Lend me your fears
I come not to praise Kwasi, but to bury him. This is an explainable, predictable but probably futile coup in the UK Tory Party, along with more King Canute from Bailey of the Bank.
But in markets there is abundant good value, but with few clues on how, or at what cost, inflation is to be tamed. Or indeed what may escape this time.
Political Manoeuvres
We have long noticed the Tory partyâs splits and factions, broadly between the left and the right wing. This was a chasm Boris was uniquely able to bridge, by talking right, and acting left. The puzzle, as we noted, was why the left would bring him down to replace him with a right talking right acting Prime Minister. The preference was for a Blairite Conservative, low tax, high spending, but a steady reformer, with a lethal penchant for foreign wars and illogical hatred of the Euro. After Kwartengâs departure, the Tories now have the doomed high tax big state faction back in charge again.
Hence the need for a pretext to overrule the party members and threaten Truss with the ever-gleaming sword of Damocles, held by the 1922 committee - we are back where the plotters wanted to be after Cameron â with the neutral Hunt playing the safe stooge to hold the fort.
Unlikely to win the next election
It foretells the inevitable party split â but we had never seen another Tory term as possible, regardless of the leader. Nor have we ever seen Keir Starmer as needing to do anything but sit tight and keep a grip on his party. If he is also spared the crippling cost of a really tight General Election, he can now face down the Trade Union money men as well.
As for Kwasi, if he stays the course, his troops will yet triumph at Philippi, he is by far the best the Tories have just now and looks to be the future. He has understood that if you fail to free the supply side, in a new productivity revolution, the current national decay will just go on, as it has for twenty years or more. But he has also not torched his future, Miliband style, in the wrong leadership move.
Will any of this stem the attacks by market traders? I doubt it. Will any of this forestall the inevitable sharp rise in interest rates, I doubt it. Or indeed stop ongoing sterling losses. To quell inflation requires interest rates above inflation, you canât bear down from below. It remains daft to think UK interest rates can be effective whilst remaining underneath US ones either, as we said in our previous post.Â
Both clipped from this site, and set out side by side. The core data as is cited below are from the Federal Reserve and the Bank of England respectively.
So, what is the shape of this next recession?
I think we are now starting to see it. Not that much unemployment, the current tight labour market, without addressing increased workforce participation, is going nowhere. Nor is a secondary residential property crash certain. That is so last century, both areas are now far more heavily fortified sectors than they were last time. And both are now designed (and legislated) to be fiercely inflexible downwards. That is what the current labour market (and our dire productivity performance) is telling us.
House prices are propped up by a very generous market backdrop, ongoing vice like planning, high land taxation, tons of liquidity and a deep political fear of the consequences of a collapse. For all the moaning, borrowers are still able to load up at negative real rates, with a highly competitive mortgage market and generous fixed term offers.
But do expect a general slaughter of small businesses (or rather the current collapse will go on despite the various support packages). Expect weak margins for UK based firms, ever more exposed to competition, from far more generous and protectionist states.Â
WTO rules really are in tatters now and routinely ignored by powerful countries like the US and Germany. Expect a resulting fall in quality both in goods and services, again a continuation of current trends, as globalisation retreats.
But remember too, that so far, we do have inflation, but not a recession. The current dislocation is caused by a resource switch towards savers, who at all levels have had slim returns for a while, and we will now instead punish borrowers, who have had an absurdly easy, subsidised, inflationary decade.
The big picture, overall
Meanwhile in the energy world, a resource transfer is taking place from energy users to energy producers, who have likewise had a thin time of it. That those energy producers are places like the US, Russia, Saudi Arabia, Iran, Nigeria, Brazil, is a remarkable own goal for Europe.
But it is neutral for the world.
Indeed, much of those surplus funds will now be collected as various direct and indirect tax revenues, or to pay down debt, or as new investable funds, or distributed as dividend payments, but very little of that vast energy price transfer leaves the known universe.
For Europe, however the decline happens with the slow loss of productivity, plus the demographic torque. Meanwhile borrowing our way out, is suddenly becoming far more painful.
The political turmoil is ultimately from this change, and the longer states borrow more and pretend nothing has changed, the less effective will be their remedies. And indeed, the more the big efficient producers, like China, the US and Saudi Arabia will thrive. Neither more debt, nor protectionism will solve this, nor indeed will more global military adventurism.
Confidence is understandably damaged
Given that backdrop the mood music is damaged just now. Markets are trying to spark rallies, but with no real confidence yet.
Investors sense there is value, but with too little data to know where.
But whisper it quietly, Santa Claus is due, and the market mood is not quite as bleak as events suggest it should be.
INDIA : âOUTER CHINA âCROST THE BAYâ?
Is India really rising?
