LOCATING THE ELUSIVE BASE

the investment impact of recent events

CRANES

I spent last Sunday in the elusive pursuit of grus grus, in the upper Marne basin, East of Paris. For some reason the Common Crane had already left in a bid to cross Central Europe, heading for the Artic, weeks earlier than in most seasons. Clearly, they knew something about the airspace ahead of them.

While the largely empty Lac du Der, also had lessons on levelling up; here was a vast and disruptive engineering scheme, it seemed executed without too much controversy, operating well and with the surrounding villages wealthy, quietly prosperous and largely content. Or so it looked in the February sunshine. It was all in pretty harmonious concord with nature too.

THE FRENCH MODEL

It seems the French can see the grand scope of government, the need to provide top class infrastructure. Here is their France Relance plan up to 2030. Up to 3-4 billion Euro is likely to be spent in 2022 alone.

The issue is perhaps not just politics, but the unspeakably low quality and lack of vision of the UK governing class. The French cities have retained their great buildings, the administration is a high profile and visible force, not something to park in the burbs, having ejected them from city centres to grab their assets for still more rentier housing. Nor does the state foolishly aim to do everything, the peage (and TGV) enable high class fast communication, but certainly not always for the lowest price. Nor is health care completely and absurdly free, irrespective of demand. But it is effective.

Power is cheap and plentiful, no hysteria about nuclear there, and the military proud and visible, even the transport police are packing heat. So, watch that off peak ticket schedule.

Of course, not all is rosy. COVID hysteria still ruled, masks and vaccine passes were required for everyone, for everything.

Yet if any UK government is serious about leveling up, (as in the recent White Paper) here is both a lesson, and an indication that Gove’s piffling attempts are a mockery; he needs more like £48 billion to start it, not £4.8 billion.

You feel they just picked up the easy option from the choices their tired civil servants had suggested. Perhaps it was the one that said, “No real impact, but sounds OK for now”.

UKRAINE - Did Putin miscalculate the West’s indifference?

Ukraine? Not a lot to add to that. We were wrong that Putin was not stupid enough to do it. Wrong too that it would be over in hours. So, treat our topical ignorance with care. Also, wrong that the West would shilly-shally over piecemeal sanctions. Whether we are wrong yet again in assuming that without a quick win, the sanctions will now damage the global economy quite badly, remains to be seen. I also suspect seizing Central Bank assets can only be done once and once done, global finance and investment will become far more fractured, forever.

But in truth, it was going that way already.

However, this blind market panic seems absurd. I really doubt if Putin, at this point, wants to line his battalions up on a border to provoke NATO, who are I suspect closer to an aerial counter strike than he thinks, and would indeed now love the excuse of any incursion on NATO soil.

He has made it into a popular potential war for the West, the most dangerous sort.

War Tactics

It looks to me as if Russia wants a pincer movement, to isolate Ukraine’s forces in the Donbass, plus a threat to Kiev to topple the government, but has he the muscle to take and hold all of the vast country? Even if he does, that does not suggest he will go further than Ukraine, just now.

While his aims are so blatantly false, success can be easily claimed for almost any outcome.  So, a collapse in currencies, and stock markets across Eastern Europe, looks an exaggerated response. True, this is Germany’s worst nightmare come true, no competent military and a gun-shy US, so they must now realign fast, and where Germany goes, so goes the EU. It is not going to fold or fissure in the face of this explicit threat. Although Germany at heart is much more like the UK than France; rapid execution will not be quite as easy as simple announcements. Remember the farce over moving Tempelhof airport?

(link to the article)

As yet, the final step of directly locking in Russian energy supplies, large parts of which go to German consumers, has not been taken, but that would, in the short term, be very costly.

Although high taxes on energy give governments a great incentive to let prices rip, (and demand destruction is great for the climate lobby too), but they are rather less popular at the ballot box.

Interest Rates

Meanwhile Powell remains determined to stay behind the curve on rate rises, it is as if the received wisdom on rates, indeed on Central Bank power, has been quietly ditched, and instead he is hoping inflation burns itself out through demand destruction/supply creation. Well, an interesting experiment, but if that’s the game, as we have predicted for a while, inflation will remain gently smouldering, but rate rises will still be very gradual.

The Fed should have turned off the monetary stimulus and reset to ‘normal’ six months ago, by the time they finally move, it will be a full twelve months late. Real rates are deeply negative, levels not seen in decades, and moving fast, this is really not quarter point stuff.

Link to source article

All of the above implies on-going nominal economic growth, ongoing share price appreciation (at least in nominal terms) and an ongoing reward for borrowing to excess.

