Reflections & Predictions
This year wonât be last year, that much we know. Nor indeed will it be the inverse, which is inconvenient. So, starting this year as last year, but simply turned face down on the desk, is a trap.Read more
Seeking an end to the turmoil
This market turmoil feels interminable, as asset markets stumble to find a firm footing and churn relentlessly. Instinct says thatâs a time to buy. But there is so much happening, as this multi-year trauma unwinds, it is quite hard to know what.
Although we try to segment it, the key problem is the terrible dishonesty of politicians, who have bullied their citizens into an unthinking reliance on institutionalised theft on a grand scale and a belief that nothing really matters, as long as you have a press release to deflect it.
IT IS ALL STILL COVID
So, working through piles of annual accounts, as a pleasant distraction, (I have always enjoyed history), the one repeated theme, is of shrinkage, under investment, caution. This, in a way, is natural because COVID reset two years of global production, and indeed destroyed large areas of output and services. Which also makes it terribly hard to understand what ânormalâ is now.
Not helped by the piteous vagaries of those craving spurious accuracy. Big banks and resource companies seem overall just to want to carry on shrinking, which is odd as their results seem very good. But they are not. All that has happened is they took big write offs and reserves in 2020 (which were not needed) and that then reversed in 2021. However, the underlying business volumes fell, the trend to more disposals than acquisitions was unremitting; these are shrinking businesses.
To the populists who believe higher taxation lowers inflation (are they mad?) and indeed, to market commentators, this looks good, but it is really not, productive employment is shrinking too, workforce participation is not roaring back.
And with inflation we will again see plenty of âtop line beatsâ or rising revenue, but that too is an illusion. And indeed, raised dividends. For example, Shell now proudly offers a 4% dividend rise, as if that is generous; last decade it was, but not now.
That is now a real dividend cut.Â
As we struggle with a badly damaged global economy, government policy is unremittingly wrong-headed: you wonder what we could do worse than the vast debt fuelled bubble after COVID?
But then we stumble on the idea of doubling or trebling domestic fuel prices. We do this to punish big energy exporters like Saudi Arabia and Russia. Only a simple clown could believe that will help us, and only a child-like vandal, that it will halt Russian armies. We take our own possessions out and smash them on the street, like voodoo dolls, because we are hurting and want others to hurt too. Nuts - it is tearing our own clothes in blind anger, but we ourselves are not the enemy.Â
Meanwhile, underneath all this noise, is the game up?
Is the expansion we have seen for two decades based on cheap Asian product imports, and low interest rates fuelling inflation in non-traded goods now done? The non-traded category is everything that canât be shipped in. Land, services and the like that must be consumed, where they are provided. Although with that went quite a lot of imported labour consumption too, of course.
I keep wanting to write positively on China, but I simply donât know. Is their COVID winter politically sustainable? Is it a massive pivot back to a closed state? Was the aberration their great expansion, and they are now reverting to being a hermit kingdom? Instinct again says no, who would reverse the greatest success story of our time? But evidence the other way just slowly piles up. Another giant nation seems slowly to be sliding towards belligerent stagnation.
And so much went crazy with the toxic mix of low interest rates, and excess liquidity. We may at last have learnt that if you have a blocked pipe, spraying it with gold is not a remedy. The pipe stays blocked, but everyone gets flecks of gold on them. Better (and cheaper) to hire a plumber.
WHAT WILL BE THE THIRD POLICY ERROR?
We certainly donât see the recent bubble implosion reversing, for all the bluster, crypto, and concept stocks, feel to us like a long term drag on the indices, remorsesly lower.
The turn feels to be more likely in bonds. The fight is between a shrinking set of outputs, but rising prices and apparently rising consumption. As long as policy blunders persist, and they show no sign of ending; then the upward pressure on rates will also persist.
But we doubt that any conceivable interest rate rise can solve this inflation. In short, the fire must burn itself out or at least no longer be stoked up.
In which case posturing about a long run 2% 3%, or 5% rate is really guesswork. But thatâs the big question. If it is 3%, we are already there, but there is no great market conviction on that. At least the belated but long inevitable addition of the Europeans to rate rises, should take some heat off exchange rates.
