AGAINST THE TIDE
The two massive current market questions are about liquidity and rates: maybe thatâs just one question.
So, do we now question our long-held assumptions?
The storm in a teacup in a short trading week over UK Gilts is of little interest, we all know where it leads, I am sorry to say.
STILL ENOUGH LIQUIDITY?
Liquidity is the scary issue, and bond yields rising indicates a loss of liquidity, but is it serious?
I donât think so; the usual sequence is a panic causes a loss of liquidity, so settlement starts to fail, causing technical defaults, and then the frightened regulators crash the system. None of that is visible.
There are real strains, no doubt, Russia is struggling to finance war, China is suffering a property bust, but notably rates there are falling. Saudi Arabia canât fund expansion on less than 90$ oil, and both France and the wider EU are in very deep. But none of that is causing disastrous rate rises. Indeed, currencies, as intended, are taking some of the strain.
Gold and bitcoin are building vast, useless, liquid supplies of wealth. While a strong tech market is luring funds away from bonds, and of course the US Federal debt is vast.
Nor does anyone want to be in the market, when the inevitable happens, liquidity crises are a persistent feature of the system.
But for all that I see Central Banks still holding the line reasonably well. No one state has seen a dramatic failure, even the UK, always the weakest, is not yet really offering an enticing rate on ten-year money, given its failure to stop inflation.
So, the current liquidity action still looks, on balance, like bets for and against rate cuts, not distress.
And Trump has profoundly disrupted global markets, by offering a genuine, large-scale alternative to secular decline.
BACK TO RATE CUTS
What about rate cuts then? And inflation.
Inflation is clearly a problem, Biden has been running the US economy hot, to try to win the election, and now Trump optimism is doing the same.
US NON FARM PAYROLL - DECEMBER 2024
And the Fed rate cuts now look ahead of the curve. Indeed, the pre-election 50-basis point one always was.
We felt it was politically motivated, so a sharp kick through a reversal and a rate rise is indeed possible, but with real US rates still positive, it would also feel gratuitous.
The rest of the world has the opposite problem. True it will now import US dollar inflation, especially on energy, and its exports pre-tariffs will look more competitive, but I doubt if either matters, when austerity looms once more.
They just serve to disguise the underlying issues. Although it is possible Germany gets a Trumpian boost, post-election.
However, it will still be really hard for the European old guard to resist rate cuts, let alone allow rate rises. Taking down an already non-functioning banking system, would be reckless.
The UK is very vulnerable; thatâs why avoiding the Euro made so little sense, if we were set on swallowing the other nonsense.
I have never seen other outcomes, given Labour election promises and the need for some attempt to steady the ship before implementing real reforms. But nor have I ever seen other exits bar Truss II. If Reeves and her team let up on real service cuts, they have signed their own resignations. Spending money and raising taxes is instant, so never the hard part. Cutting bloated budgets is also easy, but does need nerve, time and skill. The jury is still out on if Labour has those.
WINTER BLUES
All the market turbulence relates to the holiday period, which in the US now spills over into late January with Martin Luther King Day, and the added impact of various Presidential comings and goings, so I think it can still be ignored.
Thin trading encourages stunts. While Q1 data is usually terrible, the most adjusted season of the year.
The first âliveâ Fed meeting therefore looks to be on March 19th. Which is well after earnings season.
So yes, volatility and reasons to be fearful, but overall, I fail to see this derails the Trump boom. Also, at some point the UK mood will change, if only for shares with high dollar earnings.
Adequate liquidity and on-going rate cuts therefore remain supportive narratives, but both are currently on a winter break.
Assuming no disasters on their return, the year ahead looks fine.
OTHER PLACES
India
I have had a longer look at the Indian economy.
In aggregate  India remains impressive, with plenty of money being made and invested. However, it can in the end go no faster than the average voter, and for some of those, life remains tough.