But despite the rush to safety currently supporting the US dollar (and US assets) the danger to markets is not just from the noisy, tragic, East but also from experimental monetary policy in the US.  


collage of banknotes superimposed with an inflation graph - featured image of a blog post by charles gillams of monogram capital management ltd

First Principles

Principles may be lacking in certain quarters, but we will start with the economics of inflation rather than Boris.

How much inflation and for how long?

Inflation is simply too much demand for the available supply, nothing more complex than that. So, you tame it by either less demand or more supply. So, unlike it seems most Central Bank economists, who it turns out are just statisticians, for ever looking back, we must project forward.

That tells us quite clearly that the inflationary imbalance will persist as long as demand stays artificially high and supply is artificially constrained. It is that simple. Forget the rest.

So as long as governments have fiscal laxity, along with negative real interest rates, they are pushing up demand. As long as workers won’t or can’t work, it will reduce supply, as long as economic activity is made less efficient by government action and diktat, it will reduce supply; end of.

So, at the very least Central Bank balance sheets must start reducing, which is not happening, stimulus must be fully withdrawn, which is not happening, and the old workers and their old ways of working must resume, which is not happening. Fresh capital can certainly change some of that, but it takes time.

Putin, Oil, and Geopolitics

What about oil?

This is the one item that alone might distort the picture. Which is positive, as we see oil prices falling in the summer. We also don’t see the West has really grasped what Putin is up to; in all the cold war style hysteria, he is possibly just after what he says. This is for the West to stop fomenting rebellion in Russia’s sphere of influence, and to be clear about NATO expansion plans, where there are indeed none in existence. He might have higher hopes, perhaps of a deal on Crimea in exchange for the Donbas, but we doubt it (or his chances of getting it are low). As might we, less interference in our politics would be nice; but see previous answer.

Nor is it that clear he is actually rationing energy; it is telling that Russia is reported as not able to meet its OPEC + quota, which at these prices is crazy. His oil industry will have been hit by sanctions, and the loss of Western expertise, and the Russian economy will also have suffered under COVID. A loosening of sanctions would really help him, for all his bravado.

If that reading is correct, as the situation winds down and OPEC+ winds up production, oil prices will fall, I would expect quite substantially. Much of the energy spike is self-inflicted, with nuclear plant closing or offline in France and Germany, and reckless price controls, having made using UK gas storage unattractive. All of these things can be sorted out.    

Any possible good outcomes on inflation?

So, to inflation, well it won’t care much about the pinpricks inflicted by the likely interest rate rises now under discussion, especially if they creep up so slowly no one notices. It needs a unified 1% OECD jump to cool this lot down, and the ending of stimulus. Neither is likely. Closing the US printing presses, were it to happen, does also have interesting global impacts, as Andrew Hunt notes.

We see it all turning rather glacially, with a bigger slump in inflation, if energy prices fall, but then being generally persistent in the 3% area for the rest of the year. We expect to have both higher rates and inflation for a while.

All of this is mighty tricky for investors, but I don’t sense that just bailing out is right, nor that the actual interest rate rise will cause an enduring slump in all asset prices. Investors have to own something, or they will sit and be mauled by inflation.

And what of Johnson?

It is easy to read the current level of confusion from either side’s viewpoint. Yet to me, I see the normal factional infighting, the usual media exaggeration, some political mischief making, but still no reason to depose a Prime Minister with a very clear mandate and a large majority.  Like any large party the Tories have the embittered and passed over, the Remainers and fans of state intervention and a volatile and raw body of new recruits in seats no one ever expected to win. Plus, no doubt a few opportunists who sense that the heavy lifting on COVID and BREXIT is done, and they can now seize all the prizes.

The Tories do need a reset; it would be nice if Downing Street left Ministers to govern and simply acted as a cheerleader. Not that I see that happening, leaders and their hangers on always lust after more and more centralization, more control. But until a compelling, unifying, plausible Tory opponent appears, I foresee no change.

And in a way with reform all but dead, with Gove’s last hurrah on ‘Levelling Up’ a damp squib, it may not matter who leads the Tories, they have very little real power.

It is quite odd how big majorities do so little good, and how poor party discipline is, when they have them.    

Charles Gillams


a sea container with a building site beside it, illustration for article by Charles Gillams of Monogram capital management entitled 'sea change'

Sea change

A trio of influential knaves to worry about this week, united by a belief that “this time is different”. Well pantomime season is behind us, however we can still all shout “oh no it isn’t”.

Boris seems to be the least of our problems, if the greatest of villains, for the scurrilous crime of enjoying himself, what a rat. While Powell is providing an increasing threat to the poor and exploited across the globe by generating financial instability, and the lamest of the lot, Lagarde is just repeating a political line. The Euro zone debt figures look like this. A sharp rise from an already overstretched position, but still benefiting from falling rates, so when that rate line turns, the problem will really bite.

