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.
Jerome K Wiley?
We do think Powell is running off a cliff, just not the one the market assumes. As we endured the wettest February since (at least) 1836, when William Lamb was prime minister, and the wettest Tory government since records began, is there any chance of dryer times?
But first the tiresome tango of rate rises, the market swept to and fro, nation by nation, until the firm stamp of a well-heeled bond whips the whole mass back round again.
Bailey of the BoE, and Powell of the Fed
So, this week it is to be Bailey first out the gate, FTSE up, bond yields down, next week who knows? That rates will fall this year is the only certainty and the big US markets have built a near vertical climb out of that snippet. But you will note, not in rate sensitive stocks, the Russell (small cap) is still pretty flat, weighed down by the regional banks that dominate it.
And Powell, heâs guessing or as he calls it is âdata dependentâ, but for all that he is pretty happy projecting those guesses forward. So, he has moved from three rate cuts this year, to a new position of ? Well - three rate cuts this year. Not much data dependency there.
Before long he will run out of âthis yearâ, because the inflation numbers are not behaving, nor critically is the oil price. Â Like Bailey in the UK, he is desperate to cut and under heavy political pressure to do so, both have said 2% inflation is not now needed, just moves in the right direction.
I feel the only thing that can get us there is a sudden (and indeed overdue) drop in the energy price, which we do expect in the summer, but who knows? It has held up rather well so far.
So, at the moment, Powell is perhaps  running on thin air. Protectionism and vote buying fiscal measures mean he canât get there without some other help.
Markets are supercharged â is it sustainable though?
And if rate cuts are what has supercharged markets in the US, I donât see that as sustainable right through the year. It might instead be the possibility of a more market friendly, fiscally prudent, Trump, which would be more logical, in some ways; but that still feels implausible.
Nor do I see, as yet, many other markets joining in. Partly, why own anything else but the NASDAQ? Some markets have moved (Germany, Japan) but you could also argue that was after being oversold for too long. While the Swiss have cut rates, it is in part (as ever) to restrain their currency, I am less sure others will want to move ahead of the US.
They may be forced to, but there again their scope before European and UK elections looks limited. And some parts of the market, like UK smaller companies and many REITs (and some renewables) are not signalling anything but yet more damage and destruction, from suspect refinancing at high rates and over optimism on revenue.
Air Cushions
It was notable too how keen Powell is to slow the tightening imposed by reducing the Federal Reserve bond holdings, which has to date been done at a fairly brisk pace. He now talks of stabilising holdings, (in other words resuming bond buying, stopping the runoff of expired holdings) at what seems a high level, for fear of taking too much liquidity out of the system.
From this explanatory article on the process by the Richmond Fed.
For a while rates and reserve sales were working as one against inflation, but not for much longer it seems. Which should be good for bitcoin and other liquidity consuming monsters, if nothing else.
Who is Next in the UK?
The interesting Tory battle is between the Official wing, now entrenched in power, and showing no sign of intelligent life, beyond wanting to âmake a good fist of itâ in the inevitable electoral defeat. Then there is the Rebel wing, keen to cause trouble, break things, get popular support, or be nasty, if it gets them attention. Although the Official wing regards this as disloyal, it follows an old pattern. It is not just about this particular bunch: see this paper.
Faced with a like quandary under Blair, the Tory party swung left, towards the centre and power, just as Gordon Brown started the decade long Labour march to irrelevance. The Official assumption is that will work again, although the alternative scenario is that Starmer settles down in the centre for the long haul, and the Rebel wing, kept securely away from power, withers for lack of a structure.
But all ruling parties were, by definition, rebels once.
Back in 1836, William Lamb was an unsuccessful politician, wrapped around by Peel, sent to the House of Lords, then brought back as a centrist Prime Minister, and being generally useless, was turfed out again, after naming an Australian city, en route. One must hope for no repeats from history.
William Lamb, Lord Melbourne â from this site
It does not feel time for compromise candidates, nor will a âsafe pair of handsâ do. Rishi is in a fight.
Meanwhile the fields here feel like salt marshes, dark water lurking in deep cracks, the lips of which slide into clay and suck at the soles of your feet. We certainly could do with some heat.
I do expect this run in markets to go on, but the upside in the big US indices looks more limited and broader participation elsewhere will await those rate cuts. Both their size and speed have a capacity to disappoint, especially when they are so hotly anticipated.
The politics, a long time coming, may become more influential. It could get choppy.
We will take an Easter break, after what feels like a long spring.
