Halloween or Guy Fawkes Night?
There arrives a point at which our gaze lifts beyond the immediate chaos of politics, beyond the maelstrom, to the line of sight beyond, to calmer waters. We are there now, the US election (on November 5th) no longer matters much to how we trade out the year. The next administration canât start enacting policies until January, the State of the Union speech and the new Congress.
In the UK, we have had a phoney war since July, awaiting a budget, due the day before Halloween. Budgets are (or should be) a process, albeit leaky. Sadly, most of the leaks and badly flown kites, to date, are predictable, telling of a cash strapped government desperate to pay off their supporters, by ever higher taxes. They hope markets wonât notice. Some chance.
Globally inflation is falling based on goods deflation, a fair bit of which is out of China. The ongoing normalisation of energy supply, post Ukraine, also contribute, and is offset by regulatory rises in labour costs, stagnant productivity, and out of control welfare. None of that changes.
Meanwhile investment and necessities are now the areas being squeezed hardest, and business confidence is elusive.
From this OECD update
So where are the dangers for investors?
One has been to ignore gold, a long running afterthought in our in-house momentum portfolios, at a steady one sixth weighting. Some afterthought!
A more dangerous mirage is fixed interest, because it has been priced for a massive set of rate cuts for far too long, and all you get is a speedy convergence back to negative real interest rates.
Indeed, for a lot of investors, service inflation, not goods, is already the pain point, and service inflation and post-tax interest rates have already converged.
Although with the internet, net interest margin for the banks is not as volatile as of old. There are no longer big pots of locked in money in current accounts. So, falling rates are not hurting bank earnings much, indeed the danger is more of elevated rates causing defaults. But is that denting profits? Not really. Banks are getting good at holding their margins.
Another dangerous deceit has been the flow into value and into emerging markets, that trend has lifted prices, has been doing so all year, but again quite slowly, while some sectors and markets, like aerospace and Latin America, have been pretty vile.
Both Value and Emerging Markets have now had an awful lot of false dawns. Those too feel like a mainly 2025 trade now.
Europe â where next?
Europe seems genuinely to be struggling. I notice credit default swaps on French debt remain elevated after Macronâs summer failures. While Germany still relies on China and the motor industry too much. Without peace in Ukraine, it will struggle, although the arrival of lower energy prices and more tariff protection against Chinese dumping, will slowly help.
We are (nearly) all protectionists now.
So? Well, what has worked, likely still works, and while October might (yet again) be seeing a leg higher, it feels hard to get too excited, until after November 5th.
Private Equity
Two other 2025 themes are private equity and competition.
Private equity is just about holding its own. Those big, expected, discount compressions are not yet happening, so conflicting market views persist. The bears who, judged by the discounts, are still winning, see overstretched balance sheets, unaffordable debt, at any likely refinancing rate and a closed IPO exit market. So, a lot of stale assets.
The latter is both a reflection of how thoroughly investors felt ripped off in the last IPO boom and the bypassing of over regulated, backward looking public stock markets. For hot stocks, in particular, capital is still easier to raise off market. You can buy into AI without buying IPOâs.
However some mid-market managers are quite happy to use trade sales instead, and those will pick up, once politics gets out of the way and interest rates get more sensible.
Some smaller tech areas, which never relied on debt, nor expected an IPO exit, are starting to look quite frisky, as recent buys have not been at such high prices and they have ridden the post COVID technology expansion well.
And tech has been moving very fast of late. So, buying debt free, post 2020 investments, as they now start to exit, can be pretty good, and decreasingly offset by the collapse of lockdown casualties.
Competition
On competition both Draghi and then Lagarde are saying loudly that competition policy in Europe, which has been seen as being by national market alone, will continue to weigh on productivity. Instead, the competition view must now be pan-European, and on that metric, for example, we have far too many telcos and banks. We now have a new EU Competition Commissioner, but also a desire for a ânew approach to competition policyâ clearly stated by the EU President in July.
So whatever nativist German noises there are, if Commerzbank has an Italian suitor, that deal is still possibly good for Europe. If Vodafone wants a merger in the UK (or any other) mobile market, that should be fine too. Indeed, clear evidence exists globally that low prices cripple investment in the telecom sector, and to keep investing, keep advancing, sensible returns are now needed.
Of course, that goes quite contrary to the idea of competition authorities (and regulators) as agents of social change and protectionism, but it is being said very loudly now by the ECB. This comes with clear warnings about the need for spending cuts, to get Euro budgets under control, aimed notably at France, presumably as Italy is deaf and Spain is behaving.
Yes, we have heard it before, but the clash between cheap services (but no investment, no stability) and a sensible return (with investment, and stability) is getting far clearer.
Lower inflation will at last allow the rates of basic services to rise, to give a sensible return, to create a real market.