LETTERS IâVE WRITTEN
What about Boris? I was quite surprised at the swift and co-ordinated move to a no confidence vote. The Tory party is rubbish at a lot, but plotting it does do rather well. And also surprised at the vote itself. The rebels can not win, without a candidate that both factions like, that is the real Tory party and this odd âCameron lightâ lot in Downing Street. Of course, Boris himself is already largely that candidate, talks right, acts left. Which means all sides hate him, but neither can replace him, for fear of the âwrong typeâ of fake instead. Just what you want to be, you will be in the end.
There was also a fair bit of bile, stirred up by the media, and rather infecting what are loosely called the âactivistsâ, who are anything but, but do bend their MPâs ears. They just want to dislike Boris and his lack of scruples, but also like the gifts he brings them.
They donât want local trouble, so enough of those MPs voted against him, to keep their local associations happy. If that âterrible manâ stays in office, they can at least claim they did their bit, but âothersâ then let the side down. Â Â Â Â
Will Boris last up to the election?
Our core belief remains Boris stays in power long enough to hand over to Keir and Nicola. But perhaps we have rather less conviction than last week. We thought Keir was more likely to be in trouble, but perhaps the Tory plotters could be desperate enough to finally agree on a candidate? Either way this is now a lame duck UK government.
But then like markets, outside events may rescue it, itâs just we really canât see how at present.
As for where to consider investing? Our MonograM momentum model loves the dollar, for sterling investors and for USD ones, increasingly just cash, and decreasingly the S&P, so long the global refuge.
But that is in no way a recommendation, just an observation; more detail on our performance page.
He who pays the piper
A very strange quarter: the FTSE100 was up, in sterling terms the S&P 500 was up, and the Russian Rouble ended where it was just before the Russian invasion. Short term dollar interest rates are nicely positive at last.
So where is the problem?
UK policy changes â could we finally be leading in economic policy?
Well, at long last the UK Chancellor has finally realised that just throwing money at inflation has one clear outcome: more inflation. This is tough lesson learnt back in the 1970âs and seemingly since forgotten.
If true it is a turning point and we predicted that it must always come sooner for the UK, if it persists in staying out of the Euro, than for bulkier continental currencies. Sunak also seems miraculously to be finally tackling some long overdue, multi-parliament, structural taxation issues, a rare sign of political maturity.
Whether he can hold the line against an increasingly dimwitted set of MPs and a media who constantly bay for more fuel to be added to the inflationary fire is unclear, but at least he has had the courage to step out into the unknown night, not cower by his warming bonfire of magic myths.
Nor is it clear whether he has the clout to unpick the cosy mess created by Theresa May and her childlike energy price fixing, or the ensuing nonsense from Ofgen. This fine-tuned capacity to the point of absurdity, guaranteeing a massive breakdown in the generating buffers, which had been painstakingly installed under a series of Labour governments.
Inflation policy is being taken seriously
But Rishi is trying; to cool inflation you simply must have demand destruction, there is no choice. This type of deep-seated widespread inflation will be hard to quell in any other way. True, areas of it can be contained, but it is hard to hold it all.
He is lucky to be helped by a Bank of England that seems to be serious about its brief, not regard it like Lagarde and Powell, as some kind of political inconvenience, to be wished away in double talk and evasion.
But heâs unlucky in other ways; we noted a while back that China no longer seemed to care about headlong export led growth, or more broadly about access to hard currency. It feels it can invest with and gain from its own currency and avoid importing the monetary excesses of the West. That in turn means it cares less about the endless flows of cheap goods to Europe and the US, and conversely about soaking up those surpluses in luxury goods and services. None of this is good for our inflation.
Meanwhile by eliminating the oddly divergent starting points for the two income taxes, National Insurance and Income Tax, Sunak has opened the way to many benefits. It continues to drop taxpayers out of the system, despite desperate measures by HMRC to suck more in. A key step, and a sign of, for once, a more liberal, more efficient government. Many more steps are needed to unshackle wealth creation, but it is a start. It makes much of the Universal Credit complexity around thresholds also fall away. Most of all it is a step closer to combining the two income taxes.
