Sunak's Slaughter
FALLEN WALLS, FALLING VOTES
A few stats: Labour collected 9,698k votes, the Tories 6,835k, Reform 4,114k.
In vote share terms it was 34% Labour, 24% Tory, 14% Reform, 12% Lib Dem. A united right would have been ahead of Starmer on 38%. Labour dropped votes, (9,698k for Starmer against 10,269k for Corbyn), since the last general election.
What Boris did, and Sunak failed to do, was hold Reform, who did not stand in 2019 in return for some nebulous hint. Farage was scurrying off to the US, until Sunak bizarrely announced policies designed to outflank Reform. In doing so, quite apart from baffling his own party, he broadcast his fear. Once the ridiculous return of National Service was rushed out, Farage knew Sunakâs weakness and duly reversed course.
Farage is in little mood to stop, his victory speech highlighted âthe building of a centre right partyâ. No, not hyperbole, he already holds the votes, in no small part, from demonstrating the tiresome habit of consistency.
Although it is simplistic to see Reform as right wing, it is (in so far as it has policies) populist, it won its toehold in Westminster in seats of deprivation, not just of big Tory majorities. Part of its vote was from Labour, although it poses no risk to Starmer. But the Tories, after a virulent set of campaigns to deny Farage a seat, lacked the firepower this time. Farage is in the building.
But surely a great night for the clown party and Ed Davey? He has taken the absence of policy and the primacy of performance (the wrong sort)Â to new depths. He lost votes too, getting nearly 175,000 fewer than in 2019. Ed Davey had 3,520k, against 3,696k for Jo Swinson.
WHICH TORY PARTY?
What of the Tories now? They still need Farageâs vote bank. Either they neutralise it, as Boris did, or absorb it as John Major did, or they are out of power for a decade.
That seems obvious.
What seems highly risky, but quite likely, is they just leave Reform to fester. So, the ruling cabal of centre left Cameron acolytes plough on, piling defeat upon defeat.
Across Europe these archaic centre right parties have blown up, their only preservation is the equally ancient UK electoral system, for which the Tories (24% of the vote) seem the only advocates, Labour adopted a pro-PR vote motion at their last conference, and the Lib Dems, Reform and Green votes would easily make that a majority.
It is coming at some point. In some form.
Clipped from the Labour Policy Forum Page
Do not read too much into that SNP wipeout in Scotland: in the face of the extraordinary mix of sleaze (much unproven) and a well-funded (compared to England) but disastrous NHS, the SNP vote share held up at 30%, suggesting the dream has not died.
It will probably hold on to a high number of Holyrood seats, based on PR in those elections. The sole Tory loss in Scotland, saw a messy local fight between candidate and party.
Labour now has its own issues of success; it will be unwise to treat the more rural seats they have won, as any more than loans. Like the Tory Red Wall seats, these are unstable, single term members, it is not practical to help them (as Boris showed).
While Labour have also unleashed some big beasts, most notably Rees-Mogg and Liz Truss. The Tory party would be wise to lasso both, less they graze elsewhere; their attitude towards them will be very telling.
NEXT TIME
After the last election, in early 2020, even pre-COVID, I predicted 186 seats for the Tories in 2024, none in the Red Wall.
I am inclined to repeat that.
I see this as a Lib Dem high tide. Devoid of policy or power, stripped of the virulent anti Tory votes, unable to add voters, I see them fall away. While Reform is not close to power either, but the SNP will probably be resurgent. So, Labour could easily suffer a loss of a hundred seats, down to about 310, still the largest party, but potentially needing a deal to rule.
That is the real reason for Starmer to govern from the centre. For that he might actually win votes next time.
The  extreme alternative outcomes are about the Tory/Reform issue: how the already dominant right-wing  vote is divided. As in Europe, they are now numerically strong, and the deals to stifle those voters voicesâ increasingly seedy and unstable.
If the Tories spurn their right wing, it splits to Reform.
If the Tories spurn their left wing it splits to the Lib Dems.
