WE ARE NOT NOW THAT STRENGTH

Markets are confused, as are Central Banks, and while generally indifferent to small wars, we know that’s how large wars start. And we have another month till November 5th and the US election. In the UK the Chancellor says it is all terrible, but is splashing cash around with abandon, but then cancelling dozens of projects, and claiming she is pro-growth, while taxing investment ever harder and encouraging so much capital flight even the OBR has noticed.

The colossal COVID debt burden still hovers over everything, a burden that can only be shed by growth or inflation, one an investor’s friend, the other their mortal foe.

Market confusion is more about politics than economics, no US rate cut in July, then a double cut in September, now a November (post-election) cut looks uncertain. The stated reason for a double cut was weak employment, but the real reason was political. Powell even said in his press conference that the Governors voted for the jumbo cut “in the best interests of the American people” so not economics, and I suspect those archetypal insiders will believe keeping Trump out is exactly that.

So, we get a “value” rally, as collapsing labour markets would lead to multiple rate cuts, and market interest rates, surprised at the severity,  then overshoot on the downside.

Except there is little evidence of anything wrong in US labour markets, as Friday showed, they are fine, and wages, along with rigid labour markets are driving inflation. Weird. But then good labour markets, plus buoyant earnings, plus falling rates sounds pretty good for equities?

Plus, something most odd in China, which from nowhere became one of the top markets in the last year, outperforming the major UK averages. Yet no one is clear why, on fundamentals. Yes, there was a stimulus package, possibly one focused on equities, possibly bigger than expected, but no one thinks it solves anything.

So, it (and ripples into luxury and metals) seems an almighty short squeeze. China had become so unloved, even its proudest fans had bailed out. The rush back in left other emerging markets, like India, struggling.

 

[Culled from two pages on Yahoo finance – read more here and here]

MANNERS, CLIMATES, COUNCILS, GOVERNMENTS.

Meanwhile, the Tory Conference was oddly upbeat, with some real choices, and a fair bit of optimism. The Tory party is in theoretical retreat, but greatly energised by a real debate, with members involved, about the new leader and a new direction. The disastrous election result had focused minds nicely, and yet was still discounted. Starmer had won fewer votes than Corbyn, and his popularity was already below Sunak’s. The loss was about “three tens”; voters switching to Reform, to the Lib Dems and the Sofa, sitting it out.

None of that was the love of another party, all of it was hatred of those Tories, divided and incompetent and now gone. In so far as the rump of the party now had stars, they were all standing for leader, no big guns were left after the disaster.

It was generally agreed that it must be the fault of Central Office and candidate selection, not the Party. The conference was also largely devoid of the usual big brother manipulation, fake applause, dire autocue speeches approved by a SPAD and ministers just too busy to care.

Tugendhat was bouncy, had the youth vote and the best video, but not convincing. Cleverly had worked hard, was fun and avuncular, relaxing and the obvious unity candidate. Jenrick gave some very strong speeches, plenty of thought, but seemed off-form and weary at the closing main event. Badenoch is an enigma, slightly thrown by adding “2030” to her pitch, when everyone was suddenly thinking “2029” again. Yet she is the one who wants to reform, draw a line below the stale “what did we do last time” and start afresh.  She had the best merch too.

It is still a split party, for all that. A good chunk of the younger party is very keen on Net Zero, and they were extremely visible, indeed Net Zero before all else. However the MPs know that was a Cameron fantasy, so I am not sure how that plays out.

But also, a clear understanding that talking right, governing left is finally over, and that border security is high priority, and defence is too, but not with quite the gung-ho optimism of before.

In many ways Starmer’s inability to know what sleaze and greed looks like, even if it is all innocent (a big even) bodes ill for his time; “they are all the same” is a deep-seated rallying cry of pain.

THE SCEPTRE AND THE ISLE

I am enjoying “The Sale of the Late King’s Goods”, a slightly wonkish account of Charles I’s lost trophies, but an excellent canter through the lead up to the English Civil War. It is striking how state policy was all so plausible and desirable, except for a massive inconsistency on faith, finance and Europe.

