we feel falsely) boosting already elevated resource prices, and travel companies are getting plenty of attention. Meanwhile areas of bountiful state subsidy (an ever-increasing list) are happy too. However, that is a fairly unattractive list. And are valuations in those areas still reasonable?
I can see why some investors just think playing around with Tesla options is the best bet (we donât).
Then as Farce, Modern Imperial Europe
Chou En Lai when asked about the French Revolution was of the view (it is said) that it was âtoo early to tellâ. I have been reading Michael Broersâ brilliant Europe Under Napoleon, an extended love letter to the EU, in favour of rational technocratic administration, with a deep-seated fear of the sans-culottes.
This seems to highlight so much of the French desire to see the EU as the Napoleonic Empire, without the bad bits. The terror of the rabble, the urban bias, the fetishism of one law, the desire to paint any opposition to EU autocracy as unspeakable - it all rather gels.
Well perhaps the parallels go too far, but in looking at the bizarre actions of the EU over Ulster it is tempting to see more than just childish spite. The resources thrown at half a dozen sleepy border crossings (reportedly 20% of all external border EU customs checks last year) made little rational sense. Even if not that bad, it was overkill.
So, I can half see why the DUP feel that getting rid of bureaucratic bullying is just appeasement, but looking at the litany of inconvenience to be scrapped, this does still feel like a win for all sides.
But as with markets, I suspect all the fundamental problems still remain.
Hard Landings?
Local elections tell us remarkably little about national ones. We reflect on those. Meanwhile US equity markets are in turmoil, and some big numbers are changing very fast - some further musings.
Do English local elections count ?
We start with the UK, or rather English local elections, the devolved governments (oddly) have a rather greater read through from local to national. But overall, nothing in the results changed our view that Boris will probably survive, unless the Tory party unites around an alternative, which is pretty near impossible: it has too many splits.
Nor has our long-standing opinion that all Keir needs to do is keep his head down and he will be the next Prime Minister changed. Although if Labour starts to believe it is a shoo in, and can pick who it likes as leader, it will also self-destruct. Which is just about the only chance the Liberal Democrats have of being relevant.
Just how politically marginal local elections are, is shown by the surge of support for the Greens, apparently the very voters the weird Tory infatuation with hard left environmental policies were meant to entice.
Indeed, a whole set of Tory policies designed to raise energy prices, have gone down like a lead balloon.
What voters want and politicians need to deliver
You do wonder if they will ever get round to realising voters really want just three things, a roof over their heads, bread on the table and a job. Deliver those and do so competently, and politics is easy.
The roof bit is a shambles; it turns out policies designed to enrich cabinet members and senior civil servants with buy to let portfolios, are not so good for anyone else. I suspect the job bit will soon turn turtle, and the bread bit is going off the rails too. See graph below:
Here is a link to the relevant page on Statista
We notice that the big Western democracies still seem hell bent on raising energy prices, which is universally unpopular.
UK local elections - a brief look at opposition policies
So, the other thing markets in the UK (and sterling) will be doing is wonder about Starmer policies, more critically does he have the âbottomâ to either appoint radical reformers, or have them lined up in key seats? Letâs say he does. He will still continue the headlong wealth destruction of punitive taxation and the assault on business investment. He will over-regulate (thatâs his background). The sole variable therefore feels like any plausible capacity to reform.
He is not afraid of hard choices, or of thinking long, both good points and incidentally he is not Blairite enough to be Americaâs poodle and get involved in picking pointless foreign wars. Although he will likely dismember the United Kingdom, either of political necessity or by accident. We really canât see much support for sterling in that package.
Central Banks - are they signalling a hard landing?
Inflation is spiking into double figures, and Central Banks are explaining
1) it is really not their fault
2) they are only responsible for âcore inflationâ (so without the important stuff)
3) but anyway they must still raise rates to offset the malign effects of other state policies.
It is looking truly absurd.
