WHAT DO THEY KNOW OF ENGLAND?
Let us look at tech, private equity and this seeming market bounce, driven by those sectors. The NASDAQ is up almost 10% at 11,320 after a trio of twelve-month lows in the mid 10,300âs, the latest of those lows just this week. Meanwhile it looks like the US Elections have delivered both gridlock and a rebuff for Trump, which some see as a perfect mix.
Todayâs post title is derived from Rudyard Kipling at his most sanguine and reflective.
I HAVE FLUNG YOUR STOUTEST STEAMERS TO ROOST
The true horror of the tech wreck has also been concealed for UK investors, by the climb in the dollar, a move that seems to be going into reverse. In terms of closing prices sterling has rallied hard from 1.08 to 1.18 in a little over a month. This has left the NASDAQ collapse, from touching 16,000 - brutally exposed, now without much of the concealing currency appreciation.
Where is the Nasdaq headed?
We suspect that the NASDAQ is heading lower still, but accept that is a big call.
From this page on Tradingeconomics
It remains a crowded space for a lot of unprofitable companies to jostle, as they build market share. This disguises the possibility that in some spaces, even owning the entire market will still be loss making.
However, market sentiment has perhaps turned, the tech rubbish generally got chucked out early. The subsequent switching out of the tech majors probably had to be into Treasuries, where their recent price rises suggest some demand, or into cash.
It remains a crowded space for a lot of unprofitable companies to jostle, as they build market share. This disguises the possibility that in some spaces, even owning the entire market will still be loss making. Bumping up against that is the second phase of the market collapse, as the multiples on profitable tech giants returned to earth.
And cash (and oddly apparently the S&P) has also been seeing inflows from China and crypto, as those areas have sold down hard. There is also the unpleasant negative impact of holding cash, on returns. Put this together with sentiment, and this may well help the NASDAQ bounce into the year end. However, many fund managers cite the dotcom bust as meaning this is now starting a multi-year sideways recovery phase, not a quick bounce at all.
LONG BACKED BREAKERS CROON
A concurrent look at Private Equity is important. NASDAQ multiples drive much of their values and are falling, and with such a recent twelve-month low, Q3 valuations (private equity valuations are always lagged) have further losses built in. And a sprinkling of those will now also be based on a significantly higher dollar too. That wonât be pretty either.
Plus, as we know there are some spectacular blow ups lurking in there, the insolvent FTX was a big investor in, and investee company for, some well-known PE names. Overall, despite solid reports, I am still expecting some fair-sized holes in quoted private equity, as either the NASDAQ rises and the dollar falls, causing currency losses, or the NASDAQ falls and the dollar rises and the one again masks the other.
Access to distress financing, has it seems largely vanished, as it does at times like this, making the chance of highly damaging wipe outs, not just down rounds, much greater.
A possible dollar sterling parity?
But those talking of dollar sterling parity are surely way off now. So, regardless of future disasters, I want more information before seeing UK Quoted Private Equity Investment Trusts as a buy. About six months after the NASDAQ bottom, will be a good valuation point, and that likely means Q3 2023. At that point we will know what the current large discounts really refer to; I donât expect them to look anything like as generous.
THE UK - UNDER A SHRIEKING SKY
There is a lot of market optimism about the next UK budget, based on Hunt being really nasty. That may overstate his hand, as the Government has long abandoned reform, it can only support out of control spending by harsh tax rises, which will certainly kill jobs, but probably the wrong ones.
Nor can it do much to enhance investment and has foresworn labour market reforms, so both of those, with existing policies and more rate rises, must encourage the persistence of poor productivity.
Although of course the real budget numbers will be barely mentioned; energy, rate rises, and inflation are largely out of Huntâs hands. He is lucky all three do look a lot better than when he was installed. So, the need for harsh medicine is rather reduced, and may even disappoint.
