a hand shuffling cards, with a background of a graph showing stock market movements

Sleight of Hand

This week, we speculate as to what the FCA is really after in their Practitioner Survey.  How closely do their actions follow their words, with the new Consumer Duty laws? And we also look at Hunt’s budget and the likely forthcoming non-impact on stock markets.


Periodically member firms get quizzed on how we see the FCA; this time they promised a shorter form. Well, if that’s shorter, I’d hate to see the long one. Take a look here. Thirty-nine questions, but so many cover multiple topics, it feels more like a hundred.

It is typical of such surveys designed by marketing advisors: a few soft questions, how are you today type guff, a few “have you stopped beating your wife” ones, just to check you are actually awake, then a lot of navel gazing on SICGO. They really despise it.

This is purportedly about promoting competition. Which actually makes the regulator’s job harder – encouraging more firms and lowering the barriers to entry for new firms.  The FCA does not like that idea much; so, note, it is a SECONDARY International Competitiveness and Growth OBJECTIVE, get the Secondary stress, minor, icing on the cake stuff. Objective, so just an aspiration, not real. Their minutes (above) even admit that.

Then we have more ‘are you happy questions’, then some tiresome back scratching ones, just how great are we at seminars? answering the phone? sending you flowers? You get the picture.

Then a few global ones, how good are we at promoting world peace and intergalactic harmony? By this stage you are probably wondering what this is, I am. And the idea creeps in that it is nothing to do with the poor regulated mugs, anyhow. So probably not much to do with the consumer either.

Meanwhile I see a landscape of poor consumer outcomes, vast sales driven peddlers of half-truths, a fair bit of market abuse, absurd barriers to entry, the insiders and regulators getting fat, the savers, investors and users of capital paying for it all.


They also published “A new Consumer Duty Feedback to CP21/36 and final rules” more terribly exciting stuff, a mere 70 pages of it. They make much of the “Risk of Retrospection”, saying “we were clear that the Duty would not have retrospective effect and would not apply to past actions by firms”.

OK, this is a key political input; the industry has had enough of new rules, looking back. So, I take it that we won’t see big attacks on UK listed finance firms this time?

Not so, you guessed it, the entire financial sector is suddenly seeing bigger provisions, because, it seems, of the new rules. It looks very much like the damaging hits on SJP Close, Lloyds, are exactly this, retrospective application of laws, an action so vociferously foresworn by the regulator.

And this helps competition how? Well not at all. But do remember it is a secondary aim and applies only to “competition in the interests of consumers” so not real competition, but one where the mechanism (competition) and the outcome (interests of consumers) get muddled up.

So, for instance destroying UK financial services firms is fine if done “in the interests of consumer” and what could be more in their ‘interests’ than getting money back on a contract they willingly (and legally) signed ten years ago?

And that’s why choice and consumer outcomes are being lost in box ticking and adverts of fluffy kittens, sunsets on beaches and the like. Just look at the UK ISA advertisements, do they tell you anything? Beyond heavy hints at nirvana with no work.


The budget? Well, it is so dull, you feel it is simply what the HMRC nerds wanted. More complexity, a few free hits (non doms), more CGT breaks for landlords, for the rentiers not the creators, less employee NI, but no change to employer NI, that actual tax on jobs remains as harsh as ever.

We are well into Q1 now, so I guess the intriguing thing is more this firm Treasury conviction, adopted by the OBR, that inflation will fall towards 2% in Q2. Given their prior errors, that is very bullish, and does not support base rates at 5.25%, frankly not even at 3.25%.

It is all circular, despite commentators’ child-like obsession with margins for error. If inflation stays high, tax raised stays higher, covering higher public sector spend. So low inflation is (oddly) a cautious model prediction.

The market does not believe it. Nor do we. Not quite chapeau consumption time, but I don’t see 2% this year. I am not sure where this recession is, but not in any of the streets I walk down.

