JENSEITS VON GUT UND BOSE

We ponder the point of the UK markets, ignore clashing BRICs, set up for the slow fall in interest rates in 2024, yes, long lags are long.

There are two investor markets, one akin to gambling and speculation, one allocating capital efficiently to invest capital or fund governments. But like weeds in a nutrient rich field, spare liquidity attracts the rankest growth of useless vegetation. There’s no clear way of knowing which is which. Money famously does not smell, and clients don’t really care much about how they earn a return, whatever they may say.

A graph showing how often investment clients have asked about Environmentally friendly activities of the company in which they are about to invest

From: The FT Adviser Website

Fads and fashions in investing fuel some success at first - then they can no longer conquer new lands, and deflate, dragging down asset values as they go.

ARE INDIVIDUAL UK STOCKS WORTHWHILE?

I look back, as all investors should from time to time, at my successes and failures. Luckily out and out failures are pretty rare, and in some measure, so are successes, as I quickly milk the wins (usually from takeover bids), so they disappear from the record.

This leaves me a pretty solid mass of fairly dull UK equity holdings, I slightly favour value over growth. So, I know a simple snapshot won’t reveal the steady benefit of, at times, decades of good dividends.

But at the end of it all, for a UK investor, what remains is a mass of general mediocrity. Resource stocks have been good to me, still are, but the mass of industrials? Not really.

Or property companies?

Well big dividends from REITS, but again not really. Of financials? Again, long years of high dividends, but capital values stay scarred by the GFC. Chemicals, retailers, distributors, tech, utilities: well, all fascinating, with some good runs, often good yields. But in the end?

I could ignore such perennial plodders when their yields were far above base rate, but they are now surpassed, by a simple savings account.

So, I do wonder at times like this, why I hold them. Doubtless we will get rallies, but the tone feels a tad discouraging just now. And I sense the politicians of all hues, who seem to be eager to relieve me of anything that looks like a nominal gain, or enforce their often extreme views on my assets.

PERHAPS OTHERS DO IT BETTER

My long-term winners by and large stack up in investment companies, with specialist fund managers, and almost entirely overseas, or at the very least global. Not that is much of a surprise, we have mentioned before how the FTSE100 has not moved much in twenty, going on twenty-five years. Yet again it has flattered to deceive this year, yet again it has that slumping dinosaur feel to the graph.

The UK is not alone in that. Most of Western Europe shares that fate, and Eastern European investing has been a good way to create losses. Somehow Europe’s governments have done just enough to keep investing alive - and somehow the stock markets have had just enough liquidity to avoid collapse.

It is partly why so many investors love small companies, but they are savagely cyclical, as we are seeing just now.

I could blame management, and their apparently limitless greed, but while many quoted boards maybe have rogues or knaves, but nigh on all of them? No, I won’t accept that.

Globalization has freed capital to move easily and fast. Far faster than any real business can adjust, and in this world the ability to attract capital is vital. True many attract it, to waste it, like a meme stock, or Peloton, but it would be wrong to see that as a line of tricksters repeatedly finding ways to con the market (although many have) more about the power of liquidity to inflate prices, attract buyers, inflate prices once more, in an unending climb. That is until the last buyer has paid up, and the tipping point is reached.

Taken from this website

Then the whole thing unwinds downwards, down to a true value, or less.

WHERE NOW?

On the one hand, as interest rates fall, and they will do soon, even if that one last hike is much discussed and may well happen, the path looking forward is downwards.

FED rates in the last 5 years

This should benefit value stocks, as more and more dividends emerge once more above the high-water line of cash deposits. Rates won’t go all the way back to zero, that is gone, but should start on the way down.

On the other hand, the liquidity trade is here to stay, money attracts money until the thermal tops out and the vultures glide along to the next spiral, or indeed back to the last one.

And looking over decades, as fund managers must, that is all that happens in most markets globally, one or two have true secular growth that also gets returned to investors (a key caveat), most seem not to. Investors become either hobbyists in love with a stock or short-term traders. It is notable how many of the new breed of big company directors spurn the shares of their own companies, bar a token few thousand.

Markets seem to have progressively been made easier for momentum, versus ‘true’ investors, allocating capital to create real jobs. The capital allocation bit is worthy but dull, and arguably governments and regulators seem to have strangled it into stasis.

The endless, joyful, mindless dance of momentum, is simpler, prettier, easier to tax, cheaper to trade; quite wonderful really. But is it much else besides that, or is it substance without meaning?

It is odd how governments moan about the lack of growth and yet cripple capital allocation. In a market system, the best capital allocator wins. It is really quite simple.

Once the tightening stops, there should be more currency stability (of sorts) as all the Central Banks realign their rate patterns again. In (to us) an unresolved month, the dollar’s strength has been notable, when not a lot else was.

by Charles Gillams

Large pipe - with the title saying it isn't. Meaning it is not what it looks like - blog illustration

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

Let’s start with colonialism. I have been reading about the benighted past of Bulgaria (R.J. Crampton, 2^nd Ed, CUP). A Bulgarian I know said that the country ‘has a knack for picking the wrong side’ - 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 empires’ 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 ‘independence’. 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 Crampton’s work stood out “by 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.”