Politically this is highly desirable, as it strips away the pretence of a low starting rate of taxes on income.
It perhaps even gives an excuse for the otherwise inexplicable step of introducing National Insurance on employees passed retirement age. Given so much of current inflation is due to the mass withdrawal of older workers, another step in that direction looks remarkably stupid, but perhaps it has a higher purpose. It is good to see that the âAmazonâ tax as Business Rates should be called, as it gives Amazon such a massive earnings boost, is also clearly still under long term review.
Why has the rouble recovered?
Source : this page on tradingeconomics.
The recovery of the rouble is of course not a market step alone, doubling interest rates, exchange controls and the mass withdrawal of exports to Russia from the West, are part of the story too. But it also shows a turning point. At first the West was so shaken by Russian military attacks, it was prepared to follow its own scorched earth policy, regardless of the harm caused to our own people and employers.
But at some point, the realisation that Ukraineâs army would hold, that Putinâs army was not that good after all, especially up against modern weapons and we start to understand that the further blowing up of our own bridges just raised the ultimate bill. Here are the sanctions we've imposed.
So, it seems it is no longer true that any price is worth paying to help Ukraine or hinder Russia. Clearly, we donât have to jettison all our principles in dealing with other tyrants, nor one hopes do we need to alienate every piece of remaining goodwill with the rest of the world, by panicked grandstanding.
The mob is still rampant, goaded by an American president for whom no European economic sacrifice is too great.
But maybe it is also time to tell Ukraine that no NATO also means no imminent EU: Brussels has its hands full with its own struggling ex-Soviet states. Â Â Â Â
And what about Powell and his policy?
Well, we donât expect him to hold inflation down with his trivial rate rises, nor politically can he do more than tinker. It seems too that Lagarde at the very least has to get Macron back in, before telling the bitter truth about rates.
So, we feel the bond market has rates where the market would like them to be, in the US, not where they will be set by the Fed anytime soon. And the Euro is now in a very odd place, still with monetary stimulus being applied and with an unstable gap to US interest rates.
So, we may look to be where we were late last year, but in most cases the cracks are now alarmingly wide.
Europe, quite urgently, but the US as well needs a sharp jolt upwards in rates to halt inflation.
Oddly only the UK looks to have spotted the danger, stopped the false COVID âeconomic expansionâ, tightened fiscal policy, reformed taxes and raised base rates steadily, towards where they need to be. How unusual.
Long may PartyGate continue if this is the end result.
We will take a break for Easter now, and resume on the 23rd.
If the first quarter is a guide, by then everything will have changed again.
All kinds of everything
We move towards the end of the year with a great deal of challenging uncertainty and big calls to make, on inflation, China, US Politics, whether interest rates are pegged, and a few political issues. The temptation to sit it out and come back after Burns Night, is intense.
A lot of things will be clear then: the severity of the winter, and hence fuel prices, also of the EU COVID spike, the nerve of some Central Banks and who leads the largest one, and how the Beijing Olympics will go. All are potentially significant matters for investors.
Few of these issues are surprises, which is good, indeed we see advanced economies as being in fairly stable shape, but badly damaged by populist politicians, who canât face telling voters that ânothing comes from nothing, nothing ever couldâ.
Inflation
So, on inflation, we took some flak back in the Spring for talking about 5% inflation, but we regard that as pretty conservative now.
From the OECD data here.
We see it as structural too, not related solely to excess demand, supply chains or energy prices. All of these matter, but the last two are indeed transient, and excess demand is within the power of the fiscal and monetary authorities to affect. The real trouble is both the lingering and severe harm COVID is causing to productivity, especially in the service sector and in a public sector still too reliant on overmanning and allied with that, the curse of politicians trying to exploit the pandemic to pay off their chums.
Our conclusion is that we will have higher prices at least for the next two quarters and possibly all of next year. Critically Central Banks will most likely be powerless to prevent or reduce that, without bringing the house down.
Broken China?