The King was desperate to be trendy, to think common decency only applied to others, had no real conviction, in restlessly appeasing various European Courts, seeking favours that never came. While funding was all about just getting to the next OBR review with enough cash to pay off friends. (Well OK, not the OBR back then, but a truly sovereign Parliament).

After finding so many conflicting aims inevitably failed to work, he then tried to drag Scotland into a standard set of beliefs and rules, and hoped blindly that the Irish would do us a favour. The desire to be liked, to look good, to look to Europe for answers, to throw money at white elephants and foreign wars, and the absurd doctrinal battles, all felt far too familiar.

If we don’t know where we are going, just buying expensive tickets won’t complete our journey. To strive, to seek.

 

The title of this piece comes from Ulysses, a poem by Alfred, Lord Tennyson

https://poets.org/poem/ulysses

Andrew Hunt’s piece this month, which looks at the solidity of underlying data and China may be of interest to serious investors.

 

by Charles Gillams

Tiptoeing Through the Tulips

Is real estate safe yet? How about renewables? And an innocuous Tulip.

All three of this week’s topics are notable for what they are not, Real Estate valuations do not reflect property markets or indeed replacement cost, Renewable Energy valuations do not reflect anything much, but include plenty of hope,  and the new City Minister seems to have no obvious purpose beyond being a safe and reasonably loyal supporter of all things welfare related.

Unreal Estate

As we have remarked before, somehow the RICS valuations of property assets, used to value  quoted property companies, became heavily reliant on interest rates and comparable bond yields and rather less interested in the real property market. They also seem to have become a tool for bank lending, disregarding other more real-world factors. Which explains the paradox of falling valuations alongside robust occupancy levels and a level of visible new office construction, certainly in London, which remains unabated and indeed the wider market is  seemingly indifferent to the slump.

There is a lot behind those paradoxes, long lead times through planning, the desire to replace older stock if (as so often) it is to be leased out, the dominance of bank funding, not equity.  Even so both collapsing valuations and the discounts then applied, have been damaging. This has been exacerbated by underlying fears about vanishing bank financing, in many ways a self-fulfilling prophecy.

We had something of a buyer’s strike where vendors can’t get bank finance to stay, and their potential buyers can’t finance to buy. The impact of working from home and the inevitable changes in business models adds to this.

Some areas, notably much of Docklands and many regional and secondary offices, have become untouchable. Closed end property vehicles have been forced to sell to meet bank covenants, and several open-ended ones have simply been forced to liquidate. Something of a perfect storm.

Yet, prime real estate has in the end, come through over time, and as we have noted before the residential market has been pretty immune from falls in at least nominal value.

In both UK and Europe valuations are now becoming more stable, and I would expect for the same reason they fell so fast, they will start to recover as rates fall.

For all that, in the equity market this year we have seen reasonable returns, as discounts to stated NAVs narrow, on both sides of the Atlantic. A number of activists are also pushing through mergers or reconstructions, which helps.

And yet nerves persist, the underlying discounts maybe less, but for Investment Trusts that own REITs, there are two tiers of discount (one underlying and one at the vehicle itself) and that top level has widened in cases.

Having endured that lot, and avoided earlier temptation, I am looking to re-stablish positions in half a dozen of these stocks in the UK and Europe, to work out the two that look like long term holds into the next cycle.

Not Renewed

Renewables have somewhat of the same issue, they are valued in part, again on the discount rate, so were driven down by rate rises, but also an odd view that energy prices are destined to fall over time. However, just as I have seldom seen prime city centre values fall for long, the hope of long run falling energy prices, runs counter to my experience.

There is also a great deal of uncertainty, both about what they produce, after numerous equipment and supplier failures, when they produce, and most of all, how to get product to the consumer with a credible margin.

But overall, the two sectors, property and renewables are quite similar, you have to get land, get planning, install infrastructure, hire builders, pay banks, realise your timescales were always far too optimistic, be nice to buyers, accept a discount, move on.