But just as the rally helped US risk assets, so it helped others, like property, come off a deeply oversold floor. TR Property Investment Trust has jumped 30% in a month, for example, and still yields over 4%.
Post Mid-term elections for the US
And coming full circle, although slowing inflation took a lot of the credit, at least some of the post Mid Term bounce came from realising that the Federal Reserve now has an ally in the legislature. It can be less vigorous in steering the economy, just relying on the brake pedal, as Biden and Congress are no longer able to simultaneously hammer the accelerator.
Overall, however we still remain cautious, we expect this pre-Christmas rally to fade, rate rises to persist into at least Q2 2023 and rate cuts to be a 2024 feature. And peak gloom lies ahead as those rate rises conclude and then start to actually bite.
Looking ahead
In general markets have had a solid look at the worst case this year, from famine to invasion and nuclear war, to out-of-control Central Banks and deluded politicians, and nothing terribly dramatic has transpired. So even with bad things still happening, we donât see a repeat of this yearâs dramatic falls either.Â
Charles Gillams
- The Kipling Society meets on November 16th, at the Royal Overseas League.
PICTURES OF MATCHSTICK MEN
I noted at the end of our last bulletin, that markets are feeling strangely bullish, for a few reasons, which I share. Although only in some places. I still find little attractive in most debt markets. They are cheap, but given losses this year, are they good value?
And UK politics is becoming boring, which is no bad thing.
So, were we right to predict that interest rates alone cannot tame inflation?
Our original thesis for this year, that interest rates could not tame inflation alone, maybe is right. The level needed would cause too much damage. But that is applicable (we now see) to the UK, but not as yet to the US. And oddly perhaps not as yet to the EU either, although Lagarde midweek, perhaps had the same tilt. But German profligacy may wreck that.
The logic is the same for them all. You canât tame this beast by rate rises alone, as double figure inflation needs double figure interest rates and that is just not happening.
The UK is certainly not prepared for that level of rates and fiscal restraint is therefore now required. Fiscal drag will do some of the heavy lifting, and energy price declines a fair bit more.
Some commodity market statistics were released by the World Bank, this quarter. The above graph is extracted from their statistical report
But tax rises and government spending cuts will still be needed to cool the UK labour market. In particular the public sector must be reined in, or service cuts made.
Earnings will fall, taxes rise, growth stall, discontent rise. But still no collapse in housing (secondary) markets or in employment.
Nor do I therefore see much rise in loan defaults. This makes the recent round of forward-looking bank provisions unusually daft. You canât audit the future, so how can you include it in historic accounts? A weird hybrid. Best to ignore all that and focus on now, and now is still not terrible. With a pretty hefty valuation discount in situ.
(Data downloaded from the Office of National Statistics for this in house graph).
The US political situation
In the US, The Federal Reserve have effectively said if there is no fiscal restraint, they will ramp up rates till there is, or inflation falls. That is scary, but it looks as if the Mid Terms will hobble Biden and stop some of his fiscally reckless measures. He thought the wave that toppled Kwasi missed him, but it was the same ocean, and likely will give him a rough ride too.
Bidenâs approach felt good, overindulgence often does, but the pain of the untethered dollar is now starting to hurt US earnings, and in time US jobs, however much they dream of legislating against that. The impact of rate rises is also probably less than it sounds in the media, partly because most reporters are likely to have mortgages, whereas a growing number of investors donât.
Overall US government policy remains to force up inflation and challenge the Fed to sort it out. Hence all the Fed threats are directed not at the market (which cares) but at The White House (that does not). Mid Terms (on the current path) will therefore be a big boost to US markets, as it means Congress at least, will start to work with, not against the Fed. As with Kwasi, a reckless budget will not pass unchallenged again this time. Those extremes belong to the COVID era, that is now over.
Comparison with the UK position â and where Europe maybe is headed
With that battle already won in the UK, both sterling and to a degree UK rates are reverting to the status quo ante. And as sterling rises so the FTSE falls; that link also remains. If the UK is neither chasing interest rates up, nor letting the pound fall, it gives Europe some cover to do likewise.
