Black Headed Bunting
Flags should be flying, the COVID cycle is over (says Lagarde) rates are falling, currency wars are afoot.
Ignore the noise, watch the graphs.
But somehow gloom pervades.
Truly a black topped bunting.
MIXED MARKETS
Markets are designed to confuse and a lot of that is happening, with the worst of recent gloom a way back now. In developed markets it was April, after which the value rally got going, very much with falling rates. And they are falling - seven cuts (or was it Trumpās nine?) in Europe. Less than a year ago rates were at 3.75% and are now almost halved to 2%. Thereās a rising currency, giving an urgency to cut fast enough to stop the damage from competitive devaluations.
India also did a surprise double cut (so 0.5%) this week.
LatAm is behaving oddly, it has been a top market, year to date, but largely because it hit a low at the turn of the year; year on year it is not up. Brazil is almost in lockdown with rising rates (14.75%), and no surprise, a year-on-year market fall. Mexico is well into rate cutting, at 8.5% from a post COVID high of 11.25%. That market is up 17% this year.
Another year-on-year top performer is the Hang Seng, up 28%. Why is that?
Aubrey Capital kindly hosted an Emerging Markets conference in the City this week. A speaker noted that as China and Russia now avoid the USD, many traders are ending up with, or need access to, a non-convertible currency.
The PRC therefore apparently facilitates global gold exchanges, as a substitute, in three new offshore hubs (as well as Shanghai). This is perhaps helping to ramp the gold price.
But that has physical limitations. However, China also has a convertible currency, in the Hong Kong Dollar.
If that gets used more, demand for it also rises.
The actual twelve-month top performer is the DAX in Germany, up 29%. But just across the Rhine, the CAC 40 has fallen over a year. If nothing else, easy terms like Emerging Markets, Developed Far East, LatAm and even Europe, are hiding some very mixed performances.
MISTS CLEARING
But the common theme does look like rate cuts, and thatās a cause for optimism. The UK now needs to be very careful that Labourās fiscal ineptitude is not forcing rates to stay materially higher than in Europe, (still at 4.25%). Ā As a result, sterling is strong and in danger of getting stronger, helping inflation, but hurting growth. UK exporters are getting kicked enough already.
It hurts housebuilders too.
Compiled from the ECBās recent publications
The UK market rally feels a lot about beaten up, high yielding stock, sensing some relief is inevitable, regardless of the Bank of Englandās posture on inflation.
The strength in UK banks (a big part of that outperformance) is partly their attractive yields (as rates fall) but partly the belief that as rates stay high and weak demand persists, surplus capital allows them to buy back shares and reduce deposit rates, both of which the sector has been quite aggressive about. Thatās nice, for banks, but it is a Goldilocks position, either rates now fall, or bad debts rise.
For all those caveats the Europe, Value and Emerging Markets rallies are real. And if rate cuts go on, we expect these to persist. Along with this, at some point, a currency reversal when the Federal Reserve finally moves.
Our work still does not suggest an outflow of funds from the US, just as it does not suggest a recession or pull back. None of which makes much sense, given the weaker dollar this year. Although it may simply show a reduced inflow rate into the US.
So, is something moving, that we canāt see? Ā Rising long rates are giving the same signal, of assets unexpectedly moving, out of fixed interest.
While I expect political chaos under Trump, amplified by an obsessed UK media, I do wish for some days of calm; could he not play more golf?
Some of us take no notice, of course.
OFFENSIVE FUNDING
Back in the UK, the defence review - a helpful two-page summary is available here; sounds like something for everyone. (If the Tory party had the intellectual depth to suggest this, both the profligacy and militarism would have raised Cain).Ā But it is all (as ever) fabrication, there are no available funds, even though the serious work of building inventory, finally starts.
We are promised six new energetics factories, which sounds like a modish protein bar, but just means lethal explosives. It is the logical move, but only accountants can deliver it. Year to year accounting means we must accept (and hope) that 80% of the energetic output will be made, stored, and then destroyed, at a vast annual cost. This stuff does not keep well.
I have yet to find a minister that can allow that annual profligacy. Creative accounting is needed.
I also canāt see how this hybrid Truss/Reeves can borrow (and tax) another 3% of GDP for defence. She has already rewritten the rules to add billions of spend, loaded the tax burden on companies, and now like Trump, wants to spend her way out of debt.
It simply wonāt work.
KURD YOUR ENTHUSIASM
We noted last week (along with a speculation on tariffs, a mugās game, I realise) how Turkey is surviving unconventional economics. It does sit in the Emerging Markets universe, and is owned in emerging EMEA funds.
Notably, while for some of those countries, the holdings are dominated by banks, for Turkey, it is all real manufacturing, distributing and retailing outfits that attract investment. The odd impact of high inflation.
Although much more tourism will put out more buntings, including those gracing the ruins at Kars.
AGAINST THE TIDE
The two massive current market questions are about liquidity and rates: maybe thatās 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 donāt 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 canāt 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; thatās 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 āliveā 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 Ā 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 Indiaās 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.