Having been wary of Renewables on the way down, I do now wonder if they are a separate asset class, or just a subset of several, including utilities, construction and distribution. If so, is it not better to leave that to the big multinationals with deep pockets?

Planting Tulips

So, to the new City Minister : Reading the current incumbent’s speech to the Stock Exchange, (not high on my list) it was of course indistinguishable from the last lot. The Treasury keeps these speeches, and the newest minister trots them out – often this is just an exercise in how well the next one mimics sincerity.

Has the Treasury orthodoxy changed? No. The allocation of capital remains the point of pain at the end of staggering amounts of hopelessly outdated regulation, some of them completely failing in their objectives. That much is unchanged.

Tulip herself is deeply worthy, UCL degree in Eng Lit, King’s London Masters in Politics, Policy, Government, so she should know how it all works and be able to write a good memo. But if we think the Government’s talk of “growth” is anything more than the illusory plug to stop the welfare budget draining us dry, a most implausible appointment. The milch cow must be kept placidly tethered, while it is milked.

The City will naturally be content, as ever, as long as no one rocks the boat.

But for all the ill-mannered sneering at the nice Mr. Draghi, and the EU’s failure to grow, we are in pretty much the same place. Now if Tulip wanted to be useful, and justify her principled disloyalty over leaving the EU, she should be mapping out how to join the Euro in 2030.

No road back to Rome exists, save through that thicket of joining the Euro first, the EU got that wrong before, it will not do so this time.

While of course half of Draghi’s capital market complaints are shorthand for saying that after all, Europe needs the City of London, not vice versa.

 

 

 

 

 

by Charles Gillams

A near horizon with a sunrise - and a pair of hands shuffling a pack of cards

Where will the cards fall ?

The half year approaches - what has happened? Two very different quarters so far. And Investment Trusts complain too much, having stuffed their boards with placeholders with minimal stakes in the shares and multiple appointments. In markets many things still depend on how the cards (and ballots) fall.

THE FIRST HALF

With current interest rates for hard currency, high yield bonds, around 6%, you would expect riskier equity markets to be giving you over 10% a year, made up of a mix of capital and dividends. That’s the bar; it is quite high just now.

Looking back a year, only Japan and America comfortably achieve that, the S&P up +24%, NASDAQ up +30%, Nikkei up +14%. Germany creeps in at +10%, neither France nor the UK do. Outside developed markets, it is largely dire, only India at +25%.

Then looking just at the first half, all of Japan and Germany’s gains came in the first quarter, so they are now sitting well off their twelve-month highs. While as we know the big three, S&P, NASDAQ and SENSEX, are now close to all-time highs, they powered through the second quarter.

So, the challenge is, do they go on up, do the markets that have fallen back, after a good first quarter, come back to life, or do some of the dogs perform?

various stock markets - and their performance on Friday 21 June 2024

Some major markets, Friday close and intra day

I have no great faith in the UK market, nor in a new government being much better at growth (it can hardly be worse) than the current mob. But there are cheap looking international stocks in the UK and the punishment meted out to real assets, by interest rates and shrinking bank balance sheets, might be finally ending.

While quite clearly the good middle tier stocks are easily cheap enough to lure in bidders from abroad or private equity, in some number. UK valuations are in short OK, not something you can necessarily say about the US.

The residual underperforming markets do often have a nice yield, but who cares? With bond yields high and staying high, in an appreciating currency, why take a cut in yield in order to buy equities? Plenty of time for that later.

Anyhow in most European and Emerging markets, equities seem not to be able to get out from under their own feet, endlessly tripping over their own fractured politics.

INVESTMENT TRUSTS

We are hearing a lot of moaning about Investment Trusts, which the FCA really do not like. EU law always struggled with the trust concept anyway. That the FCA has shown no interest in freeing us from those shackles is not a surprise, it seems they too would rather channel money to Nvidia than invest in the UK. Here is their Lordships’ briefing on what EU rules we might be repealing. Nothing for Investment Trusts.