In truth although sounding dramatic, in the real world it is inflation that really counts not (as yet) interest rates which are still absurdly low.
The Tory Party â what can we discern?
Talking of status quo, thatâs where the Tory party is now headed. Cameron drifted too far left, Boris dithered, Truss drifted right, and now the new government is a hybrid, although colloquial English perhaps has a stronger word for it.
I sense that spending decisions may correctly be back with a powerful Chancellor. There is a seeming party truce till the next election, when half the current Cabinet seats will vanish anyway, and then who knows?
Or if this coup and enforced hybridisation fails, we really will know the party is split, and a General Election could follow. Unlikely, though.
Why bullish then?
US earnings except for highly indebted outfits, will probably stay surprisingly strong for a while yet. And likewise, the dollar pivot point is being pushed further out, as no one else in the developed world is going for rates quite that high (or that fast).
There are also two market forces to look out for, rising rates and slowing growth is one, but the simultaneous loss of liquidity is another. The former will cause a patchwork of changes, both good and bad, but the latter the ending of a multi-year bubble.
It all remains cyclical â a transition, not a bounce
The difference is key, rates are possibly a two-year cycle, a bubble a ten-year one. The bubble in non-revenue companies, and in absurd multiples for even profitable tech, will take longer to deflate, be slower to re-inflate and be muddied further by all that spare capital accelerating technological change. This is still not an area we either feel confident in, or trust their valuations.
If we really are back to the status quo in the UK, about to be in the US, why would markets be going down, down, deeper and down?
FEEDING FIDO
International interest rates - what a dogâs dinner! But perhaps also a wake-up call: this is real life - governing for your social media feed does not work. We take a glance, too at the property market.
MARKET EVENT OR MACRO?
Our view has long been that we need rates at 5% to make a dent in labour inflation, both in the UK and US. It looks like the Fed (to our surprise) finally agreed. But with that comes a risk of overshoot, driven by the timing of the US mid-term elections. Powell, perhaps rather more attuned to politics than his banker colleagues, was keen to drop the bombshell early, rather than on 2nd November, right on top of the mid-term elections. So, I think the Fedâs now done with giant rises. Future rises may be less and spaced out, and quite possibly not that many.
One of the most chilling sections in Powellâs press conference was when asked about the global implications: yes, he assured us, he quite often takes tea with international colleagues. That was it. This time round the US is happy to crash through the global economy without a care in the world.
Encouraging short sellers
It seems Bailey of the Bank failed to get the memo, because oblivious to the soaring dollar, he stuck to plodding domestic rate rises, as if Leviathan was not bursting forth from the deep. Lifting rates by 0.5% when the dollar lifted 0.75% the day before felt like a joke. And if Bailey could not see that, the markets could: UK two-year gilts abruptly repriced to US rates.
But sterling is still hobbled by UK rates at 2.25% - too low. By trying to be clever on the rate rise, Bailey has simply let the short sellers in. As the chart below shows, having already hit the renminbi and the yen, it was obvious who was next. Sterling is a small but liquid currency block, with no allies â so it typically pays more to borrow. The markets just needed the signal.
From : this siteâs fine moving graphs
I doubt all that volatility really makes much difference to the real economy. Indeed, the Bank has now braced sterling nicely. As for the pension schemes, the FCA (Baileyâs last top job) created the foible of pensions being forced to hold loads of so called ârisk freeâ assets to prop up UK government borrowing. A most amusing idea, always going to blow up one day.
Not that sure even 4.5% rates will slow wage inflation up. But we will know soon enough, after all the destination was to us never in doubt, just the arrival time. I still see the strain of rates rising to (say) 8% as too much for the electorate in either the US (the leader) or the UK (who follow).
Recession fears?