And return with the sun (we hope) on 14th April.
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.
Sweet Dreams
Here we talk about the delights of the Conservative Party Conference in rainy Manchester, the failure of the in-built two-year time horizon in inflation models, and what may happen to interest rates.
FANTASY IN BLUE
At times in Manchester, it felt like everyone was looking for something. As government steps up spending initiatives, and empowers regional governance, and drives big spending on not achieving net zero, the chorus of demands for more taxpayersâ cash grew deafening.
There was utter silence on efficiency or capital allocation; it was all just âa good thingâ to spend more.
And oddly too, with so much lip service to the long term and reducing debt and halving inflation, the âhowâ of those was also ignored. Surely halving inflation is not even a government task? It was devolved to Bailey of the Bank - yet we heard not a word of criticism. If ever an eight-year commitment to a disastrously run project needed cancelling, his appointment looks to be just that.
This would spare him (and us) those endless letters on why heâs failing to control inflation.
For all that Conference was oddly cheerful - quite a bit of steel on show, from Suella of course, the only natural politician involved - some guts from Steve Barclay at Health, and Stride, a little less convincingly, at work and pensions - else, all rather wooden and on autocue. Although you could not help but notice that Farage still charms the fringe crowds.
COMPETENT DELIVERY?
The abiding issue remains competent delivery. It was odd to hear the government on HS2 arguing for accountability by sacking their own Euston delivery team. As if the failure of HS2 is not theirs, and theirs alone.
Instead of penny packet incrementalism, government needs a holistic delivery view - perhaps why France can build a TGV, and we simply cannot.
From this report of the Institute for Government
The Maude/Osborne âreformsâ destroyed half our domestic contractors, by a short-term focus and ceaselessly moving the goalposts. As a result, home grown firms are in the minority on the HS2 contractor list, and giant multinationals with more lawyers than bulldozers were the main bidders.
They want top dollar to take on the risk of a lazy, indecisive government machine - no wonder.
THE CHANGE PRIME MINISTER?
We have been very clear since 2019, that the Tories canât win another term, none of that changes, but the scale and composition of the anti-Tory majority next year is rather less clear.
In many ways, the best case for a Labour defeat, at the next election, is that the Tories have done it all already. They have blown the bank on out-of-control spending, splurged on unaffordable welfare, and raised taxes to unsustainable levels.
From this website
This government also crashed the pound, let inflation loose, let rhetoric overtake sense and has gone in hock to foreign debtors. I suppose they have yet to invade a sovereign country without a UN mandate, but they are working on that too.
So? Well oddly Starmer is still slightly boxed in, and in terms of polling data, not really getting much help from the weak Lib Dems, in those critical three-way marginals in the South. While Scotland clearly has had enough of the SNP running Scotland, it is less clear that they donât want the cause of independence to be heard in London. The Rutherglen by-election could be sending both messages, but in a general election voters only send one. I would not assume that genie is back in the bottle just yet.
JITTERBUG BLUES
We continue to see US rates above inflation, which is very different from UK rates which are still below.
So exactly what Powell (and Bailey) are doing with selling down the Central Banks balance sheets at a time of maximum new issuance, is not clear; it solidifies vast paper losses, creates new losses on the rest, so seems to be quite a pricey warning shot to politicians. But it is a plausible reason (along with super high levels of new issuance) for current bond market nerves.
We have always felt the Central Bank models, where whatever the question the answer is âit will be fine in two yearsâ are a fiction. The awareness that rates and inflation are staying high, is long overdue. But we have been in no doubt about it, for two years, nor have we ever flinched in our aversion to bonds, we were never being paid enough for the risk.
The jitters in the bond market feel more like a turning point, the sudden chop as the tide turns. The dollar has risen; people want to be there; if there is enough demand, that will lower bond yields again. So, I am not looking at US rates rising, so much as at the battle switching back to fiscal policy. Although in the end if Biden really wants 7% rates, I guess he can try to have them.
The UK and Europe are less contested, the labour market in Europe at least is not that tight, although still at record low unemployment levels, but with a lot of surplus workers in France, Spain, and Italy, and especially amongst the young. Euro interest rates are also really quite low still and are not yet looking restrictive.
So, it looks like another round of softening currencies, stagnant inflation and rate rise pressure. Central Banks still hope they have done enough. Even so it is quite odd that UK long rates are only just touching the level of a year ago, logically they should be two points higher. As for oil, we have seen this autumnal spike as a little surprising but transient, and as ever at this time of year, the short-term path is weather related.