Will markets ever trust the Fed (if they did this time, outside the gilded denizens of Wall Street) again? Hopefully not, the trouble with putting administrators in charge of Central Banks is they rely only on historic facts, it is in the job description, that’s what they polish, hone and serve up.

But the economy is dynamic

The mismatch is that the economy is dynamic, and has no printed rule book, beyond that of the rocket; what goes up, must come down, immutable like gravity. And you simply can’t wish gravity away.

So, this Fed is programmed to repeat what it can see looking backwards, and all the obedient commentators on Wall Street who simply echo its nonsense, are of little use, except to fleece the gullible and to signal false comfort to one another.

Having said for most of last year “there is no inflation” they have turned on a sixpence, to say inflation is now out of control. Talking of six or seven rate hikes; they wish, just banker’s fantasies. Although markets, not surprisingly, are now suddenly jittery.

Eu consumer price index December 2021

Investment implications

This week we went from feeling over 20% cash was too cautious, to feeling we had missed the boat on value stocks, back to feeling 20% cash was really just fine, all in the space of four short days.

So, because that sea change in inflation expectations was so abrupt, this is a genuine dislocation, we do see the NASDAQ and both the concept stocks on infinite multiples and the mega tech stocks on thirty- or forty-times earnings, as in some trouble, in a process that does not feel over yet.

There is a ton of selling, and the spoofing assets, including crypto, will be heading down, in a dip that feels likely to be around for a little while. But two things stand out, firstly until rates start to top out, this excess money simply can’t go into bonds, so what happens to it? Secondly if the market assumptions about Powell and Lagarde are both right, you are going to be paid handsomely to hold dollars, while simultaneously being charged to hold Euros. We don’t see that as sustainable either. One must be wrong.

Looking ahead

This is why Lagarde’s confidence in no rate hikes, feels like a lawyer’s bluff, as if currencies move, it won’t be her choice for long. While uninvested money, on which fund management fees are still charged, always makes asset gatherers nervous; it will all go somewhere.

That also leaves the question of how much growth we will actually see, as if it is below expectations, then inflation will be choked off, labour force participation will fall, US rate rises will run out of steam. There are already signs of that. While given the scale of market movements, the ending of bond buying by the Fed (long overdue) and even a modest run off of the balance sheet, will be pretty irrelevant, both are really drops in the financial ocean. 

The froth blown off

So, the good news is we will see normal investment conditions, the froth blown off, bonds producing a yield, along with slower growth and moderating inflation, which we do feel will be backing off by mid-year. All of course will rather depend on the progress of COVID, because we still see (and have done for nigh on two years) this inflation is directly caused by COVID responses.

Reducing the output capacity of the economy, with no cut in demand, has to cause price rises. These price rises will exist everywhere COVID does, so trying to pin them to a single cause or location is not easy. They will persist until the demand/capacity equations correct, which with COVID is a multi-year task.

The FTSE finally gets a look in

So, a sea change yes, a market dislocation yes, but if it is as bad as is currently feared, with some big winners resulting in the financials, real assets and energy. All of which, on those fundamentals, still look to us good value, hence the visible support for the FTSE 100.

FTSE for the last year
FTSE for the last month

While if it is not that bad, sufficient money will flow into US Treasury stock, from low interest areas, forcing the dollar to rise, and rates down, until other areas are simply pulled along. So no, we won’t then be getting seven rises on this data and equity markets can start to relax.

And what of Boris?

Finally, Boris, now degenerating into farce, but much as we hate what he has become, we recognize one wing of the Tory party feels he is too right wing, while another feels he is too left wing. Both dream of replacing him with their own, but in so far as he splits the difference, the risk that the other faction wins, should keep him in office.

Either faction will demand more of his replacement than they can ever deliver, given that core fundamental split, so such a divide simply hands Downing Street to Keir Starmer. For now, I still feel he survives, and given his nature he will remain impervious to change, but remarkably adept at promising it.

Sterling seems notably unfazed by it all.      

Charles Gillams

Monogram Capital Management Limited


This is an illustration showing a dog running towards a woofle bear, a character created by Martin Speed, an illustrator. The purpose of the image is to illustrate the text of a post by Charles Gillams, where he mentions the phrase 'not my dog', regarding inflation expectations.

NO NEWS?

Staying on the sidelines till Burns Night still remains rather attractive. Christmas as ever brings thin trading, a lot of speculation and some brutal repression or natural disaster, in a far-off land. Although these days ‘far off’ could include Lille or Llandudno, both pleasantly calm and now even sounding a bit exotic.