Either split creates a third party with over 100 seats and hence a route to power.
Instead, the Tories need unity, a cap on recriminations, no triumphal ascendancy, no coups, and an end to the chaos of central office, and its hapless parachute candidates. The party needs true devolved powers to the associations â and the party must spend money on good agents. That is where they will rebuild to back over 200 seats.
Then it has a chance.
Will it take it?
Despite the noise, as we listed above, successful political parties donât add voters, in the main, they just donât lose them.
Otherwise, markets feel dull, and thin. Central Banks have a sparse diary. France might excite, but likely will see stalemate. The big story remains the clash of the dwarves.
Charles Gillams
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. Thatâs 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 Germanyâs 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?
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 Lordshipsâ briefing on what EU rules we might be repealing. Nothing for Investment Trusts.
I am on balance on the Trustâs side, I do think closed end structures (as they all are) allow long term decisions, while protecting daily dealing, one of Europeâs 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 âindependentâ 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.
Too chilled
Markets seem far too relaxed about world elections; we suspect from ignorance. Logically if you move from certainty to uncertainty (with a range of possible outcomes) you should adjust your level of risk. India has already shown some of the volatility of the 'wait and see' approach.
Too hot?
So, we start there, where prior confidence in an enhanced majority for Modi, was well wide of the mark, he ended down 63 seats at 240; a majority is 272. Some of that chaos is the electoral system, and some of it the ban on opinion polls - although some accurate information inevitably crept out, despite restrictions, but international investors did not pay much attention to it.
So, when the exit polls announced all was well, the market rose, only to reverse hard when the real result emerged within a few hours. Although then buyers came back in, and we ended up flat.
From this website â date published : 8th June 2024.
On a call with local managers, (and the options for investment in India are wider than you might assume) clearly something had changed, one was almost pleading with the international audience not to take money out. Very little spooks other fund managers quite like being repeatedly asked to not redeem.
The Congress Party has almost doubled its seats, from 47 to 99, a strong result. The other beneficiary was the Samajwadi party, nominally socialist, with a strong presence in Uttar Pradesh, a vast Northern state. They went from 5 to 37 seats and are very much in Modi's BJP territory.
India has always had strong states, with the more populous ones often having a local ruling party, which has been around for ages. So, this is a reversion to the long term normal.
In house collage of a state by state analysis of Indian share ownership percentages
But that is what scares investors; coalitions nearly always break down. There was also damage to the Index from the Adani group of interlocking holdings (long hounded by Congress for alleged corruption).
A weaker Modi
That allied with the long-standing fears about political corruption, uncertainty of policy and no national enforcement, is an unwelcome reminder that Modi is now in his last term. Hopes that stability will follow him, rather than a swing back to the broken past, always felt optimistic.
The commonly voiced issue is that a weaker Modi will have less ability to drive structural reforms and will find it harder to resist welfare payments, and labour demands. Historically, some of these payments and concessions reach the poor, either in higher consumption or better services, but a great part gets stuck with middlemen. That should be less of a problem now, as a result of reforms already implemented, putting in a national bio identity scheme and almost universal individual banking services.
We will see.
While generally expecting strong growth to persist, we are now more cautious about signs of the lost consensus, into the medium term.
The UK - far too chilled
Which brings us to the farce that is a UK General Election, where such discourse as there is has been about whether families are or are not facing a ÂŁ2,000 tax hike (or roughly 20% more for those on average earnings). Not knowing where they live, or how they spend their money, or indeed how they will adjust to high taxes, you can never tell these things with much accuracy.
This comes with minute (and futile) attempts to list every one of the myriad ways that the assumed tax hike won't happen and extracting a "pledge" from all parties not to raise them. As if all Chancellors do not have multiple ways to raise revenue, carte blanche to create new charges, and a great ability to lie or concoct exceptional circumstances to hit us. Sunak of all people should know that.
Yet most voters are thinking, is that all? Is it enough? We know that existing service demands are not being met and that no party seeks to resist the endless demand for expanded services.