If interest rates are really about to fall off a cliff, the FTSE looks oddly stuck, miles behind the US indices, and sterling also looks curiously strong. If saving rates are about to be pummelled, the yield stocks that fill the FTSE will suddenly look very cheap. Which suggests the markets are not buying it, not yet.

A 500-point rally might even be plausible, if the OBR is right, but it is not, and talk of headroom is nonsense. This remains an expansionist fiscal mind set, but of quite limited duration, hence the market caution.

Elsewhere we are in ‘riding-the-tiger’ time: if you are onboard, how and when do you get off it?

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.



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 sellers’ 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 CEO…) 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.


A screenshot of a section of Close Brother's website

From: Close brothers website – section on ‘who we are’ - 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 FCA’s wide and unpredictable view of its own remit makes financial services insurance premiums rather high, but that’s 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 that’s 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 £300m, and the price can be “wrong”, 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 ‘protect’ 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 IPO’s, with their juicy listing fees.

Investor protection is about investors making money, not about them losing it as cheaply as possible.


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 don’t 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 ‘hugging’ or enslaved, to the benchmark. For good reasons in one sense (you don’t 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 can’t find India funds without Reliance Industries (the biggest stock), for example, and indirectly so as to “generate alpha” 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 won’t be able to stop breaking investors’ 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.



Blowing through the Jasmine

What is happening in the offshore wind market? Come to that what is happening in the onshore hurricane blowing round Westminster? And even after this market rally, arriving much as we expected last time, what should we still worry about? Valuations, recessions and inflation, all matter even if rate rises don't now.

A Feeling of Unreality in Westminster

One year in, Rishi looks incompetent and chaotically inconsistent. I simply can't explain Cameron's grinning re-emergence, it feels like a bad dream or worse joke. I hope he could never be selected again as an MP, after his murky financial dealings. The House of Lords is clearly less constrained. The arrogant indifference and heavy taint of sleaze can't be in the interest of voters.

There is a feel of an echo chamber inside Downing Street, of a puppet leader being strung along by unseen forces. Just last month the whole theme of the Party Conference was a fresh start, the last thirty years were apparently rubbish. Then we have this.

To the country and investors, it does not matter, although a half-awake opposition, or slew of oppositions, will be desirable in future; even if opposition politics is now easiest if you just wait for the other side to foul up and social media to rip them apart.

Zero-carbon? Can't Do it Yesterday?

A lot of notable recent shifts in the offshore wind sector, not surprisingly, as with so many zero carbon panaceas and the rush to do it all yesterday, the wheels are starting to come off. It is nothing like as cheap, or job creating, as the green zealots claimed or hoped. Protectionism is not helping either.

As Platts shows, for September, the more you make, the lower the price, just like real farming. UK offshore wind power is the least desirable in the entire European market.

Nothing wrong with the idea of offshore wind, and experts like SSE in the UK do well on big arrays in shallow waters, planned slowly, at least so far. Although even those are pricey and tend to need massive connecting grid structures.

Both Siemens and Orsted, to a degree newer entrants (at least compared to SSE), have taken a battering. Siemens had acquired a Spanish maker, but during the COVID fall out something came adrift, and it has hit big capacity and quality problems, resulting in billions in write offs – now it is restructuring – with a € 7BN subsidy from a group of banks. Heavy rotating machinery is always engineering hell; sticking it up a windy pole in salt water, is never that wise.

Orsted, the Danish developer, lopped 50% off its share price after ditching projects off Rhode Island and New Jersey - further billions written off. The idea you can put these things up off rocky coasts in areas of strong ocean currents and loads of shipping is quite interesting (and very New York, form over substance).

What torpedoed those projects was funding. The political desire for easy answers to high energy consumption made for poor outcomes (as ever), if everyone rushes to do it all at once, you simply create a cost bubble.

The single unit cost is never the same as for a thousand units; scaling up is always the tough part of any new technology.