Not that interest rates are off the floor yet, although the US bond market seems convinced rates over 3% are now nailed on, while oddly the UK Gilt-edged market seems unconvinced of exactly the same thing. This of course is helping an on-going collapse in Sterling.
Meanwhile the possibility of ending negative rates in Europe has caused great excitement and the Euro to strengthen, at least against sterling. The divergence is related to a belief that the Fed which raised three months after the Bank of England is now more hawkish, a belief which seems more about wishful thinking than anything the Fed has actually done so far.
We are less sure on how high interest rates go. All three Central Banks seem to be hoping something will turn up, and inflation will ease. This is a view we share, but we really doubt the trivial rate rises so far, are the âsomethingâ.
Market turmoil - how far will they fall?
This leads on to the current market turmoil: With the US feeling very exposed, partly because it went up so high (relative to other markets), it has further to fall. Nor do we see the valuations on quoted US growth stocks as offering good value at these levels. They had become so detached from reality the gap is just too big, and the repeated attempts to buy the dips, just disguises a long-term trend down. The FTSE100 over five years is down, and the NASDAQ climbed over 100% in the same time. A 25% further US fall is at the least plausible.
Other markets will then get sucked down, and in Europe and Japan they are hard hit by their reliance on imported energy (the US is an energy exporter). While for now, their rates are not moving either, the resulting devaluation makes the value gap to US growth stocks, feel even greater. Buying overvalued stock in an overvalued currency, is not always great.
What do our models say about the markets?
Our MonograM momentum models suggest a turning point for both Europe (including within that bundle the UK) and Japan is close. It is only a model, we remind ourselves, and is quite able to give a false signal. It also sees this as true in dollar terms, not sterling. So, there is plenty of noise and last week had all the elements we dislike, a month end, plus a shortened market week, plus Central Bank meetings, created a baffling miasma of signals.
However, on current policies we anticipate a crash; the only issue now is how hard the landing is.
REINSTATING REAL ECONOMICS - WISH YOU WERE HERE?
A return to the real world, where money has a time value is a great achievement. Inflation is after all transitory. At long last the most important of all price signals (interest rates) can break free, allowing for growth to resume. That is a cause for optimism.
Letâs look at the basics and start with food and fuel. Cereals are a critical foodstuff; we should remember they are almost automatically in surplus. All the great famines in history have been caused by logistical and storage failures, not an absence of global grain. Nor is energy a problem; our self-imposed constraints on its use are. Those are political, not physical.
Cold Comfort for Change - inflation, voters and price trends
Inflation, as we all keep hearing, is a supply side issue, which if true will always get sorted by either demand destruction, substitution, or new supply. But sorted it will be. The good thing about energy and food is that they are universally available, we favour one source or another because of price, convenience, fashion or dogma.
So, at some point they stabilise, it all depends on where the greater political heat is from; currently most Western governments fear lost âgreenâ votes more than high prices. Or indeed they may be simply locked into the Orwellian power surge of a foreign villain to fight, using young menâs lives.
However, history says that at some point jam tomorrow is less attractive to voters, than simply living today. We are not there yet. But either prices will ease, or we will ultimately take a pragmatic route and use our abundant low-cost resources.
These problems are not like microchips, with genuine supply issues; the extra chips simply donât exist; extra food and energy supplies do.
For grain there are vast swathes of the planet where it could be grown and is not, from the field margin just over my hedge, to parts of every other continent, outside the polar regions. The rest of the neighbouring field has spring wheat, an early sign of switching (a winter wheat crop would have to have been pre-planted). Yields may not be great, machines may not be efficient, but thatâs what price discovery does, if the cheapest producer drops out, the marginal one steps in.
In global terms lost planting land in Ukraine is trivial. And every year land is left fallow due to warfare or natural disaster, thatâs why markets exist. As for Russian surpluses, they will simply get stored or eaten in the half of the globe, that does not think as we do.
So, prices will sort themselves out.