NOT THE FOGGIEST
We have no idea why we are having a General Election just now. Not the foggiest idea how we remove the keystone of free trade and yet the edifice of beneficent competition remains intact. We have not much idea how you have free capital flows without free trade, or how floating exchange rates then work.
But we are all about to find out, apparently.
Meanwhile, we did enjoy Andrew Baileyās valedictory talk, at least under this decade of Tory rule, to the LSE. It made clear the Bankās view on its own Reserves and fired a shot across Rachel Reevesā bow in the process.
ELECTION TIMING: WHY NOW?
We could speculate on Rishiās slicing through the Gordian Knot, and admire his nerve in doing so; but it is just speculation. We do know a General Election costs about Ā£20 million per political party (yes, only that much in the UK). This will have required many earnest meetings and interminable slide decks. So, it must have looked like a good idea, at least to someone.
It leaves some largely superficial legislation half completed, and hastens the retirement of hundreds of Tory MPs, voluntary or otherwise. Even Gove has gone. A whole new cast will take the stage. Starmer then has eight weeks of summer bedding-in, before the treadmill grinds into action for him too.
A new cast wonāt change the script, however. They should be just as careful of sinking beneath ill-judged promises; delivery is all, and the toolbox is empty. Whilst coups and factions could be just as ridiculous.
A DIVIDED SMALLER GLOBAL ECONOMY
Free trade and the wealth of nations is much more interesting. In the last five years COVID has allowed the erection of unthinkable trade barriers.Ā Meanwhile, an imperial power wary of spilling the precious blood of just one nation, has over indulged in the funding of extraordinary slaughter, in too many others.
We seem to have lost our view of one humanity seeking development and freedom from poverty, for a globe divided into blocks, quite familiar to Bidenās distant youth, but strange to us. Naked protectionism rules, now trumping even the climate emergency.
Sanctions pile upon sanctions, 16,000 against Russia alone. Yet all of the above is now normal. There are no rounds of trade talks. The WTO withers, for lack of an appeals panel. Neither Trump nor Biden helped by their blocking of appointments.
THE SUPPORTS LOOK ROTTEN TOO
But what else is supported by free trade? Well for a start free trade is the international version of competition. Competition has no inherent virtue; it is, like free trade, quite destructive of businesses, seeking the lowest price. So, it too is junk, only valid within the four walls of a protectionist jail, which is hardly valid at all.
So, once we accept globalization is irrelevant, out goes competition, or rather it becomes a political tool, and as such has no economic validity.
In this context, consider the issue of floating currencies; if we junk that, then out goes the free movement of capital as well.
Look at how China devalues the Yuan to offset tariffs. Or how Japanās state policy is now devaluation.
We must expect some pretty hefty steps to shut out American access to markets or to act against floating currencies, coming down the track, if someone does not stop the madness. Nationalism will get ever harder to contain, once we donāt trade with each other. And superpower battles will lead to ever more defaults and destitution for the poorer countries. Look at Yemen, Venezuela, Myanmar, Somalia, Sudan, Afghanistan. Proxy wars are being fought in odd places; they are still people, and these are still wars.
Cut out free trade, and you cut out the economic heart of the globe.
NOT BANKING ON IT
Still taken from this Video of Andrew Baileyās talk.
The graphs speak volumes ā do look.
I didnāt know this was Baileyās last gig before the election, but maybe he did. He made a densely argued case for being very careful about political tinkering with Central Bank Reserves.
As he tells it, we went from post war banks dedicated to commerce and trade in the 1950ās and 60ās. Then came the great liberalization of consumer finance, in the 1970ās and 1980ās, followed by a perilous patch of virtually no reserves, through much of Tony Blairās time, quite visible for an extended period before the crash (the slim orange block below). However cleverly he called it global, it started in domestic errors.
Then the sudden explosion of reserves under Quantitative Easing, followed by the virtual end of commercial and business lending. The term funding scheme was an attempt to rectify a surge in consumer lending, but is now itself winding down.
So, to now when our system rests on vast bloated mortgage books and tons of gilts in the vaults. It still looks a very long way down to ānormalā.
There were a couple of well-placed questions at the LSE, strongly hinting that the next Government will try to exploit those bank reserves (perhaps by stopping interest payments on commercial bank funds held at the Bank). Bailey was making the case for not reducing the balance sheet much below Ā£400 billion, back to the 2016 level, that yellow shoulder on the graph.
That in itself is a sign that the banking system is not really working; as he ruefully noted, the recent crises (Silicon Valley Bank et al) came from not too little money in reserve, but too much in too few places.
And stock markets? Well childishly they seem pretty chill about it all. If money is being trashed, donāt hold money they say.
Well, do watch that ten-year gilt: for six months it has trended up.
What does that tell you? Not a sign of rate cuts soon. Almost back to the Truss spike, which apparently, we could not live with.
Like a few other things of late, it all looks fine, until it isnāt.
While the UK index is up overall, the indebted part is flat to falling, and there is plenty of that in the āvalueā area.
Altitude sickness
Do āhigher rates for longerā matter?Ā Is China doing anything different? Has the UK election become a one-horse race?