Orsted share price - sourced from Yahoo finance - sharp focus on data

So, while Xi and Biden proclaim they will still save the planet, Biden rhetoric meets cost inflation once again, and cost inflation (and higher energy prices, a speciality of his) wins. Toss in protectionism, so that a Danish company is disqualified from his WTO busting subsidies, and the numbers no longer worked.

The Germans meanwhile find their own green funding trick ruled out by their own Constitutional Court, it involved taking a pre COVID funds surplus, and applying COVID emergency rules (on excessive deficit funding) and then spending it all post COVID. Isn't it odd that didn't really work? All three parts seem wrong.

Finally, the UK got no takers for this year's wind farm licences, as the guaranteed power price was too low. Next year the price has shot up, again guaranteeing higher energy prices for UK consumers (and industry) in the process.

Recession, Inflation and Valuations

Of the trio of recession, inflation and valuation, each investor has a particular fear. To me the nasty one remains inflation, and its friend rationing and stagnation. A lot simply can no longer be done. So that the modern solution (see above) of just throwing more money at it, from higher taxation and debt is largely pointless. Indeed, any farmer knows if you quadruple the inputs, it is still quite easy to halve the outputs.

We are deep into public service rationing now; we don't call it that, but persistent planned under delivery is rationing.

So, service sector inflation with declining 'outputs', is the issue. And that's the funny number 'outputs' we still record in GDP, so turning up, and being paid is an output, even if nothing (increasingly the case, both on turning up and doing anything) is actually done.

Recession? Well, I guess so, basic logic still says it must arrive some time; yet I still don't see big credit defaults or strain and a cooling labour market is clearly beneficial anyway.

And finally, valuations, well nearly everything looks cheap, outside big cap tech in the US, which somehow always feels pricey.

As rates fall through 2024, and funds flow out of cash and fixed interest, and M&A picks up, valuations still appear attractive. Albeit 2024 will (once more) be politically rather interesting.

Still, we could end up with some big questions answered and indeed big characters finally, finally, leaving the stage.


Maybe a summer breeze does lie ahead.



Charles Gillams



The Sleep of Reason

Big picture risk assessments today, and worries about the prevailing style of regulation - we look at where the next bank blow up maybe. We’re assuming this will again be caused by regulators and their herding behaviour. On the upside, an improving medium-term market outlook. Also, dollar danger.

But before I begin…

First of all, many thanks to those who replied to our sentiment survey, you are a cautious crowd! Over half (53%) sitting on the fence, alongside us. The largest directional group is bullish on equities (18%), but it is a pretty even bull/bear split with bonds, and quite a few equity bears too.

Regulatory Myopia and Declining Banks

Bank boards (and auditors) are still clearly confusing regulatory approval with sound banking, in the odd belief that excuse will wash, when they implode. In particular we worry about the vast amount of debt that is sitting on bank balance sheets, at below current market levels, and not in this case issued by governments.

We have notable anxiety about two areas, fixed rate mortgages and investment grade debt where, especially for the former, the numbers are vast. Perhaps the tightening steps to date appear so ineffective, just because so much of this old low-cost issuance, is only very slowly rolling off .

Big picture – the effect of long dated low-cost loans, with rising interest rates

This leaves cheap money in the system, funded by banks, that have to pay way more to keep funding these long-term deals. They’re doing this typically with short-term sources, like deposits. In sub-prime, asset finance, trade finance, consumer finance, none of it matters much, as they are pretty short duration.  Which is where most people worry, because of default rates, we don’t.

But in mortgages especially the regulator typically issues the future economic scenarios to banks, who then price (originate) and provide for losses against that projection.

If that projection is absurdly few rate rises, for a decade (as it was till fairly recently), it seems banks just follow obediently along. As a result, they have issued vast amounts of long dated, low cost loans based on false or unrealistic assumptions.

Those regulator driven economic assumptions/scenarios are key, and yet are lost in the detail. Each bank has to publish them if you dig deep enough.  (Some are on p155-157 of the HSBC accounts, for example, if you have the stamina.)