I am on balance on the Trust’s side, I do think closed end structures (as they all are) allow long term decisions, while protecting daily dealing, one of Europe’s quirky hang ups. Daily dealing is fine in deep markets, but an illusion in many medium and small equity markets. With liquidity ever more narrowly focused, closed end funds seem more, not less, important, for balanced capital allocation, competition and growth.

Trusts directors should also protect investors from over mighty fund management houses, who treat closed end funds with disdain, as captive funds, with often high fees. Their greed lets in low-cost passive competitors. Instead, their permanent capital should come with an obligation to hunt down good, index beating performance.

Sadly, the FCA has perpetuated a system, where the fund management house appoints the Boards, not, in reality, the other way round. So, they are decorative, good for marketing, and highly unlikely to fire the manager. Too many are industry insiders, serving on multiple trust boards, often in sequence. Seldom do they have an investment of at least their annual pay cheque in their current Trust, and often, little investing expertise in the relevant area.

So, Investment Trust boards hardly ever sack fund managers for poor performance. David Einhorn explains the bigger issue very clearly, noting benchmark hugging over time is what investors now get. There is a clear link to poor performance and bigger discounts, and to big discounts and treating shareholders badly: One area where big certainly does not mean better.

Rather than sabotage the sector with old, irrelevant EU law, the FCA should be hunting down poor performance, and making the “independent” directors just that, including banning directors shuffling around a set of one-manager trusts.

INTEREST RATES

We have just had Powell hold US rates, saying it is all data dependent, and slightly oddly he conceded the expectation is for a pick up in inflation, on the technical grounds that the abrupt drop in inflation last year, creates base effects.

Although he rules out more hikes; you get the feeling if he had held his nerve last summer, and added a bit more, inflation could be beaten by now. Not that he wants to or can add such instability now, so he is stuck, and we with him, watching paint dry.

With no real distress there is no pressure to cut prices, service inflation remains too high, energy prices are still quite strong, so no longer giving a deflationary boost. Both the AI boom and the resulting stock price gains, encourage consumer spending and keep (in most sectors) a strong labour market.

Markets are evidently OK with that, falling rates, no recession, growing earnings, is almost ideal. Meanwhile we are all hoping that Congress will keep either of the two old men from doing anything unusually silly, and the electorate will keep Congress on a tight leash.

Quite a lot of hoping and several months still to go.

by Charles Gillams

THROUGH A GLASS

This is a curious market, swinging between pessimism and optimism on the thinnest of data. Is this rally for real, or just more rotation? Is the UK really breaking free?

Certainly, if you include dividends (and it is odd that we don’t in the UK; others do) there is indeed something moving in the UK. But is it more than one big takeover bid and a rising dollar, this time?

While the continued weakness in the AIM smaller companies index in particular, but also setbacks in some Emerging Markets (like Brazil) suggest this is indeed just jousting.

 

What can we see?

 

Markets have had a couple of sudden, dramatic jolts upward in the last eight months. Some ran up hard from October, while the FTSE sat trading sideways till mid-February (at 7,500) then launched upwards climbing almost a 1,000 points to now, and along the way had a shedload of ex-dividend dates to battle with, adding yet more to that return.

Others like the NASDAQ began their charge earlier, in the last week of October, then eased off in April, where they peaked and went sideways. The Mumbai SENSEX did almost the same, and again has been sideways since April. While the Japanese TOPIX took off in late December, but also peaked in late March.

That topping out in late March and early April does fit with the realization that US rate cuts had been, at best, substantially delayed.

 

Spinning, not climbing

 

That feels like rotation not recovery. The merry-go-round has just ended up on our own doorstep of late. If you look elsewhere, in small caps, my bell weather of doom, the Amati AIM VCT has been relentlessly down since late 2021, but has very slight recent uptick, and is trading on quite a slim discount now.

My other small cap telltale is Herald IT, very much taking off in late October and still making new highs, with (for this stock) a narrowing discount. Albeit it has a much less restricted remit and some of its small companies turn out to be quite big.

On a one-year basis, the US, Japan, India, Brazil all top a healthy 20% return, but on a three-month basis, only the Hang Seng (amazingly) hits double figures, a good chunk of which was last week, and Brazil is negative.