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 “responsible” 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 won’t 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 20^th 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 decade’s 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 :

by Charles Gillams

Skipping along

Skipping is the week’s theme, following the inadvertent use of the term by the Fed Chairman, along with the rather weird behaviour of Jeremy Hunt.

Although any skipping seems unlikely soon, on this side of the Atlantic.

The dear old ‘recession’ still lingers, unseen but feared, like an ex Prime Minister. We are convinced it will arrive, but as a ‘technical’ recession only. It should be hard for anyone to be surprised. Labour markets are much stickier and far more fragmented. Supply is short, so any systemic shock feels unlikely. While as old hands keep noting, single figure mortgage rates, well below inflation rates, are hardly restrictive.

Chair Powell (almost) mentions ‘skipping’.

Jerome Powell was bowling along contentedly, when he suddenly described the Reserve Board’s June inactivity as ‘skipping’. Although it actually was just a ‘skip’, before he realised the error and with a guilty look speedily reverted to the far more passive ‘pausing’. But we knew how he was thinking. He was going to keep his foot on the neck of borrowers for a bit longer – interestingly, he refers to real rates of interest, as somehow unjust and injurious. Odd that when asked anything about fiscal policy he instantly plays the neutral, technical banker, no good and evil there.

Moves in the real economy.

So, what has really happened?

Not a lot, energy prices have climbed all the way up, and now slid all the way down. Aggressive fiscal stimulus continues, any chance Biden has to bribe the electorate with their own money, he still takes. Employment remains strong, although there is some tightening in hours worked, but it is still pretty hard to see how the Fed gets down to 2% inflation for a year or two.

And yet, markets by a mix of that unseen recession and faith in so called base effects, do think inflation by the autumn, will justify a real pause. No skipping.

UK Chancellor’s odd statements

Here in the UK Jeremy Hunt is in quite a different place. Inflation still looks high and embedded, but he has carefully outlined how he would keep going with substantial hand outs to offset inflation (aka fiscal stimulus).

However, inflation control was all for the Bank to sort out.

This is nonsense, of course. The UK Government is yet again stoking inflation while taking no responsibility for stopping it. He then gave a tortuous explanation as to why his policies have now produced exactly the same interest rates as the Truss typhoon, created by his reckless predecessor, but somehow, not at all the same.

Rate rises – a global feature.

Funny that, as we noted at the time, there was little odd about the October rate spike, and much that the Bank could have done (but refused to) by a prompt rate rise (matching the US) to stabilise the currency and inflation.

Rate rises are a global feature, with not a lot one small country could do about it.

2021 chart produced by the UK Institute of Chartered Accountants

So quite where the virtue of the Truss toppling quarter point rise is now, is rather unclear.

As sterling shows, the prize for that autumnal sloth will be higher rates (and inflation) than elsewhere for longer. The thing about fire fighting is the sooner you start the less you have to do.

So how did Monogram’s methodology work?

Our in-house model switched into Japan in December 2022 and Europe in March 2023. As we only ever deal in half a dozen big global index Exchange Traded Funds, this is not a tickle, but 25% of the total equity position in (or out) at once.

Brutal and scary, but effective.

We look at the signal, kick the tyres, thump the bonnet, turn it off and on again, look for reasons to ignore it, and then six months later look back in wonder and say, “oh yes, that was right”. These signals are delicate enough to very seldom feel right at the time, but after almost a decade of running the model, we have learnt to obey.

So, our Momentum performance discussion, yet again, is about how much we made, not about in which direction the money went. While the GBP version, seeing similar signals, has also never come out of the S&P 500, which for a good while also felt wrong, but it seems was right, taking a long view. The USD model was more skittish but is back in both (S&P and NASDAQ) US indices now.

So, we do know where momentum has been, and it is quite strong.

Markets in the political timeline

The rational thinkers say the market is (still) too expensive, but the trend followers don’t agree, who is right?

We tend to feel just as Central Bankers were very slow to spot inflation, they are possibly being too slow to see it has now been contained, and the US skip may be a pause and then a snooze. Which would be very convenient for the Fed during the US Primaries, allowing for cuts into the US election?

Related to that, we watch with amusement a dialogue about the attractiveness of stock exchanges, in particular in London, couched entirely in terms of what potential listing companies say they want. Not a mention of what investors want, as if they just don’t matter. Quite absurd, as what all listings need is a deep market, good liquidity, stable tax regimes, and an attractive base currency.

Is London aiming to provide these? We seem to favour founders – so, tweaks to voting rights, smaller free floats, fewer shareholder rights. But then oops! No buyers.