Blue Skies from Pain - insurance and government borrowing
To reiterate, the big win is the defeat of the zero or negative interest rate world. The effect of that is quite tangible, in some cases: we wonât have insurance companies forced into a negative discounting of their liabilities anymore, nor will every defined benefit buyout be able to pretend there is no time value for money, releasing a fatal burden on pension schemes. Discounting will be back.
Time once more exists.
But the greater victory is against Government debt, the intergenerational horror of saying we can incur infinite debt for our children to pay down, because look, it is free! No more. Once more jam today means dry toast tomorrow.
Capitalism cannot work without price disclosure, and without prices, populism can roam free to destroy everything. At last, it is back in chains again, much as it yearns to fracture them.
The political price maybe high; I doubt if both Lagarde and Powell can keep their jobs. They still grandly support ever greater restraints on supply, almost as foolishly as they say they still believe interest rates wonât rise that much. An amusing deceit.
A Cold Steel Rail
Ploughing through the accounts of Glencore, one of the big resource outfits, I realise just how much of their recent good fortune (and it is spectacular) is tied to Governments forcing producing assets off the market and reducing the operational efficiency of installed plant. Demand is up, but supply (so the tonnages mined) is down. The production restrictions are state imposed, but there is little desire to invest anew, while they exist. Indeed, the CEO earns a bonus both for high profits and also for low capital expenditure: a strange way round. A critical supplier for the energy transition, that wants to be smaller, a fine tribute to governmental mishandling of our world.
For all that we still donât expect Powell to be that aggressive on rate rises; all along he has talked tough but acted soft, it is his comprehension of what âgoodâ market communication means. Many of us have another word for it.
So, we do see rates as having risen too far, too fast, and they now need to stabilise, Powellâs talk and the market need to get back in line. Although the collapse of the Japanese Yen reminds us where the void lies too. And that a host of market decisions all really just come back to your faith in the US Dollar. While sterling has juddered lower at the whisper of cowardice by the Old Lady, but she has talked mild, acted fierce, the right way round, and I expect the UK to keep raising rates.
A Walk on Part in the War
While the UK political scene hots up, two factions in the Tory party are tussling for power, the populists and the realists. Both incidentally dislike Boris as a sell-out and will speak ill of him to the media.
The populists have done very well, loading on taxes and regulations and fluffy aspirations. And they have chanted fiercely in favour of pouring arms into a foreign war, simply because it is what gets approvals on Twitter. As if that ever ends well. Their new-found blood lust is extraordinary. So too is their fierce advocacy of fighting inflation with hand-outs, which is so 1960âs and known to be altogether futile.
The realists meanwhile seem to know that is the path to doom, but lack the nerve or confidence to say so outright. To eject Boris therefore requires two swarms of slightly crazed insects to coalesce, and in a mutual fury sting him fatally, then try not to destroy each other in a fight for the spoils. Are Tory MPs that stupid, mindless or incensed? Interesting question. I suspect like Powell they seek advantage in talking tough, knowing they canât act.
While aware I may already be wrong as I write this, I feel compelled to say that I wouldnât expect Macron, a realist, to fall before Le Pen a populist, but you never know.
So, I do feel we are, after a long wait, where we should have been after the GFC; if so thatâs a great win for rational investing. It is odd, that one crisis (COVID) is treated with monetary excess, while another (Ukraine) with monetary tightening; to an economist the problems (supply destruction) feel quite similar, the responses feel oddly confused.
But as Churchill noted America usually gets it right, albeit after exhausting all other options.
Perhaps it now has?
Will the March lows now be re-tested?
In dollar terms that looks likely, but sterling investors remain well clear of that point. I suspect (for now) uncertainty is doing the real damage and making it too easy simply to stand aside. But a belief that yields are high enough would draw funds into US bonds (clearly is already) Â and by definition, the currency. This oddly will then help US equities to find their feet.
That combination of forces, for now, has meant un-hedged S&P 500 has been a clear (and stunningly simple) winner in our flagship MonograM sterling strategy.
The modelâs skill is in making that prediction, so that we were already correctly positioned, going into the year.
Were you?
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