Modernisation and urbanisation look great on the IMF charts, but always come with a cost, in particular for the urban poor. To be clear, there is no old-style deprivation, no lack of food or clean water, no loss of civil order, there is some basic healthcare, but for all that a lot of surplus marginal labour still. Navigating those strains, while building a modern state, is no small feat. So, India looks great, but only if it can hold a basic policy line through and beyond the retirement of Narendra Modi. Here is a summary of Indiaâs 2025 issues, as taught to its civil servants.
Pakistan, Argentina, Poland, Hungary
Of the true frontier markets, which is the tier below emerging, the best Asian performer last year was Pakistan at +83%, but even they failed to match Argentina at + 91%. While closer to home the expected ending of the disaster that is the Ukraine War, let Poland achieve +46% and Hungary +36%.
None of these have much depth, all feel like recoveries from oversold positions.
Yet at some point Europe needs a single functioning capital market, not a string of small historic ones. Within that, the great advantages of New Europe, low state debt, plentiful land, skilled labour and big EU spend, could be attractive in the multi-year boom that will follow the end of hostilities.
Cheer Up, They Said
After a pleasant summer, the dampness returns, exposing a quite enormous and unbalanced level of growth among the verdant thickets of both Middle England and the NASDAQ.
Markets must climb a wall of worry, and the next two months are not short of that. Forget interest rates and non-existent recessions, thatâs just the stuttering voice of old economic models, fed fouled data from the last century.
IT IS ALL POLITICS
No, the risks now all look political; the prevailing orthodoxy is the West can keep borrowing levels high, to fund bloated and protected wages and welfare weirdness, impervious to international competition, or indeed to inflation. It has worked so far, and with excess and free flowing capital, there may always be a funder, mainly of state debt or residential mortgages, as well as a buyer of a few anointed equities.
And so far, that has remained the trend and indeed, somehow, the centre has held, once exceptional debt has now become permanent. This is aided in part by centre and centre left parties collaborating to silence the right, often behind the somewhat specious argument of protecting democracy from the wrong kind of votes.
But markets are jittery, they know the sums donât add up, as do voters.
Debt as % of GDP, US in red, Japan in purple, UK light blue, France dark blue
 IMF data mapper â from this page.
The same defence of democracy continues to require the now usual never-ending wars, and divisive and punitive trade barriers and sanctions.
Both businesses and investors are quite happy to sit on the sidelines, until a few questions get answered. The UK budget is expected to finally nail the myth of growth, by heavy new taxation, although it has almost been oversold, the reality might be a relief. It is not just the severity (it wonât be that bad) that matters, but also the direction of travel. Will it hammer savers, investors wealth creators and employment or attack consumption and waste?
Labour denials of an extra ÂŁ2,000 a year tax on average incomes remains to us implausible and indeed we suggested  many would be relieved at only that. Well before the election we said it will need about ÂŁ20bn (economics is pretty simple really) and suggested the biggest chunk of that will come from fuel duties; we will see. Indeed, weâve always known that various fudges would be used to skirt round the creaking OBR defences too.
The main UK stock market indices are once more in slow retreat, and while sterling is strong, we attribute that to short term interest rate differentials. High government borrowing is after all good for lenders. While in the US, it remains impossible to tell where the legislature ends up. Although like Starmer, many voters are so convinced the alternative is useless, they will overlook the socialist taint.
EMBRACING THE SIDELINES
Just now, the sidelines feel a good place: hedge funds, shortish term, high quality debt. There is scant evidence that the normal run upwards for emerging markets and smaller companies, from rate cuts, with attendant dollar weakness, has started, although many areas have moved in anticipation. But why buy in September when November is so much more certain?
That switch to smaller companies and emerging markets also may not happen this time, emerging markets have a lot of china dogs that look quite fragile, and smaller company liquidity is dire, so if yields stay high and defaults low, why add risk? While the inevitable fiscal squeeze will not help the hoped for returns and dynamism of a monetary easing cycle; you need both to work.