Re-mortgages – what they contribute to our big picture

The other part is refresh rates, in a falling interest rate world, borrowers re-mortgage every few years, but in a rising one early redemptions virtually stop. So, the whole system gums up, without fresh liquidity. Regulators have not seen, and have no data, on such a ‘higher rates for longer’ world. So, it is assumed that world cannot exist. While the key thing (still) on these scenarios is that interest rates are still assumed to be like rockets, straight up straight down.

Now if you assume that, there is some short term pain, but normal service resumes soon enough with no long-term issue. But is it realistic? It is a vast slow moving market as in this publication of the FCA’s mortgage lending statistics .

Inevitably the scenario dispersion used is small, indicating a regulatory finger remains on the scales. So, most banks take the Central Bank forecast as the middle way, with say 10% either side. All as at the historic balance sheet date. Last year they were nonsense even before publication, two months on.

That is aside from Hong Kong, where real economic models, with real outcome ranges are visible. For most markets you see a skein of twisted rope drifting laconically into the future, but on HK they produce an exploding ammunition graph, smoke trails looping everywhere.

To a lesser extent BP debt (a classic investment grade, big, global borrower) is a similar problem. It has half fixed, half floating issuance, but the fixed is at 3% with a fourteen-year average term and the floating at twice that, at 6%. Now someone holds that fixed debt, and if regulated it will have to now be held below par. Are BP going to prepay it? Despite the roar of cash coming in, why would they? It is stuck, unusable for 14 years, unless inflation (and rates) collapse as fast as predicted.

What else is driving markets?

The big upside drivers to us are, the end of COVID, the end of the energy spike and falling rates. The first two will help through 2023 and 2024. Rising rates are still hurting, but again 2024 and beyond  looks good.

While the biggest current downside driver is the recession, which will impact 2023, but again rebound in 2024. So, the issue is: will the rather timorous monetary tightening and anaemic reductions in the absurd fiscal overdrive, be enough to defuse all that good news coming in the next year?

Markets apparently think not.

We are particularly struck by the NASDAQ up 18% year to date, yet our tech bell weather share, Herald Investment Trust (HIT) is still (marginally) down YTD. So is this a bitcoin-type story (all about liquidity) or is it based on tech fundamentals? If the latter, then why is it seemingly glued to the US, and not translatable? Even failing to reach non-US holders of US companies.

For now, until the price of global tech shifts, I treat the US as a special case; growth is not back yet.

While the currency charts are unclear, it does also feel like the beginning of the end of the great dollar story, with sterling persistently ticking higher of late.

Graph showing the dollar share of global reservesFrom: this page published by the NY federal reserve.

That’s a real danger for portfolios that thrived on dollar power last year.

We close wishing you a happy Easter break. We will be back with St George.

Thin ice skaters or savants?

photograph by charles gillams

Are we drifting out further from the shore of reason, confident we can slide gracefully back to safety, or do we have insight others lack? Perhaps rates just can’t rise, whatever the inflation rate? If so, they are a paper tiger. While in a week others have pondered the failure of UK investing during this century, we look at why our biggest bank seems to hate the country.

I’m talking about the economics prognostications from HSBC, our largest bank. Following an intellectually flawed change in accounting standards (yes, another one), on top of the insanity of “mark to market” comes the “predicted loan loss model”.

Now professional bankers (unlike those in fintech) don’t make loans to lose money.

So, the politicians have instead required them to assume that they do.

Do the regulators know the industry they’re regulating?

Imagine portfolio management where you assume a certain portion of your buys always fail. Might be true, but how?   And if you admit you have to buy a certain number of your holdings to instantly lose money, what do your investors feel?

But although banks advance money on the basis of their credit committee assessments, the  hordes of regulators deem some of it is immediately lost. Being rational people on the whole, the banks, not great fans of predicting the future (given their record), hire economists to do this for them.