Nor do I consider either the US or UK end rates to be high enough to cause a severe recession, although clearly, they will have an impact on asset prices, and in the end, labour markets.
So, I conclude this is more a market event than an economic one. And surprisingly it is all in bonds (and therefore currencies).
Investors will hang back until they see those settle down and that could take the rest of the year. So, although everything is perhaps cheap, the VIX will keep many on the side-lines.
The UK at least feels at bargain levels, but buying dollar stocks still feels somewhat pricey.
BRICKS AND MORTAR
So, to property. Well, we got this one wrong. Partly we failed to see Ukraine becoming a big war, but one with no quick winner. This triggered European (in particular) energy inflation. Partly we therefore saw interest rate rises staying in single figures, which is not what some REIT prices imply.
Not that we have changed our longer term â4&4â view on interest rates and inflation, (so higher for longer) but other investors and markets clearly have. You canât fight the tape.
In general, outside the warehouse sector, real estate companies (unlike say Private Equity) had already taken the hit to values, their balance sheets showed the new world, backed by real deals. So, adding a second discount does seem odd.
Gearing levels are not high, and debt maturities well extended, and interest (still) well covered. Maybe private markets are worse, but it is not clear why that contagion spreads into quoted ones. If there is a blow up, it is not obviously in public markets or mainstream lending.
But if quoted markets are right, what of residential markets?
Well logically as they are still going up, do residential prices now have a big drop built in, which is yet to happen? The price of mortgage banks, home builders and buildersâ merchants all say âyesâ. But how will it happen? It is not a big sector in UK public markets, but the odd couple that do exist (Mountview, Grainger) have also taken a hammering. They have some debt and are rental specialists (of various types).
So, markets say yes, house prices will also collapse.
Do I believe that? Anymore than talk of imminent dollar sterling parity and 8% base rates? Frankly no. Stagnate, chop around, go sideways, blow the froth off. Sure. Collapse; is wishful thinking.
After Armageddon I fully expect to see a plucky estate agent emerge from the ruins, justifying an offer above the asking price for the debris, with potential (but may need planning consents).
So, if true, that means despite a hair-raising ride, those mortgage banks and residential owners will in time emerge resilient.
Sadly, for many, that also suggests, without forced sellers from the buy to let market (where there will be a few), the stock of housing units wonât change and therefore nor will rents. Housing stock is very lagged and current moves will only close the pipeline two years out. Only mass unemployment hits rents, and if this is a market event, not an economic one, it wonât change, because structural unemployment is not the issue. Indeed, we are at record low unemployment levels.
In summary
A market tremor created in Washington, was transmitted to the UK, and is now rippling round the world; either currencies hold their interest rate differential with the dollar, or get crushed.
Old news; it is odd isnât it, how so many clever people failed to read the memo?
The Turn of the Screw
So, we have Truss now. The continuity candidate, not the dull man who would take away our sweeties. But also, the same old Fed, keen to do just that. And its time we took a look at Starmer, the other continuity candidate and an excellent book on him; required reading for serious investors.
Otherwise, it is always a good summer when nothing changes. Markets swoop and soar vainly trying to catch our attention, but the reality remains that rates have to rise enough to destroy the excess demand that causes inflation. And they have to rise to equal or surpass that level, eye-watering as that prospect is. It will not be over until the US jobs report goes negative, and stays negative; anything less is prolonging the pain. Â
Presentation over substance
But this is a time of intensely political Central Banks, headed up by people without a grounding in economics, but a lot of âpresentation skillsâ. They will be dragged kicking and screaming and smiling to do what they should have done last year, hoping vainly for some supply side reform or windfall to help out. But largely still facing the exact opposite, populists who think subsidies âcureâ or ameliorate inflation.
Markets are oddly buoyant; they get like this at times, but we see that as a mix of delusion, the self-reinforcing strength of the dollar (be very careful of that one, it is a new bubble) and the spluttering remnants of buying on the dip.