India meanwhile still stands out long term, but both the centre and more starkly the states are showing a notable loss of fiscal discipline, unrest in Bengal does not help and the IPO market is frothier than a Bollywood musical.
ROULETTE AT THE TORY PARTY
Given the apparent penchant for gambling, how many of the six (now five) chambers hold live rounds? We should glance at these ever-fascinating trials. The party faces strategic questions. Notably when does it expect to recover the 200 odd seats it needs, and how?
Well, I suspect the group saying next time (2029) will still dominate, although it looks rather unlikely. As to how, the assumption, I assume, is by halving the Lib Dems, but thatâs only 36 seats, which leaves over 150 to get from Labour.
Interestingly every leadership candidate agrees that it was all Central Officeâs fault, not for instance the wrong policies or a foolish rush to the polls. Most also at least pay lip service to rebuilding from the bottom up through local councils. Indeed, they even accept associations might matter.
Although there is also quite a bit, still, of finger crossing and waiting for Labour to implode. Not such an obvious solution this time.
As for Reform, if they also fail to implode, but settle in to be a real alternative, like their French and German counterparts, they will at least deny the Tory party their votes. Who knows, David Cameron might even emerge, in twenty yearsâ time, like Barnier as the compromise leader, from a party of no current electoral relevance.
It is hard to get involved in the contest, which will be down to four from the original six by next week. With so few MPâs, the choice is not brilliant.
It is a very narrow electorate, just 120 survivors of the wreck, so calling it and the shifting allegiances it reveals is hard. However once decided, it will be clear if the party is going long or short and which seats it is targeting, which in time will matter a great deal. Is it still unaware that a missed target could be fatal?
SAVERS TO BORROWERS
As for markets, I tend to ignore summer and short week trading, and the switch from bonds to equities, from savers to borrowers is a powerful economic force, as rates fall, but while the direction is clear, the angle of descent is not.
I assume it could be worse, that is even more uncertain but wondering how. Roll on Guy Fawkes Day.
OUR OWN EVOLUTION
This blog is evolving - when we started Monogram was a fund manager in widely accessible products, but thatâs no longer the path - we are increasingly moving towards family offices and offshore clients.
With a less domestic focus, it seems time to move this to a stand-alone blog. Which brings with it a touch more freedom. It will continue to remain fascinated by the world of economics and politics, and indeed fund management. But may be happier to poke about in the mud for sustenance, or sound a startled alarm, as we become the Campden Snipe.
The Glass Bead Game
We look today at a domestic version of a complex, rulebound meaningless pursuit that too many of our brightest and best waste their lives pursuing, and whose twists and spirals ultimately signify nothing. Â I mean the UK Office of Budget Responsibility (OBR), of which I took a tour this week. Almost nothing there is as it seems.
Meanwhile markets reprise 2023, with tech or bust once more. Although tech and bust is the market fear, as fiscal stimulus and services inflation hold rates too high for some to survive.
UK OBR
The OBR was an explicitly political creation of the coalition government in 2010, with a remit to somehow restrain the ever-increasing debt governments take on, to bribe electors. They were also keeping half an eye on the much older âdebt ceilingâ style US legislation. It failed; so now the OBR just thrives on telling the government how much more it can spend or not collect, with spurious accuracy; purportedly managing public money.
It doesnât forecast anything as a forecast is an expected outturn. All it does is crank the handle on the old, discredited Treasury model, creating projections. A projection is 1) a âwhat ifâ assuming all other things are equal and 2) only as good as its underlying model.
One clear flaw is the requirement to take government spending plans as viable when they are usually not. They also have no idea where public sector productivity is heading. It has no remit to look at how productivity might be helped and no capacity to look back at how wrong its old âforecastsâ were. That is the job of the National Audit Office, it seems.
It also wonât talk to the Bank of England, as that organization has executive powers (to raise or lower rates) and the OBR apparently must just be a commentator: more glass bead rules.
So, it fiddles with the model and its six hundred inputs and countless equations to give precise answers to pointless questions, because each answer sits in its own vacuum.