So far, both the markets and Central Banks have acted as if rate rises matter far more than they do, in real life. High interest rates are simply a pot stirring device, they donāt take any money out, they just shift it from borrowers to savers at a higher speed. The net effect is that they donāt matter to the totality of an economy as such, although the government takes a slice (as ever), and the exchange rate may shift.
It can also change investment decisions, affect confidence, restrain borrowers. But these are generally quite gradual influences. And the pile up in saversā cash offsets them. It is a change of content, not of quantum. Meanwhile, in order not to move the āconfidenceā needle, governments get spooked and start giving more handouts in compensation.
Investment decisions focus as much on corporate tax rates, costs and technology as on interest rates. While the evidence of resulting restraint by borrowers, where the dominant one is actually the government, appears a bit thin and is longer duration. Even the UK mortgage market has perked up.
Where rate rises may matter more, is if the winners (savers) donāt spend, and the losers (borrowers) default, creating value destruction, rather than simply price movements. Not much of that is evident yet, as loan underwriting has (generally) been good, and neither the level of rates, nor their duration, has eaten far into the big credit buffers still in place.
Defaults on bank loans, set against the greatly increased rate differentialās impact on earnings, have been minor. Bank provisions for purely economic reasons are not rising fast.
Overall, given the dominance of the āvote buyersā in most markets, I am not that worried by consumption, and judging by London theatre prices, the high end is not showing much restraint either. While all those second order effects donāt matter much this year.
It is no surprise to us that the world has now drifted back to ānot many rate cutsā nor is it clearly a disaster, for all the sudden market noise. The political imperative for a rate cut to throw before the electorate (justified or not) still leaves June in play.
It is fairly clear where the froth is, where any nosebleeds are due; also that this market response is all sentiment, unrelated to actual economic forces.
A SECOND LOOK AT CHINA
What of China? For a while in the un-investable box, and I think still largely so for the mainland indices. Reasons? political risk, both internally and externally, growing sanctions, unequal treatment of overseas investors, disappearances etc ā same as ever. So why look again? Well in part if globally the UK looks cheap, China looks even cheaper, right at the bottom of the pile.
The mists seem to be clearing on their economic strategy : manufacturing is still at the heart of it, which implies so is exporting and hence some engagement with the wider world. Not just high-volume low-cost production, although recent trade statistics do show falling value on rising volume. But a clearly and often stated desire to move up the value chain, seems to be coming off.
Chinaās factories have a lot going for them, they are still building coal power plants (306, yes three hundred plus, currently in the works) and nuclear, (150 plants planned over the next decade) at high speed, plus plenty of renewables, providing abundant cheap energy.
From this site
Labour laws are to them just an amusing Western concern. Also noticeable is that Chinese universities still study real science, based on academic merit ā they are the world leaders in many areas ā just ask your university professor buddies.
Plus, they have no interest in electoral cycles.
If China wants to stay at the core of global manufacturing, it can. A flat rate 10% tariff seems to barely touch the existing and growing price advantage. There is also a point at which consumers will baulk at the price of domestic protected production, even in the US.
So, if China is simply the old ill tempered, paranoid, Communist dictatorship, flooding the world with cheap goods, stealing intellectual property and manipulating currency, then the problem is at least familiar.
In that case, it is not throwing its lot in with Russia and going back to Stone Age military adventures as yet.
So, when fund managers hang on to well researched individual stocks, knowing all that background, I am inclined to at least listen. Trade needs cash, wants cash, uses cash, needs investment and therefore some global engagement.
INTO THE ABYSS
We have long predicted the loss of the Tory Red Wall seats, one term rookies as we called them. Under 200 Tory seats left in six months, seems well-nigh inevitable as well. So yes, it is a one-horse race. And is Starmer really going to say anything substantial (and in truth there are quite a lot of plans and approaches on the table already)? I doubt it, he has no need to.
It is just the older and far tougher problem of working out how to pay for it all, without raising taxes so high no one wants to work, invest in the country or indeed live here. Given the record of the last century or so, expecting things to change now, is delightfully naĆÆve. They wonāt.
It needs radical reform of regulation, entitlements and cost bases. No more salami slicing, no more buying off vested interests. There is some of that from Wes Streeting, but a lot more would be needed, the new ministers must do more with less, not less with more.
Looking at how the UK and US markets have performed this year, tells you a lot about those expecting such a grown-up approach. A backstop approach is to plan for the change.
Where many people choose to live and work, will be decided within this year.
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, heās guessing or as he calls it is ādata dependentā, 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 ?Ā Well - three rate cuts this year. Not much data dependency there.
Before long he will run out of āthis yearā, because the inflation numbers are not behaving, nor critically is the oil price. Ā 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 Ā running on thin air. Protectionism and vote buying fiscal measures mean he canāt get there without some other help.
Markets are supercharged ā is it sustainable though?
And if rate cuts are what has supercharged markets in the US, I donāt 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 āmake a good fist of itā 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 ā from this site
It does not feel time for compromise candidates, nor will a āsafe pair of handsā 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.