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.
Skipped - what will 2024 look like?
May I say we told you so? In "Skipping Along" before the summer break we called the end to rate rises, and by the November Fed meeting, we were well on board for a "rip your face off" rally. Feeling ripped? Anyone coming to the equity party in December, has just not been paying attention.
And our powerful MomentuM model had investors buying Japan and European Indices LAST December, so they have milked that entire rally. It also signaled buying back into the NASDAQ from May, arguably a bit late, but still very effective.
Jerome Powell said nothing new this week, and the New Year still looks bright for the beaten-up stocks, regions and sectors, as rates decline. I suspect prospects for the perennial winners to keep on winning are not too bad. Although economic growth will suffer (and so will earnings), but valuations still have some space to catch up amongst a lot of this year's losers, as discount rates keep swinging lower and bond yields dwindle.
A RED CHRISTMAS â Looking forward a year.
A year ahead, politics looks more interesting: so, what will the newly elected British House of Commons do next Christmas? What are the choices and likely outcomes?
The new Labour prime minister will care relatively little about political opponents, and quite a lot about holding party discipline.
Nor, we are told, will he seek early solutions to some of the more intractable constitutional problems (Second Chamber, Proportional Representation, Party Funding etc.), as based on his predecessor's experience, that just wastes precious time.
For all that, when it comes, his manifesto will (at last you may say) be festooned in clear deliverables, a plan to govern, at least for the next year. Â Â While Rachel Reeves is influential, the drive will be legislative, not economic. But as ever The Chancellor will have to then deliver the possible.
A DOLLOP OF BORROWING
So, more debt, extra tax, spending cuts are the options facing her, to fund that manifesto along with a cursory fig leaf for growth. The latter is needed (like the absurd Tory public spending targets) to get the Office for Budget Responsibility on side. Albeit responsibility is what you take, whereas the OBR offer simply a comptometer's sign off on specious forecasts.
For all that the Treasury thinks Gilt markets pay attention to the OBR, although I doubt it. So very early on, the rather too stringent self-imposed spending and funding restraints the Tories have adopted, will be quietly reconfigured. The rise again of a few PFI like schemes to keep stuff off the books is likely; Labour does not do fiscal hawks.
Falling interest rates and lower indexation provide small windfalls, and binning the 'irresponsible' Tory promises of tax cuts, won't hurt the numbers either. So yes, more debt, low tens of billions at least will be used.
A SPLASH OF TAX
What of tax? Can the pips be made to squeak. Yes, again, I am sure they will be, although not really on income tax, and I think for employed staff not on NI either. Labour has no love of the entrepreneur, who is too poor to hire lobbyists or to make donations. So, a bit more squeezed there off the self-employed and small business owners.
I expect a big hike in fuel tax, especially petrol and aviation fuel, under a green cloak, generating another ÂŁ10 billion. Consumption taxes remain rewarding: VAT rates, thresholds, and exemptions are all likely targets. And if they are inflationary, just adjust them away in your numbers. Nothing new â claiming them to be a 'one off' (of course).
UK property taxes are low in the South East, due to a long-standing failure to re-rate, so there is some scope there. With more housing coming, this will likely be punitive. But there are other enduring loopholes, that make little sense: REITs, Limited Liability Partnerships, a lot of EIS, VCT, Freeport stuff, albeit none of that is big ticket. I guess some simple populist tariffs may arrive as well. Labour is at heart protectionist.
All in all, I expect Labour to get enough from extra debt and taxation to provide a budget to tackle (rather than just top up deficits in the funding of) some long-standing reforms. I'd also expect seizures of assets. The Treasury seems to have a taste for balancing the books illegally, and there is little judicial protection.
PRESENTS FOR SOME
I don't expect infrastructure or defense budgets to be much loved â that's some of the cuts. The undoubted green spend will likely benefit (or keep on benefiting) China's manufacturers, more than the UK, but do still expect energy prices to go on up. They are the modern sin tax.
But higher tax, debt and spending can be pretty good for the economy, as Biden has shown, it all depends on how long you can get others to fund you for, and at what price.
Much as I am sure Labour don't want to crash the pound, they normally eventually find a way to do so, and for all my glib assumptions, they will be starting far closer to the edge than most new governments, for some while.
THE HANGOVER
How useful is that analysis? Well don't expect the FTSE to collapse, this will be a spending regime, but do expect stock specific damage, although arguably a lot of that is in the price of impacted sectors, or indeed the long standing (and ongoing) flight from UK equities overall.
The FTSE is mired in a twenty-year stagnation, from 7,000 in 2000 to well, 7,000 now, although not to altogether discount the medium-term Tory inspired rally. Note what Labour, even Blairite Labour, gives you.
On the other hand, sitting, duck-like, waiting to be hit, or worse buying into vulnerable areas, feels quite high risk.