But be under no illusion, Central Banks trying to guess where the economy is going is like fly fishing with a jar of marmite. Entertaining, but highly unlikely to catch anything.
Truss: Issues and options
Truss meanwhile looks like a re-run of Boris; it wonât be quite that simple, but it looks like more style over substance, a different set of lobbyists, but nothing really changing. The idea either she or the EU can afford a bust up with the UK, just shows how silly markets can get.
Some of her programme may make sense, both the NI (tax) rises, and the corporation tax increases were badly timed and should be reversed, given inflation is doing the hard work already through fiscal drag (or frozen tax thresholds).
The rises were proposed when we were exiting the COVID crisis, but before we understood the energy one. We said so the last time we wrote to you.
Ditching a few Treasury backed white elephants (HS2, Freeports, the crazy fiddling fetish on capital allowances) would do no harm either, but overall, the marketâs verdict is clear: fiscal responsibility is still a long way out. We can all see how sterling has collapsed against the dollar; it is less clear why it has fallen against the Indian Rupee or the Chinese Yuan.
Source: See this website for all the daily data.
A book to read for all investors
So to Starmer, the likely next UK prime minister, where we need to pay more attention. Both on his mindset and on why the Labour Party hates him so much. Which in turn explains why (and with the Tories fatal ideological split heading them into Opposition), he is so fixated on party control.
Oliver Eagleton writes very well. His recent book The Starmer Project looks at four episodes, his left wing legal start, his transformation into a Tory enforcer with a penchant for exporting judicial expertise to the colonies (donât laugh), his alleged machinations to back the Peopleâs Vote nonsense to bring Corbyn down (pretty dense stuff, even now) and his use as the Blairite stalking horse to put a stop to Corbynâs chiliastic tendencies, (which also gives you a trigger warning about a light dusting of Marxist ideological claptrap).
So Starmer is all about what works, which would make a nice change.
Weâre looking at a very global mindset, apparently quite a strong Atlanticist outlook, keen to work with European authorities, but aware that the Brexit boat has sailed. An interest in devolving power down, but keenly alert to the risk of anarchy that entails. Indecisive, a Labour Party outsider (on his first election in 2015, apparently his nomination had to be held back to ensure he had the minimum length of prior party membership). Starmer is not exactly collegiate, but he has run a Whitehall department (as Director of Public Prosecutions) so not a loose cannon.
Very London too, Southwark, Reigate, Guildhall School of Music (sic), Oxford for post grad law, Leeds as an undergraduate. So should at least know where the Red Wall was. But lest you relax too much, a total ignorance of economics or business, let alone how to create growth. It wonât be easy.
And what about Markets?
Well for a UK (or non US) investor you only had one question this year. If you ditched the local currency you made money, and if you held onto sterling you got hit. Our GBP MonograM model is doing fine, it got that one big call right: kind of all you need. If you are a dollar investor, outside of energy your best place was cash. And our USD model took longer to spot that shift. As for active investing, sadly pretty much the same, the dollar is the story, or dollar assets. All of which perhaps makes dollar earners in the UK look cheap still.
But for now we see the story as a currency one, and at heart that is just about the timing of tightening interest rate spreads. The widening of those spreads has caused the recent havoc.
So when (finally) the European and UK Central Banks abandon futile incrementalism and get the big stick out, that will call the turning point.
Charles Gillams
Hard Landings?
Local elections tell us remarkably little about national ones. We reflect on those. Meanwhile US equity markets are in turmoil, and some big numbers are changing very fast - some further musings.
Do English local elections count ?
We start with the UK, or rather English local elections, the devolved governments (oddly) have a rather greater read through from local to national. But overall, nothing in the results changed our view that Boris will probably survive, unless the Tory party unites around an alternative, which is pretty near impossible: it has too many splits.