One cannot but be envious of the performance turned in, yet again, by Scottish Mortgage. The half year gains are massively from one stock, Moderna, and then a broad raft of e-commerce and big data plays. So, really, they just continue to surf the NASDAQ run. By contrast their big cap China positions generally damaged performance but have not yet been visibly trimmed. Although China does drop from 24% to 17% of their NAV, which is significant, with North America rising from 50% to 57%. (I should also mention we donât hold a position in this stock and have not had one this year.)
So, NASDAQ strength allows them to survive what for most fund managers has been the poison of owning anything in China this year. A decision we took, guided by our momentum models, very early.
We also note the managerâs viewpoint, which broadly aligns with a view that what Beijing is doing, is what the West should do as well, in attacking and controlling big tech platforms and their associated excesses. Telling the biggest companies to also do more to reduce inequality and cure social problems hurts profits; but they still see both as not unreasonable requests and they claim big Chinese companies are already willingly complying.
Yet for all the apparently cold rationality of the Scottish Mortgage viewpoint, we do understand it, and do see China trashing their participation in areas of global commerce and capital markets as an odd piece of self-harm, if it is really their aim, not just an ill-thought-out consequence of domestic actions.
So, we see the set back so far in China stock prices, as based on the possibility of the area being uninvestable, like Russia, but not yet on that certainty - see the how strong the trade figures are even with India, a so-called political antagonist. But tipping over to uninvestable would be a market shock and again we inch closer to that, with each diplomatic spat.
United States - and the Fed Chairman
The big US call, and again we signaled this as critical a while back, and actually well before the US Presidential Election, is about Powell. My sense is removing a competent Fed Chair for purely partisan reasons would be damaging to markets and the dollar. But the pressure on the ailing Biden to do just that feels intense, and I am struggling to see who in the White House will have the maturity to stop it, if Biden caves in.
Would a new Chair do things differently? Might markets push harder still for a rate rise and the dollar, short term at least, suffer? For now, re-appointment is still expected, but the odds on a shock are shortening.
Interest rates
The Bank of England is also, quietly in the midst of a storm, it is not actually independent however hard it claims otherwise, it relies too much on Whitehall just to survive, and, in a way, canât do anything meaningful on inflation anyway. Still a rate rise, even a notional one, would show it is still awake. It makes little sense just now, but as a symbol might yet happen. To us it simply adds emphasis to the political chaos overtaking Johnson and the ongoing shift towards an institutional alignment with a Starmer government.
Material interest rate rises (so returning us to positive real rates) during 2022 therefore still feel impossible. Indeed, German rates have once more flirted with changing the nominal sign, only to collapse back into negative territory.
To sum up - where does that leave us?
Well curiously, mildly bullish. We may not much like the position, but who cares about that, our task is to make money for investors. We also have had a think about what rescued investors from the COVID slump, on the basis that a future sharp inflexion in interest rates could look much the same.
What we see is the power of real growth, not the flotsam of cash hungry concept companies that can never pay a dividend, but fast-growing, broad-based technology â following that has been the winner for a decade. We do want to call time on that, partly for the nonsense and scams it tugs along behind it, but we still struggle to see the turn.
Charles Gillams
Monogram Capital Management Ltd
Thin ice skaters or savants?
Are we drifting out further from the shore of reason, confident we can slide gracefully back to safety, or do we have insight others lack? Perhaps rates just canât rise, whatever the inflation rate? If so, they are a paper tiger. While in a week others have pondered the failure of UK investing during this century, we look at why our biggest bank seems to hate the country.
Iâm talking about the economics prognostications from HSBC, our largest bank. Following an intellectually flawed change in accounting standards (yes, another one), on top of the insanity of âmark to marketâ comes the âpredicted loan loss modelâ.
Now professional bankers (unlike those in fintech) donât make loans to lose money.
So, the politicians have instead required them to assume that they do.
Do the regulators know the industry theyâre regulating?
Imagine portfolio management where you assume a certain portion of your buys always fail. Might be true, but how? And if you admit you have to buy a certain number of your holdings to instantly lose money, what do your investors feel?
But although banks advance money on the basis of their credit committee assessments, the hordes of regulators deem some of it is immediately lost. Being rational people on the whole, the banks, not great fans of predicting the future (given their record), hire economists to do this for them.