So no, not a classic recovery led by small caps and emerging markets, something more obscure.

From this pdf report.

But will it be another fake, like that immense pre-Christmas rally? Well fundamentals would still say yes, which is why I find it irksome.

 

Rate cuts - how many, how soon?

 

To me rate cuts look nothing like as baked in or as fast as in December; there really is no economic crisis, no recession. Growth keeps on, surprisingly strong despite so called high interest rates.

A rapid staccato set of cuts just won’t happen, it will be a gentle decline driven as much by politics as economics, and absent a crack in the labour markets (also not visible) not really going that low.

In particular, rates would then be neither low enough to give value stocks the boost of having their yields go way above gilts or treasuries, nor will they allow them to refinance absurdly cheap debt, at the same old give away rates. Both of which felt very much part of the pre-Christmas rally.

Until some sign of fiscal tightening (post elections) appears, we do expect the economy to run hot, and we do want central banks to have leeway to cut rates. And we want savings rewarded, modest but controlled inflation, sensible capital allocation, so what’s not to like?

Yet we have the risk off, value heavy rally from Christmas reprised, in what looks like a very different world, triggered it seems by Powell promising not to raise rates (as if he ever would).

So, we have a classic unloved rally, with summer doldrums and unpredictable US elections coming, to add to my unease.

The longer term, as I said, still looks fine, but we have to get there first.

 

What do UK local elections conceal?

 

Labour looks like a dead cert still, but it will be oddly unloved. Although in electoral terms (given first past the post in the UK) having four or five 10% opponents is a delight (Greens, Pro Palestine (if different), Lib Dems, Reform and that mysterious Independent group, mainly but not entirely unbadged Tories).

The total seat score and an absolute majority remains certain, but it does give some scope for odd three-way fights and surprises.

Then, there is the work of the Electoral Commission, creating weird new electoral patchworks out of their ruthless numerical hegemony. It is not clear how that shakes out.

It does also add an element of jeopardy, should one alternative faction catch fire. It will also leave a complex, disputatious opposition adding sand to the fuel lines, as the next Government tries to achieve something.

This also looks like a local councilor low (or high) water mark, solid Tory areas seem to have stayed resilient, and in the vast bulk of the middle ground, where the national majority rules don’t apply, ‘no overall control’ has done exceptionally well of late.

So, I quite like this market, nice to see some prices get off the floor and move past my “always buy” category, nice to see years of adding into falling prices finally reverse, but it is not (if it ever was) entirely logical.

The economic outlook is different from last year, and this rally should therefore be different.

That in many ways it is not, feels odd.

 

 

by Charles Gillams

The name of the game

What is the point of investing? How has that changed over time.? Do we still need so many choices? Are single stocks relevant? And we salute the prime palindrome.

We were taught that investing is an economic process for allocating capital to allow competition to seek out the best opportunities and fund the best businesses for the benefit of all. Countries with good markets have good capital allocation, grow faster as enterprises with the best return on capital, and then attract more of it.

Really? Not what it looks like now. Things change. The old gateways got knocked down, so anyone can access any investment anywhere. The paternalistic City was never sure about that, but in reality, markets followed communications, which went global.

The FCA (and to a degree the SEC) has a muscle memory of these protected times, and constantly wants to suppress innovation, keep new issues and ideas away from investors. Slow it all down, so they don’t just regulate markets, but control them. But excess capital flows are changing all that. It is instructive how the SEC, by trying to stop Bitcoin, has simply made it respectable and transacting in it safe.

And looking skyward and not understanding how this excess liquidity is created by quantitative easing is sadly no longer viable for investors; entire economies are built on it, like Japan. Nor is it transitory, it is embedded in the US and EU as much as anywhere.

Governments hoped to take control, using QE they forced the cost, to them, of debt down to zero, on the way creating such a shortage of bonds, that  prices rocketed. Paradoxically as did equities, for they could keep offering a yield and had no “lower bound”, so their prices could rise for ever.