But for all the noise, has the investing world really shifted? We did kind of have a Santa Claus rally, but with COVID about, he got shoved back up the chimney pretty fast. Meanwhile Powell was transformed into Scrooge with the terrifying thought that in a massive boom, with high inflation, perhaps he didn’t need to be reinvesting maturing state-owned bonds?   

What we see is confusing data, a fair bit of economic damage from Omicron, some people not wanting to be ill, but mostly from a Pavlovian reaction to the very idea of COVID the Sequel. Fortunately like most sequels it was a pale imitation, we knew the cast, guessed the plot, will leave the show early.

Inflation - where have we got to?

Peter Sellers in The Pink Panther films asks an innkeeper if his dog bites; having been assured it did not, the dog snarled and bit him. On remonstrating he was kindly informed “that is not my dog”.

Well clearly Powell, Biden and a few other innumerate players wish to tell us the same about inflation.

Sadly, and transparently, it is their dog, and equally clearly it will bite.

There is an econometrics game of saying there is no inflation (except in; used cars, housing, fuel, take your pick really). That is like selecting the first brick to burst in a failing dam, and saying that the structure was fine, except for this one defective brick.

Therefore, the first sign that (finally) the ‘just a blip’ inflation nonsense has been retired must be good news. This comes along with some evidence that sensible Democrats (well at least one) have spotted that more money for less work in order to buy fewer goods, is probably not actually helping poor American families.

The energy question

We will sort out energy prices, if governments are sensible. So, if, like President Xi, we do bring back a bit of stand by coal capacity, for next winter’s peak. There is plenty of coal around. We have not been too short of wind around here either, of late, the UK also has a good number of salt caverns, which we can (as we used to) stuff with gas, rather than believe the idiots in the Government who felt it was too expensive to have cheap summer gas on stand buy. While at 80 USD even the Saudis will pump more, the Permian certainly will.

So that just needs a bit more planning, a bit less spurious forecasting to within three decimal places, a bit more building in a margin for error, whilst hopefully all the Whitehall types who claimed they were fostering ‘competition’ and could ‘cap’ prices of a global commodity, get moved on (or better out).

It is still next winter’s answer, none of this will help this year much. Most capacity for the next two months is sold.

So, what will Powell do next?

All of this leaves us with massive liquidity, poor labour market participation, excess demand and the normal reaction to all that: inflation picking up and negative real yields slowly being eradicated. What is not to like? Demand plus capacity usually equals growth.

While Powell may have failed to grasp the intricacies of inflation, I am not expecting him to suddenly declare his job done on minority employment rates, with such a poor participation level. So, I expect he will keep trying on that. Which suggests he’s not going to over-indulge in rate rises. Hence the idea the Fed will look at other ways to soak up liquidity, is quite logical. 

At this stage of tightening, we don’t find most bonds attractive, but recent history suggests that if the US 10-year bond gets closer to 2%, it attracts foreign money, unless Euro base rates also rise, which still seems unlikely. More buyers will of course push the yield back down.

While China is both cutting rates and provoking some hefty defaults, which is not a great background for foreign investment, especially as they seem to be targeting offshore investors. Without knowing whether the US interest rate tops out at 2% or 4%, emerging market debt (like their equities) could be either cheap or expensive; just now it is very hard to gauge.

So cautiously we plough on - funds must be invested, the (as of now) attractive alternatives, all look pretty expensive or rather risky, while if rates really do start to rise, the dollar will itself become desirable. So, we expect something, some asset, will suddenly catch a bid and soar away. Outside the US mega cap tech stocks, value already abounds.

Overall, a return to normality. With rather fewer gifts from Lapland to be had just for asking; all of this should be quite encouraging.

While it looks like sterling has strengthened for now, the various tin pot media storms have led to the Prime Minister’s critics looking into the abyss and not liking the view very much.

It may look bad to bend some rules, but dropping a Prime Minister for disliking Theresa May’s taste in wallpaper, or treating staff like human beings, or because Liz Truss is ambitious? Not really.

MCM had a good 2021, in our global lower volatility space. The CityWire link to our subsector is here.

Charles Gillams

Monogram Capital Management Ltd

9th January 2022

(article illustration by Martin Speed, creator of the Woofle bears)


whale in the sea - sometimes called Leviathan

Which is the Leviathan?

This is a week to ponder the role of private equity in portfolios, in what may be an early phase of a great investment and technological explosion. There seems to be no sign of higher interest rates and a stubborn refusal by Central Banks to care much about inflation. The talk of a UK raise always looked to us like a head fake which we ignored.