Economists, as we know, actually know little, but they do build nice econometric models. The regulators, who know even less, tweak the models, the bank Boards (see above) also tweak them. Soon every model is so tweaked that the economists wonder why they bothered.

UK shown as the riskiest of places to lend

Which leads us to page 62 of the HSBC Interim Report. We read it, so you don’t have to. There on the excitingly named, but dull as ditch water section called “Risk” it is set out.

Now HSBC lends globally: Mexico, India, Vietnam, Peoples Republic of China. So, guess where “The highest degree of uncertainty in expected credit loss estimates” relates to?   Apparently, the basket case to end all wicker weaving is . . . Yes, the UK.


Well first up their ‘central scenario’ model sees the short-term average UK interest rates for the next five years, as 0.6%. Which at least is positive (unlike France, as they hate Macron even more), France (i.e., the Euro) rates are assumed to stay negative till after 2026.

This gloomy central scenario has a 50% chance, although for France it is a tiny bit better at 45%.

Now these are central estimates, but their “downside scenario worst case outcome” for the UK is heavily weighted, with a chunky 30% chance, and oops, France then gets a 35% chance of that disaster, neatly using up the slack just given to them, by the central scenario.

From this OECD page - our particular selection of countries.

Oh, and there’s worse: house prices crater, double figure unemployment is locked in etc.

And that’s a combined 80% of outcomes sorted; for a bank, that is pretty near certain.

China compared to the UK and France

What about Mainland China, then, their biggest market, if you now include Hong Kong. Well like the US (75%), China is at a high (80%) central scenario certainty, with Hong Kong at 75%. The worst-case scenario for the PRC is ranked at just a measly 8%, the lowest of any of their major markets.

Call it impossible - a prediction that China can’t fail.

Well, if that’s what the economists believe, who are the dumb Board to argue? Well of course they can, to cover their well-appointed posteriors, they then chuck another couple of billion of extra reserves in on top of the doomsday forecasts.

So, you see the vortex, everyone, regulators, economists, non-executives are just adding to reserves, like the good old days.

Maybe they are right, but we are seeing very little sign of those incredibly low global interest rates for five years, negative in France, 0.6% in the UK, 1.1% in the US? Really? If they are right, the markets are wrong.

And it is not just technical, with a 35% chance of France hitting the worst-case scenario, no wonder the Board has shipped out their French operations to a fin tech start up, albeit one backed by private equity giants Cerberus. Not an outfit known for overpaying. With five-year rates at 1.1% the dash for cash in the US makes sense too, selling out of their retail side as well. While with a virtually nailed on, global leading, 5% five-year average GDP growth in the PRC included, surely time to expand there?

Their loan book does not bear out HSBC’s bullish estimates of Chinese infallibility

So it is with some trepidation that we look at their loan book, on Real Estate, in China. It must be massive? Certainly, markets apparently assumed so last week. But no, a paltry $6.336 billion, for HSBC that’s a rounding error. Luckily too, all rock solid, just $28m of reserves needed, although given their certainty that almost feels excessive. The Board probably slipped that bit in.                      

I have great admiration for HSBC, and for me personally it is a long-term hold, but I have much less regard for regulators and ‘economists’ models, about which only one thing is certain. They are wrong.

So, I try to just strip out the predicted loan loss nonsense, but it is still driving asset allocations, even when palpably false. It explains much of the last two year’s volatility in bank share prices and reported profits, it also justified the highly damaging dividend ban.

Yet the HSBC share price is still not much above 50% of its pre-COVID peak. Great investor protection that was, it hammered HMRC receipts too, for what? Based on what? 

Does anyone challenge those weird scenarios internally at HSBC?

Is there really a 35% chance of France virtually collapsing in the next five years?

Or is this just part of cozying up to China? In which case as the IMF has shown, bankers accused of fiddling data for China, are not always seen as professionals and can lack credibility.

Regulators should not impose those odd fictions on real investment decisions either.

If they do real economies and yes jobs, suffer. 

Charles Gillams

Monogram Capital Management Ltd