Then equity investors got back in control, they realised they could move the price, on the thin sliver of equities that are actually traded, pretty much as they wished. In particular they could signal or co-ordinate, so that everyone was on board with the price direction. Which is both the meme stock phenomenon, but also at the heart of momentum investment.

And liquid, global, interconnected exchanges were designed to let all those price signals out in an instant. Of course, co-ordinating them takes only a few seconds more.

THE POINT IS

Which brings us back to what the point of investing is. I am only interested in capital allocation, if by understanding it and dissecting the choices, I can get better returns.

I can have an altruistic angle of course, I just like old style engineering and banking outfits, I sponsored the IPO of an art gallery once. I have a soft spot for Kenya and Bulgaria. I want to avoid ‘defence’ industries, I dislike tobacco and polluters, and not sold on slave labour either. How nice, and in the investing world, how utterly useless. Never, ever, fall in love with a stock they said: quite right, sadly.

Indeed, what you and I call capital allocation is what others call hot money, and it moves faster and faster. As for those bad actors, well money always attracts crime, the faster it moves the more options for criminals exist, quite a few of whom wear suits.

But then who needs stocks and analysis when you can now buy a market cheaply? Everything says invest in multiple geographies, but really? The process I have outlined above favours one or two markets, they win, so they give a good capital return, so they win again, almost regardless of what the underlying business does.

Indeed, Bitcoin shows, it can indeed be regardless of the underlying asset. Coordination and belief matter, not reality.

So, what of all the rest, the unfashionable markets, unfashionable stocks, they just keep underperforming, keep being sold, with very little scope to recover. With rates low it was possible to pay a competitive dividend, but when money market funds are expected to offer you twice the rate of inflation, even those dividends are unattractive, and they get taxed hard.

NO COMPETITION IN COMPETITION

While the Government has also destroyed the competitive market for companies, by largely sidelining hostile takeover bids. In any event issuing poorly rated paper for poorly rated paper never sounds great. But that closes out profitable exits; sure you get insiders sweeping the Aim floor for cheap deals, but by definition those are not competitive, you can’t have two sides both inside.

The government knows that almost any deal has a loser, or someone not as well protected for life, as they had hoped. Which means media noise and MP’s getting lobbied, so far better to ‘long grass’ it, via a competition investigation. Isn’t it odd that the competitive market in asset allocation created by an active takeover market, is the one market the competition authorities simply won’t investigate. But without that cheap stocks just stay cheap, it is why buy backs are so prevalent: the companies are right, the price is wrong.

Of course, index investing has issues, you buy the bomb maker, cigarette seller and dodgy legal firm all in one bundle, but that’s the game. If it is big enough, it goes in the index, and you buy the package.

And hot stocks are likely to favour low commission markets, and low transaction costs. It may be an accident, that UK commission and tax is based on total deal value, but US commission is based on share count (and there is no stamp tax). But it does mean that you buy a share in Berkshire Hathaway for the same dealing cost as one in Game Stop, or if you prefer Nvidia and Trump Media.

Assuming sanity, you trade in the US, or in stamp free index ETF’s, not UK stocks. Although the FCA are fighting a rearguard action against both ideas, with the discrimination against holding ETFs seeming particularly bone headed and indeed against consumer interests.

But few stocks, fewer markets, more hot stock volatility, it is just the way we have set it up, don’t be surprised that is how capital is now allocated, growth funded, prosperity achieved and destroyed.

TIME FOR A BREAK

As for this market, it had to break, we have said it for a while.

Levels have dropped sharply, and money is rotating back into bonds, or at least not flowing out of bonds.

Waiting to see through the summer, when that first rate cut arrives and who wins the US Presidential election, is all impacting the hot flows and making staying in cash feel easier.

While a more sinister undertow is coming from the narrative that the terminal interest rate settles out higher.

Our core assumption is still that real interest rates are now in a steady decline, but the equity bonanza of negative real rates is not coming back anytime soon. While for now, only one Central Bank and one market is going to keep on winning the hot money race. No prizes for second anymore.

The Winner Takes It All.

by Charles Gillams