I doubt if growth will save us either: we are close to the point where those that can take investment elsewhere, have left, and no sane investor would now invest, without substantial state subsidy. So, we are simply building up to an inevitable budget crisis in the medium term.
There are a few who hope that change will be its own reward, maybe, but we can't really tell much until after the first Budget, (Labour have pledged to revert to just one a year), and a couple of Parliamentary sessions.
Just waiting and hoping is illogical. Markets do just that, though.
Frozen in the US
Which brings us finally to the USA, the Presidential election feels (to me) fairly easy to call, but how the US Congress and Senate go, does not; the resulting power (or otherwise) of the President is less easy to predict. It may be that we get a split between parties again, which markets like, and it feels unlikely (but possible) that we end up with constitutional change, which markets certainly won't like.
The current Federal Reserve Chairman will be in office for all of 2025, but almost certainly not beyond that, and who replaces him, will figure high on the consequential concerns, as unlike other Central Bankers, he sets the global tone. Powell is not popular with either of the spendthrift presidential candidates seeking office. Nor will he be trying to get reappointed. He has been an odd and erratic champion for the dollar and sound money, but he has been that.
I am not sure other elections are so consequential, the European Parliament has hopefully done its worst already, while investors in both Mexico and South Africa are starting from a low base of limited ambition.
So, to us, the question is how long to follow benign short-term themes, while such dramatic shifts may be hitting us within six months.
Inactivity from ignorance remains attractive, but is it wise? At some point in the interim, markets will probably decide not.
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 donât 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 âlower boundâ, 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 âdefenceâ 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 canât 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 MPâs getting lobbied, so far better to âlong grassâ it, via a competition investigation. Isnât it odd that the competitive market in asset allocation created by an active takeover market, is the one market the competition authorities simply wonât 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 thatâs 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 ETFâs, 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, donât 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.
Good intentions
Two quite technical topics this week, hinged on the persistence of old viewpoints on current markets: pricing in UK stock markets, and China, and how we might look into emerging market funds. Plenty of good regulatory intentions, but rather less than welcome outcomes.
FIXED ODDS
Little in the debate on UK markets has looked at the major role played by an increasingly poorly performing small UK bank, Close Bros. Even when it was doing well, it felt odd to have a vital market role being undertaken in a backwater, but as its capitalisation dwindles, the core task of equity market maker, which it provides, seems oddly misplaced.
In smaller UK stocks, we therefore still have a ring holder who, it is said aligns buyers and sellersâ interests. Not mine.
Given the fortunes at the disposal of state banks or indeed the London Stock Exchange, why is Winterflood (a part of Close Brothers) still trying to provide this vital service in the style of an old-fashioned bookie?
It matters greatly, because in many UK stocks and investment trusts, the wide bid offer spreads make dealing almost impossible. If you are eking out a high single figure return, and in these markets not doing badly to do so, Close Brothers scooping 10% off a single trade, in the bid offer spread, is pretty lethal.
With them restricting trade, liquidity disappears, without liquidity so does price discovery, and it is not a stock market any more.
Close has itself also suffered a number of hits lately. It is a hotch potch of old merchant banking activities, along with an expensively acquired asset management business, plus a shocking venture into litigation funding that might ultimately (it is itself a matter for litigation) cost almost as much as they paid for it.
While just lately the FCA has been asking (dear CEOâŠ) about insurance premium finance, oh, and Close has a lot of motor finance too, an area of recent expansion, but also another hot spot for the FCA, after issues on commission. The latter Close has known about for a while, it was a disclosed risk in their last accounts.
All places where margins are quite high, perhaps in the view of the FCA too high.
From: Close brothers website â section on âwho we areâ - their business model.
Given the lack of any announcements, the 40% share price decline in Close (CBG) over six months, to levels seen just after the GFC, is remarkable. Perhaps this benign graphic is not quite the whole picture?
Premium financing is ironically a good business, because the FCAâs wide and unpredictable view of its own remit makes financial services insurance premiums rather high, but thatâs another story.