The election outcome is (and has been for a while) clear. Nor is this a safe European coalition of the sane and less sane. Â It will be red through and through.
Given so many other options, and that some of the pain will be direct on pensions and property, it seems a good time to start planning on the investment side.
The MP's pension fund invests only 1.7% in UK listed equity. Do they know something?
Have a magnificent Christmas and thank you for reading.
We will be back on January 14th.
Charles Gillams
17-12-2023
By their works . . .
The November bounce in markets was a bit of an illusion, as interest rates may no longer matter, but foreign exchange still does. Inflation in commodities is probably sorted.
Meanwhile, Jeremy Hunt tinkers.
EQUITY MARKETS and the FABLED FIRST RATE CUT
The dramatic November rally, only looks that way if you are a dollar investor and for some weird reason the archaic Gregorian calendar matters to you. Sticking with the even older Julian one would have made October's performance much better and leave us ten days more of November to enjoy. Plus, lots more shopping days to Christmas.
While it was great for the big US indices, almost (but not quite) hitting the year's highs, in the UK, it was rather less so; the FTSE hit 8,000 in March and has slid down since, back to pre-COVID levels around 7,500.
The November US rally was also dented for sterling investors by a dramatic 4% slide in the dollar.
So, while it feels attractive, the fascination with the first rate cut date is pretty spurious. That is not the market driver. Markets have so far given us nothing this year for avoiding a global recession and seeing the last rate hike of the current cycle.
Surely that is worth something?
AND LONG BONDS
In a like fashion long dated bonds are giving us very little for having nailed inflation, and having (at least in the US) a credible inflation fighting stance again. So those, if you trust the US Government's credit, are not looking bad. This patch of inflation may have stretched the meaning of transitory, but it clearly remains just that, not a 30-year phenomenon.
Instead we see the recent fall in yields as being more driven by relief that rates have topped, and a desire to lock in nice returns in the global reserve currency, attributes which seem likely to overwhelm domestic US worries about high levels of issuance.
COMMODITIES
Commodities are where economics in the raw is most visible, especially soft commodities. High prices will always bring in marginal land, and there is no shortage of land on the planet. It may take a planting cycle or two, but food inflation always was transitory. Corn is now below pre COVID prices, let alone pre-Ukraine.
We believe the same is true for energy, for two long standing reasons: the first is that sanctions don't work, certainly not against enormous blocks like China and Russia. The second is that high prices create supply and in a highly tradeable commodity, they do so quite fast.
So, the idea of shutting in energy to manipulate the market price, is in the end self-defeating. It has to be. So however much the anti-carbon lobby and OPEC desire high prices, they are not sustainable. Indeed, it feels as likely that we get one of those crushing late spring drops in prices designed to flush out over-geared operators. That weapon works best, when interest rates are high and storage tanks are full. So why not use it? Â I remain far more nervous about the oil patch than most, it has yet to see the post COVID, overstocking crisis, that has rippled through so many sectors. Held off by the Ukraine war, oversupply is still around.
The World Bank October commodities forecast base case is for continuing declines.
Look at Healthcare stocks, still suffering from the COVID bubble deflating, despite new wonder drugs.
A stock like Worldwide Healthcare Trust, peaked in summer 2021 and has then slid remorselessly lower.
A LOOK AT HUNT'S TAX FANTASIES
Well, why bother, his tax give back is rightly mocked as trivial. His vague attempts to get welfare under control are painted as draconian, when they are anything but. While his games around a set of unrealistic self-defeating assumptions that he gives the OBR to produce nonsense projections in return are just absurd.
Full expensing for corporation tax is clever in only one sense, it is certainly not a tax cut, whatever he says, it is just bringing forward deductibility from after the next election, so off his watch. It is not changing what is deductible at all, and there will be loads of complex rules against deductions still, as ever.
While to most sensible cap ex modelling, the tax treatment remains damaged by last year's massive corporation tax hike. The long-term tax profile simply does not change, so it does not encourage investment, whatever he claims.
Oddly the real tidying up, as ever, is handled by Gove, quietly putting in place critical and very welcome new political funding measures, which reverse some of the long slide into democratic absurdity inflicted by inflation.
And he pops up in odd places as the fixer still, like Dublin trying to get the Ulster Assembly back in action - a vital if unpleasant piece of plumbing too.
Those are late but worthy actions, as a career ends.
The efforts on investments, while welcome and overdue are still tinkering, and the games with ISAs are as boring as ones with capital allowances. We see no real effort to simplify matters for domestic investors. The joke slashing of capital gains allowances (far from indexing or freezing they are still going down) shows a profound dislike of investors and investment.
Instead, a we get a work round to help UK investors buy fractions of Nvidia, - really?
Charles Gillams
3-12-23