Thereâs a heavy focus too on tax revenue, but with quite a thin staff, this results in excessive reliance on HMRC, who can be hopelessly wrong (and typically over optimistic on tax yields). But again, if the tax bods claim some complex, job destroying, arcane nonsense will raise income, in it goes. The side effects of such decisions must also be ignored.
It has no remit to assess how taxes impact productivity, which partly explains many of Huntâs blatantly anti-growth measures. As a result, the economy is locked into low productivity, getting steadily worse.
From the ONS flash report here
For all that the financial press will be full of the OBR cogitations on the forthcoming budget (March 6th). One little bit of power they do have involves a requirement for the Chancellor to give ten daysâ notice of the budget contents (hence no doubt the usual leakage levels) and for two months before that, they sift through proposals and indicate how each, in isolation, would work. The economy is an interconnected entity, they know, yet there is no attempt to give us an overall view.
THE LOST RALLY
I have few rational reasons why anyone would lend the UK Government at under 4% for ten years, were it not for some foolish faith in the OBR projections, without reading the small print.
Which brings us to markets: back in November the UK ten-year gilt yielded 4.5%, by about Christmas falling to 3.5%, and now it is back over 4% and headed higher.
Chart from this website
Quite a spin in ten weeks for a ten-year duration instrument. This is why that Christmas rally in value stocks was ignited, and indeed started to push out into Real Estate, various Alternatives and certain smaller stocks.
Although it didnât move those stocks most sensitive to the credit markets, who will need to rollover/refinance current debt. This affects for example, the renewables, private equity, and office property. The problem there is of both rates and availability. With the scale of asset mark downs, whether interest is 6% or 8% is not the issue; there is no funding appetite even at 20%.
The year-end rally moved a wide group of stocks, from extremely cheap to still very cheap. We then realized that it was not yet safe to go back in, so buyers evaporated, and prices faded. With state debt at 4%, against persistent inflation, fixed income is also oddly unenticing. So, the market default has been to pile back into the biggest, most liquid, US tech stocks and similar easy-in/easy-out momentum trades, like bitcoin.
There is little sign of deflation in services, no evidence of it in housing, where supply issues dominate, and little in financial services; indeed, all the supply side mess of COVID and excess regulation, is simply getting worse. Public sector pay inflation is also high and going higher (donât tell the OBR).
This does not dent the 2024 story of cutting rates and hence higher stock markets, but it may require some patience, and that delay may itself create more pain.
The Glass Bead Game and the âlost marblesâ qualification for office
Our games of self deception are not to be confused with lost marbles of course; it turns out that the onset of senility is now a bar to being prosecuted for storing secret state papers and also, somehow, a recommendation for re-election for four more years, to the most powerful post in the world.
If that ends up giving us Trump again, by default, presumably he will at least have a defense in future years, against those same crimes? He does not have the âBiden defenseâ available at present, perhaps thankfully.
As the OBR shows, very clever institutions can come up with very silly solutions.
WENN DU LANGE IN EINEN ABGRUND BLICKST
We look briefly at China, not as an investment, but more an existential threat. And we finish the lessons of the Greek coup in 2015. While little else surprises? Except perhaps the pessimism apparently shown by the long bond.
But even that might have a good reason.
DIRE STRAITS
I looked idly at a certain pink paperâs New Year quiz and asked my companion for views, and on most topics, we had one, or could find one. But on one, âwill Xi invade Taiwan?â I had no idea.
Not because after Ukraine there is any doubt it would be mindlessly stupid to do so, and plunge China back into the dark ages. That much is obvious. There is no way China can âgo it aloneâ - without Western markets, capital, and innovation, it heads back to where Iran, Pakistan, Congo, and Argentina have been.
But a distant echo tells me that I donât know for certain. Perhaps my confidence that Putin would not be so stupid as to invade Ukraine, tints my view; I was wrong there.