Economists, as we know, actually know little, but they do build nice econometric models. The regulators, who know even less, tweak the models, the bank Boards (see above) also tweak them. Soon every model is so tweaked that the economists wonder why they bothered.
UK shown as the riskiest of places to lend
Which leads us to page 62 of the HSBC Interim Report. We read it, so you donât have to. There on the excitingly named, but dull as ditch water section called âRiskâ it is set out.
Now HSBC lends globally: Mexico, India, Vietnam, Peoples Republic of China. So, guess where âThe highest degree of uncertainty in expected credit loss estimatesâ relates to? Apparently, the basket case to end all wicker weaving is . . . Yes, the UK.
How?
Well first up their âcentral scenarioâ model sees the short-term average UK interest rates for the next five years, as 0.6%. Which at least is positive (unlike France, as they hate Macron even more), France (i.e., the Euro) rates are assumed to stay negative till after 2026.
This gloomy central scenario has a 50% chance, although for France it is a tiny bit better at 45%.
Now these are central estimates, but their âdownside scenario worst case outcomeâ for the UK is heavily weighted, with a chunky 30% chance, and oops, France then gets a 35% chance of that disaster, neatly using up the slack just given to them, by the central scenario.
Oh, and thereâs worse: house prices crater, double figure unemployment is locked in etc.
And thatâs a combined 80% of outcomes sorted; for a bank, that is pretty near certain.
China compared to the UK and France
What about Mainland China, then, their biggest market, if you now include Hong Kong. Well like the US (75%), China is at a high (80%) central scenario certainty, with Hong Kong at 75%. The worst-case scenario for the PRC is ranked at just a measly 8%, the lowest of any of their major markets.
Call it impossible - a prediction that China canât fail.
Well, if thatâs what the economists believe, who are the dumb Board to argue? Well of course they can, to cover their well-appointed posteriors, they then chuck another couple of billion of extra reserves in on top of the doomsday forecasts.
So, you see the vortex, everyone, regulators, economists, non-executives are just adding to reserves, like the good old days.
Maybe they are right, but we are seeing very little sign of those incredibly low global interest rates for five years, negative in France, 0.6% in the UK, 1.1% in the US? Really? If they are right, the markets are wrong.
And it is not just technical, with a 35% chance of France hitting the worst-case scenario, no wonder the Board has shipped out their French operations to a fin tech start up, albeit one backed by private equity giants Cerberus. Not an outfit known for overpaying. With five-year rates at 1.1% the dash for cash in the US makes sense too, selling out of their retail side as well. While with a virtually nailed on, global leading, 5% five-year average GDP growth in the PRC included, surely time to expand there?
Their loan book does not bear out HSBCâs bullish estimates of Chinese infallibility
So it is with some trepidation that we look at their loan book, on Real Estate, in China. It must be massive? Certainly, markets apparently assumed so last week. But no, a paltry $6.336 billion, for HSBC thatâs a rounding error. Luckily too, all rock solid, just $28m of reserves needed, although given their certainty that almost feels excessive. The Board probably slipped that bit in.
I have great admiration for HSBC, and for me personally it is a long-term hold, but I have much less regard for regulators and âeconomistsâ models, about which only one thing is certain. They are wrong.
So, I try to just strip out the predicted loan loss nonsense, but it is still driving asset allocations, even when palpably false. It explains much of the last two yearâs volatility in bank share prices and reported profits, it also justified the highly damaging dividend ban.
Yet the HSBC share price is still not much above 50% of its pre-COVID peak. Great investor protection that was, it hammered HMRC receipts too, for what? Based on what?
Does anyone challenge those weird scenarios internally at HSBC?
Is there really a 35% chance of France virtually collapsing in the next five years?
Or is this just part of cozying up to China? In which case as the IMF has shown, bankers accused of fiddling data for China, are not always seen as professionals and can lack credibility.
Regulators should not impose those odd fictions on real investment decisions either.
If they do real economies and yes jobs, suffer.
Charles Gillams
Monogram Capital Management Ltd