Nor has our long-standing opinion that all Keir needs to do is keep his head down and he will be the next Prime Minister changed. Although if Labour starts to believe it is a shoo in, and can pick who it likes as leader, it will also self-destruct. Which is just about the only chance the Liberal Democrats have of being relevant.
Just how politically marginal local elections are, is shown by the surge of support for the Greens, apparently the very voters the weird Tory infatuation with hard left environmental policies were meant to entice.
Indeed, a whole set of Tory policies designed to raise energy prices, have gone down like a lead balloon.
What voters want and politicians need to deliver
You do wonder if they will ever get round to realising voters really want just three things, a roof over their heads, bread on the table and a job. Deliver those and do so competently, and politics is easy.
The roof bit is a shambles; it turns out policies designed to enrich cabinet members and senior civil servants with buy to let portfolios, are not so good for anyone else. I suspect the job bit will soon turn turtle, and the bread bit is going off the rails too. See graph below:
Here is a link to the relevant page on Statista
We notice that the big Western democracies still seem hell bent on raising energy prices, which is universally unpopular.
UK local elections - a brief look at opposition policies
So, the other thing markets in the UK (and sterling) will be doing is wonder about Starmer policies, more critically does he have the âbottomâ to either appoint radical reformers, or have them lined up in key seats? Letâs say he does. He will still continue the headlong wealth destruction of punitive taxation and the assault on business investment. He will over-regulate (thatâs his background). The sole variable therefore feels like any plausible capacity to reform.
He is not afraid of hard choices, or of thinking long, both good points and incidentally he is not Blairite enough to be Americaâs poodle and get involved in picking pointless foreign wars. Although he will likely dismember the United Kingdom, either of political necessity or by accident. We really canât see much support for sterling in that package.
Central Banks - are they signalling a hard landing?
Inflation is spiking into double figures, and Central Banks are explaining
1) it is really not their fault
2) they are only responsible for âcore inflationâ (so without the important stuff)
3) but anyway they must still raise rates to offset the malign effects of other state policies.
It is looking truly absurd.
Not that interest rates are off the floor yet, although the US bond market seems convinced rates over 3% are now nailed on, while oddly the UK Gilt-edged market seems unconvinced of exactly the same thing. This of course is helping an on-going collapse in Sterling.
Meanwhile the possibility of ending negative rates in Europe has caused great excitement and the Euro to strengthen, at least against sterling. The divergence is related to a belief that the Fed which raised three months after the Bank of England is now more hawkish, a belief which seems more about wishful thinking than anything the Fed has actually done so far.
We are less sure on how high interest rates go. All three Central Banks seem to be hoping something will turn up, and inflation will ease. This is a view we share, but we really doubt the trivial rate rises so far, are the âsomethingâ.
Market turmoil - how far will they fall?
This leads on to the current market turmoil: With the US feeling very exposed, partly because it went up so high (relative to other markets), it has further to fall. Nor do we see the valuations on quoted US growth stocks as offering good value at these levels. They had become so detached from reality the gap is just too big, and the repeated attempts to buy the dips, just disguises a long-term trend down. The FTSE100 over five years is down, and the NASDAQ climbed over 100% in the same time. A 25% further US fall is at the least plausible.
Other markets will then get sucked down, and in Europe and Japan they are hard hit by their reliance on imported energy (the US is an energy exporter). While for now, their rates are not moving either, the resulting devaluation makes the value gap to US growth stocks, feel even greater. Buying overvalued stock in an overvalued currency, is not always great.
What do our models say about the markets?
Our MonograM momentum models suggest a turning point for both Europe (including within that bundle the UK) and Japan is close. It is only a model, we remind ourselves, and is quite able to give a false signal. It also sees this as true in dollar terms, not sterling. So, there is plenty of noise and last week had all the elements we dislike, a month end, plus a shortened market week, plus Central Bank meetings, created a baffling miasma of signals.
However, on current policies we anticipate a crash; the only issue now is how hard the landing is.