Spotting good and bad private equity

So first to private equity, a beast that comes in many guises, not all benign from an investor viewpoint. All liquidity fueled equity explosions come with a heavy loading of chancers; Bonnie and Clyde’s rationale for bank robbery remains valid.

Good private equity relies on management being superior to that of their targets. This can be in their analysis, their execution, their swiftness of foot or their innovation. All of this generally flourishes away from the hidebound inertia of many listed companies and their professional Boards of tame box tickers.

Bad private equity uses accounting tricks, the malleable fiction that the last price is the right price in particular, and the terrible phrase “discounted revenue multiple” which is a nice conceit for “never made a profit”. All of these share the same vice of management marking their own work.

So, we struggle with the likes of Scottish Mortgage and its little array of unquoted Chinese firms, the alphabet soup of non-voting share classes and love affair with management. Maybe they are that skilled, but nothing that looks like a real two-way market is evident to us, in many of these valuations. We have by contrast long admired Melrose Industries for their quite ruthless devotion to turning over their investments, good or bad and stapling executive pay to actual cash realizations paid to investors.

Where we stand – given our strategy

For an Absolute Return specialist there are added constraints: we want to hold under twenty positions altogether and all in ones we can sell tomorrow afternoon. And we like holdings where valuations are transparent, there is no gearing (there is usually quite enough in the private equity deals already), and you can pick them up for a fat double digit discount: oh, and we do like a yield too.

So, we are looking for big, listed options with hundreds of high-quality funds bundled together and for any yield, a bias towards management buy outs. We are certainly not at the venture capital end, with silly pricing, high fail rates, unrealistic managers, and not a decent accountant in sight and aspirations to change the world. Met those, invested in too many, and donated more shirts off my back than I care to enumerate to their serial failures and inexhaustible funding rounds.

But there are good things about Private Equity, one is that in a rising market, it can be like clipping a coupon. The accounting rules require them to be backward looking, so coming out of a trough they are typically reporting on valuations that are three or four months old, which in turn reflects business activity up to six months old. As they trade at a discount of typically 25% or so, you can buy today at a 25% discount to the value of the business they were doing in the spring. There are no guarantees, but for most, that was a lot worse than current conditions, so today’s price is simply wrong. This is a time machine that lets you buy now but pay at old prices.

Watch for built in volatility in private equity

These lags are complex, the reference points are often public market valuations, and so there is volatility built into them. While in an Absolute Return fund, not only are choices limited but the overall exposure must be too. However, in those rare purple patches of fast recovery and expansion they are excellent for performance.

What kills these bonanzas off is tight credit. In part they need debt for trade, but also their realizations rely heavily on it. A closed IPO market does them no good (just as they enjoy an exuberant one). That is a risk, as liquidity starts to tighten, that this will hurt, but as Powell and the Bank of England both showed, there is no political appetite for that just yet.

The UK and US on taming the leviathan

Indeed, Sunak’s UK budget yet again feels reckless, devoid of any discipline and with every department cashing in. Government spending is predicted to rise to 42% of GDP by 2026, a fifty year high. Healthcare alone is predicted to have grown by 40% in real terms since 2009 (both estimates from the oddly named Office for Budget Responsibility). At that level of loading, it is inching closer to hollowing out the entire budget and causing it to implode. (Leviathan was just such a creature “because by his bigness he seemes not one single creature, but a coupling of divers together; or because his scales are closed, or straitly compacted together” feels an apt description of this new giant state apparatus.)

But that gamble means there is no room to pay higher interest rates, or the economy will be reduced to a double-sided monster. The one face devoted to raising debt and levying taxes and paying interest, the other to feeding out of control public spending, with nothing left in between.

Thanks in a slightly odd way to a Democrat Senator, America has avoided throwing itself under that same bus, but with no effective political opposition the UK is now powerless to resist. Sterling’s relentless decline from the summer high and a FTSE 100 index still below its pre-COVID peak signify what markets feel about all this.

This is a graph illustrating how the FTSE index is not back up to its pre-Covid high, on 7 Nov 2021. This helps us look at private equity as an option.

From the London Stock Exchange graph

So, while we were more bearish than we have been all year, in terms of asset allocation, at the end of October, we have yet to call time on the Private Equity cycle, that has provided such a powerful boost this year. It still feels good value to us.

Of course, we recognize too, that the populist fear is of the wealth creators and an opposing adoration for wealth consumption. Unlike politicians, however, we are tasked with producing real results not vapid dreams.

I guess we can each choose which to regard as the leviathan – the burgeoning state, or private equity.

Charles Gillams

Monogram Capital Management Ltd