This is worse than nonsense, it damages what little is left of London’s reputation. In this market you start with the buyers. The price performance of many a recent IPO spells out the problem, the sellers are finding it too easy to deceive people – a call is needed for greater transparency, longer lock-ins, and less pandering to insiders and their advisers (not more).

by Charles Gillams

First as Tragedy, then as Farce

This is turning into another unloved bull market, we look at why, and wonder if Chou En Lai was right about the French revolution. Lets start with inflation.

I chanced upon Paul Krugman’s The Return of Depression Economics, written in 2008. Krugman is very much an establishment man, Keynesian to his socks and seeing the great failure of late 20^th Century economics being the sudden lack of demand. He has other work and more recent books, but I will focus on this one.

IMF Remedies

He has particular vitriol for the way the IMF repeatedly used austerity in its many forms, as the antidote to all and any of the chaos created by a deflating bubble. So, taxes up, spending down and crush demand to stabilise a currency, to avoid the extremes of bank collapses.

In Krugman’s world, it was more important to regulate banks, and it seems hedge funds, thereby stopping the sources of instability in the credit markets, and to then prop up demand.

Well, the echoes are there, current policy remains both IMF applauded austerity to save the currency, which is just what Hunt inflicted on the UK last year, and a desperate search for ways to pump up demand, to stop stagflation. Much as Biden is doing with the US and the amusingly called Inflation Reduction Act, and indeed the MAGA type, neo-Trumpian, protectionism now evident in the CHIPS Act. The rush to global rearmament should be just as effective.

All in the end versions of Keynesian demand creation – digging holes in highways to refill.

Echoes of Old Bubbles

Krugman is not indifferent to the bubbles this creates in the US stock market and US housing prices but would seem, like Senator Warren, to suggest whatever the question, more bank (and shadow bank) regulation is the answer.

It is odd as you piece together many establishment views, how this policy of ‘create bubbles, and then carefully regulate their deflation’, but never cut demand too hard, is now the undeclared reality of mainstream economic policy at Western Central Banks.

Krugman is blistering on some old tropes, the Schumpeterian theory of creative destruction gets short shrift, which still lingers in the financial press in complaints about ‘zombie’ companies (which I have always found weird). Likewise, that global development is all about rigging resource prices, which haunts the walls of a million coffee shops and a fair few churches and is also (sadly) tosh.

So, he is not all bad.

The New Bernanke Put

Nor when you understand how deep his influence is, does this financial market seem so strange, because the Central Banks hope inflation is external (weather, politics, madmen fighting etc) so this will “mean revert” in time. Alongside this sits a very wary take on destabilising currencies by interest rate differentials. The old guard real world elements break through occasionally (and have supporters, like the splendidly lucid El-Erian) especially with double figure inflation on the rampage, but they are not heeded for long.

Seen like that, while the stock market hates bubbles and inflation, it can’t shake the belief that in some form the “Bernanke Put” is still in play.

In which case ‘higher for longer’ on interest rates is a paper tiger, as rates don’t cause recessions, regulatory failure and hot money flows do. In that world buying an overpriced but liquid US market and buying the dollar looks, to many, like low risk. Not to us.

Inflation control?

And yes, as we have long argued, this won’t control inflation, but it seems who cares? We don’t need to fear the stock and housing bubbles deflating abruptly, as the Central Banks won’t allow that. Nor should we worry about rates, as Central Banks can’t let them rise much more, without jeopardising their over-indebted host governments.

So yes, old hands may hate a rising market into an economic slow-down, but they are it seems, just part of history.

What then to buy? Arms companies are not significant post ESG, the China trade is (we feel falsely) boosting already elevated resource prices, and travel companies are getting plenty of attention. Meanwhile areas of bountiful state subsidy (an ever-increasing list) are happy too. However, that is a fairly unattractive list. And are valuations in those areas still reasonable?

I can see why some investors just think playing around with Tesla options is the best bet (we don’t).

Then as Farce, Modern Imperial Europe

Chou En Lai when asked about the French Revolution was of the view (it is said) that it was “too early to tell”. I have been reading Michael Broers’ brilliant Europe Under Napoleon, an extended love letter to the EU, in favour of rational technocratic administration, with a deep-seated fear of the sans-culottes.

This seems to highlight so much of the French desire to see the EU as the Napoleonic Empire, without the bad bits. The terror of the rabble, the urban bias, the fetishism of one law, the desire to paint any opposition to EU autocracy as unspeakable - it all rather gels.

Well perhaps the parallels go too far, but in looking at the bizarre actions of the EU over Ulster it is tempting to see more than just childish spite. The resources thrown at half a dozen sleepy border crossings (reportedly 20% of all external border EU customs checks last year) made little rational sense. Even if not that bad, it was overkill.

So, I can half see why the DUP feel that getting rid of bureaucratic bullying is just appeasement, but looking at the litany of inconvenience to be scrapped, this does still feel like a win for all sides.

But as with markets, I suspect all the fundamental problems still remain.

by Charles Gillams