Overall if the start is any guide, October yet again could be rough for markets, but longer term still looks brighter.
By their works . . .
Well, the works this week: a pensive Jerome Powell does nothing, a reckless Andrew Bailey does nothing, Canada joins Biden in picking fights, and the bulk of most equity markets are stuck, going nowhere.
NO MORE US RISES
So, the apparently knowledgeable financial press said that Powell predicts rate rises? He said nothing of the sort of course. True the other members of the FOMC dot plots were in aggregate higher than the current rate, but by a fraction, it is like the average family being 2.4 children, meaning everyone, in the absence of King Solomon, has three children. No, it does not, it means on average there are no more rate rises.
So, Powell has stopped the runaway train, by lighting red flares in front of it and throwing railway sleepers across the track. Job done. Inflation is way below base rates. Bailey has asked nicely and tried to lasso the inflation express from half a mile down the track - wonât work. Inflation above base rates is misery, inflation below base rates is time to loosen.
Powell did start rambling, describing parts of the economy with âby their works ye shall know themâ but decided that was all a bit erudite, before he had even finished the thought. He then reverted to the old saw, âforecasters are a humble lot, (with much to be humble about)â. Presumably that is unlike Central Bankers? I still think that judging them by their works makes sense.
But Powell is happy: the Q&A session threw him a litany of gloom, government shut down, students having to repay debt, auto plant shut downs, but no, all is fine.
The core US consumer and therefore the US economy, is in a good place was his verdict.
BAILEY DITHERS
Bailey seems to like to crash the pound every October, which is not good for inflation, just as picking fights globally is not good for oil prices. And it is also bad for inflation.
And either the UK government will cave in to public sector strikes or productivity will keep falling due to said strikes. Neither are much good for the economy. Nor is it good for the markets: in performance terms, the UK remains the sick man of Europe, amongst major markets.
THE MAGNIFICENT SEVEN RIDE ON
I was at the annual Quality Growth conference in London again, a stock pickerâs feast as usual. It seems that if enough stock pickers can agree on the menu, as the dominant prevailing theory of investments, they will drive the prices of their favoured stocks ever higher. Which they do, it seems. This is helped by the âover the long run valuations donât matterâ line, pushed hard by Baillie Gifford (amongst others). You might recall my article on Scottish Mortgage a while back.
And of course, as we know from both index and momentum investing, once something starts to move in a flat market, it keeps moving.
But that leaves the vast bulk of quoted stocks flat or down on the year, which makes some sense. When rates rise, bonds are substituted for stocks. The last two quarters in particular have been flat to soft, and while some of these stocks may have hit a bottom, it is still very hard to tell.
The only good news for UK investors is that Andrew Bailey has ensured their overseas (especially US) stocks have a nice currency tailwind.
MADE IN JAPAN
Meanwhile from Comgest thereâs a radically different view of Japan. The equity rally there has been fantastic, but it is not the typical exporter boom of a weak yen, in their view, but more about bank stocks soaring on the expectation of the end of Central Bank rate control. This allows their vast balance sheets to earn a real return, at last. This is quite a departure from the general explanations about âthis is Japanâs timeâ. That one has caught me out far too often, but explains the horror show from respected funds like Baillie Gifford Shin Nippon - small and illiquid is just nasty everywhere.
So, although the global rally looks to be strong, it is terribly narrow, and built on different foundations in different places. Or more positively, a broad advance awaits the first rate cuts, either from triumph (US) having controlled inflation or disaster (Europe) having created a recession and left inflation out of control. Either route to rate cuts wins, it seems.
GLASSHOUSES AND THROWING STONES
Oddly, I feel the Canadian spat with India is really quite serious, the tendency of rich Northern countries to preach, in this case standing very carefully behind the only global superpowerâs shoulder, really annoys the global South. It has been going on for centuries and is at heart simply the old colonial mindset.
Indiaâs continuing reaction may well portray the accuracy (or otherwise) of the allegations, as on the face of it this is deeply insulting to the worldâs largest country, and one that has tiptoed down the line between offending the West and creating starvation and destitution for millions in the South.
I donât believe it - murdering virtuous plumbers in Canada over the Punjab, which has long ceased to be a primary source of domestic concern, is plain weird.
All things are possible, and India cares far more about Kashmiri terrorism (for instance), but if it is false, expect a sizable slap to Canadian interests, and more accommodation for Putin.
After all, if you are treated as if you are behaving like Putin, why would you ostracize him?