And market making is run as a bookie, not as a market utility. Winterflood itself can be taking a long or short position. So, investors must fathom both the share price, and which way their market maker is facing. In big stocks with lots of choices thatâs all fine and pretty transparent. But in small ones, they can look (and behave) like the only game in town.
And it looks as if last year, they possibly went too short in the autumn. So, when the market turned on a dime in November, a fair bit of short covering took place, prices leapt, in places by over 20% and spreads opened out. And market size dwindled to penny packets.
It matters how? Well, you can get ripped off to deal in smaller UK stocks, where smaller is up to about ÂŁ300m, and the price can be âwrongâ, volatility increases, and liquidity goes. Do companies or investors like any of that? Nope.
It is notable that their trading profits in this area seem to far exceed both their gross (long and short) and net (long less short) positions.
Every big company was small once, and if you choke off the supply you get an ossified market, like the current moribund main FTSE index.
Perhaps the FCA could start to look more at best execution and market depth, and less at arcane ways to double count costs, or âprotectâ those trying to enter the primary market from strict rules. This interview with Witan makes a reasonable case for looking after the secondary market first, not just the big IPOâs, with their juicy listing fees.
Investor protection is about investors making money, not about them losing it as cheaply as possible.
CHINESE BURNS
After our piece last time, we have been looking at Emerging Market funds ex China, because far from being the great hope of EM investors, China (and not just the PRC, but also Hong Kong) has become the rock that shatters fragile performance.
The role of benchmarking
There are several structural problems in EM funds, one is the role of benchmarking. A good idea at one time, it allows investors to compare performance to something specific. But it has become quite expensive (guess who pays?), as benchmarks donât come cheap, if you now have to have them.
It also rather neatly points out to investors, when an index fund might do a better job than active managers, and worst of all, especially with the oddly amateur directors of most UK investment companies, leaves them âhuggingâ or enslaved, to the benchmark. For good reasons in one sense (you donât get fired for just about beating the benchmark) but for bad in others (all the funds are boringly similar). They just make the same mistakes together. And a beaten benchmark, that is itself falling, means the investor still suffers losses. I have yet to meet an investor that liked those.
The impact is both direct, so you canât find India funds without Reliance Industries (the biggest stock), for example, and indirectly so as to âgenerate alphaâ funds take bigger risks within a market, rather than have a below benchmark position in that market, even if all their analysis says they should just quit that particular town. Which is why funds find reasons to linger in bad neighbourhoods.
Another bias that hits the EM sector (which for a decade now has flattered to deceive) is that their stock analysis is focused on stocks they have held, while the investor wants to hear about stocks they should hold.
So, a fund manager typically gives a detailed list of analysts and companies followed by their firm, and it is full of what looked sensible when all those analysts were hired. So, in EM, there are stacks of China analysts, of organisations based in Singapore (the preferred offshore China centre, after Hong Kong got too hot), hundreds (if not thousands) of Chinese stocks covered, but all the buying is now into India. With quite nominal stock coverage; and hardly anyone based in the country.
Just as to a hammer, every problem is a nail, so to those EM analysts every opportunity is in China. Until outfits like Janus Henderson and Templeton stop having toolkits full of hammers, they wonât be able to stop breaking investorsâ hearts with China. Nor will investors realise quite how much this infects their performance.
This will slowly correct, but small funds that can exit China totally in a week, and have a global remit, with no equity benchmark, dare I say it, have quite an edge.
It is a vast and nuanced space, Lazards provides a good overview.
And it is not just EM specialists, we looked at Ruffer of late, it has got broken China littered amongst its portfolios.
So, we worry that the Christmas rally looked broad based, because of a bear squeeze over a range of stocks, that then reversed with early January selling, based rather more on fundamentals. In which case 2024, so far, is in danger of looking more like 2023, less like the cyclical turning point many hope for. We do see earnings falling, of course and then ultimately rate cuts rescuing valuations. But ultimately may be quite a while.