I am also largely assuming any military contest is unpredictable, so I tend to focus on the long-term economic impacts alone. But I still donât know that Xi wonât try, which will clearly crash world markets.
I will deliberately not gaze into that abyss, but I canât ignore it. The best response I have is where two stocks are equally attractive, and on like valuations, I would buy the one with the lower Chinese exposure. Maybe my limited action says that I think it is possible, but really not that likely. The other option of course is adding to gold and safe haven currencies.
Looked at a Swiss Franc graph of late?
From : Google Finance currency page
Most investable firms can shed China, just as many have shed Russia, but at a much higher price. The reciprocal asset seizures will be vast.
And although it wonât cripple Starbucks, Tesla or Apple, it will be a big slice of asset destruction for them.
NO DEMOCRACY
Back to Greece - when we last wrote it was to note the ravages imposed by the EU and IMF on the Greek economy, and how the scars still remain. But completing Yanis Varoufakis and his seminal tome, other contexts are clear.
As an academic his note taking and indeed voice and video recordings were quite an exceptional contemporaneous record. Not just of Greece, but of how Europe really worked, in a crisis.
We forget now, that Ukraine also needed a big bailout in 2015, and a choice was made as to which mattered more to, in effect, Germany. The answer in 2015 was Ukraine, with the late Wolfgang Schauble wanting Greece out of the Euro, and Angela Merkel seeing that as a lesser evil, for Germany, than the collapse of the Ukrainian economy.
There is very little âEUâ in this incidentally, Germany was the dominant and controlling creditor. The IMF largely sat safely behind its super creditor status. As Yanis notes the IMF funds itself on interest, and that mainly comes from having plenty of distressed debt. Not an attractive feedback loop, however logical. And of course, it largely stood back from Greece â inactivity is often an action taken.
Moving on, the Greek crisis was closely followed by Brexit, at the time we thought that was chance. It is clear it was not, and both sides had learnt a lot from the prior event, to take into the next battle. The EU and Merkel in particular had no interest in rational arguments, having waded through all that guff in Greece; you can see Cameron may have been useless, but he really had no hand to play in his âre-negotiationâ. Simply âneinâ had worked well in Greece, so Merkel pressed repeat.
The old apparatchikâs argument about âreform from the insideâ was clearly flannel; popular mandates are for the birds. As a result, the Brexit faction knew it had to be a clean exit, with one shot to the head. Sadly, Theresa May failed to realise that, and when the EU subsequently realised she had thrown her majority away, they had no reason to agree any deal, or not to expect another craven capitulation.
What of Greece now?
Well, it simply lost a big chunk of its economy (circa 20%) to creditors and demolished welfare payments and entitlements, for a generation. Was that fatal? Not really, life expectancy rose through that decade, as elsewhere in Europe.
The left largely destroyed its high-water mark, one-off advantage, but remains a mid-teens political faction.
The October 2023 regional elections saw even more regional governorships fall to the centre right New Democracy. This was along with a rip-roaring stock market in 2023 as the long rebound continued.
EU
And in Europe? Well, those June Parliament elections are getting interesting, Syriza will suffer more losses, and the gains by the centre right in Italy, Holland etc. are likewise yet to show up in Strasbourg. This provides context for this weekâs defenestration of the French prime minister, for a near novice (at ministerial level). It seems this was a poisoned chalice for the big guns of En Marche, as the party are well behind Le Pen in the polls.
The European Parliament is such a mash-up of parties, and with limited real power, no change can be dramatic, but for once it could be at least interesting. The super-spending high regulating internationalist left, may get a setback.
Financial markets
Markets? I donât think they ever get going till after Martin Luther Kingâs birthday is celebrated on Monday. Despite the need for news, the decline in global rates is baked in, and remains positive for equities, especially rate sensitive stocks.
You can stare into the Chinese abyss, but be careful that is does not stare back at you, you will see what you most fear or least know, as Nietzsche knew.
Happy New Year.
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.