For much of last year India was the top major stock market, and remains the best on a twelve-month basis, the main index up +9%: not bad, we look at why. While less exotically the lags in global markets, when the macro picture is changing rapidly, are getting tough to navigate. Too many fund managers and Wall Street analysts simply donât change, when the facts do.
Indian Stock Market rises to 4th largest, globally
First to India, in Premier Modiâs time in office it has gone from the tenth largest global economy to knocking on fifth, which is now predicted for 2027.
If true it will have overtaken a lot of Europe on the way. It is also already the fourth largest global stock market.
Welfare - and Highways in India
It has done it in part by two great leaps, firstly to take the millions of poor onto a national database for the direct distribution of welfare, creating the fastest monetisation of a society in history: the type of simple, big scale computerisation that works. It allows vast, complex, nimble schemes, both for welfare and tax, to be executed without a morass of red tape and civil servants milking them. The cash, meanwhile, gets right to the app of the men (or importantly as often) women who need it. Secondly it has taken a once Federal system, at least in commerce terms and unified it, creating a true single market. Neither seem that big, but both were critical steps. Remember how fond we were of the European Single Market? This one is twice the size.
While on the ground, the highway network has expanded by 50% since 2014 and in the air the number of domestic air travellers has doubled, air freight is almost as fast growing. A great deal of this is built on the IT sector, which has doubled in the last decade, and was already pretty big.
India seems to have achieved all of that while cutting oil consumption (per unit of GDP), and while racing ahead with the renewables it is so well suited for. It is also as we now know, one of the worldâs big grain, especially wheat, exporters.
Some patches of India excel, others not so much
Stock market performance has been good over that time too. I went to kick the irrigation pipes in Modiâs Gujarat, before he got the top job. I liked what I saw; they were colossal and the vision to take them far inland, well away from current irrigation, spoke of a great ambition. The co-ordination and mechanisation spoke of good (and rather un-Indian) execution. It was a shock, when in Bengal at that time, I felt it was mired in politics, with too many huddled and piteous masses, inhabiting another century. But the West and South of the country were different; Bangalore was already aping Silicon Valley, albeit with traffic congestion to match.
That has kept going, tough reforms, enacted on a big scale were needed, and have been provided. But for markets, especially for the ex-colonial power, it has not been easy. Modi is a populist, he tore up the Mauritius tax treaty, introducing CGT to offshore investors, re-wrote the tax law to force Vodafone India into a billion-dollar insolvency, and had to have national assets embarrassingly repossessed, before paying Cairn back an unlawful billion-dollar tax heist.
The other big risk was that the park was overrun by unicorns, and it was (and is) hard to know which will flourish, exploiting this vast unified fast-growing market (the OECD say the fastest growing large economy this year) and which will get foot rot in the monsoon floods.
While some of that was also funk money from Silicon Valley, which may now return to base, as the NASDAQ valuations fold, and indeed from China, which still remains in a different universe.
The history of jumping on (or falling under) Indian juggernauts, is not that great either. Racy IPO valuations falling to earth, have been painfully apparent.
But perhaps India will indeed come up like thunder, outer China, âcrost the bay*.
Now to Stock Markets - in a word, Horrible.
We are having the normal churn, as a lot of vested interests and âlong term holdsâ get destroyed and no one seems to know where the lags are, in either debt or equity markets; a toxic mix. Certainly not company management, and therefore not the big lines of âanalystsâ often printing corporate client forecasts on fancy notepaper. Odd how so many research teams think the FD they diligently talk to has a clue. They do eventually (one hopes) but day to day, week by week, not really.
The finance team in companies
The finance team sits at the end of long and confused reporting lines, stuffed with dud AI (especially on inventory), and with no handle on returns, credits or sudden weather spikes. Knowledge? No, not much. While on top of erratic demand, their supply chains are like using a rubber band to pick a lock - all over the place and unpredictable, and remarkably elastic. Trouble is what you ordered, the currency, the freight costs and arrival dates are all plus or minus quite a lot. Fine if you can sell all you land, at any price, not so good when others have too much stock too.
Try picking a reliable single digit margin, out of that morass.
So, when rates and demand shift fast, forecasts simply melt away. Valuations donât really change of course, but market prices do, and thatâs when you need to clearly know fundamental values. The rest is froth, just crypto analysis, not the real thing.
So, markets that rely on earnings forecasts quarter by quarter, could go just about anywhere, because no one knows.
For me, now is the time to buy cheap quality, with a yield, but otherwise just watch the spectacle from the sidelines.
REINSTATING REAL ECONOMICS - WISH YOU WERE HERE?
A return to the real world, where money has a time value is a great achievement. Inflation is after all transitory. At long last the most important of all price signals (interest rates) can break free, allowing for growth to resume. That is a cause for optimism.
Letâs look at the basics and start with food and fuel. Cereals are a critical foodstuff; we should remember they are almost automatically in surplus. All the great famines in history have been caused by logistical and storage failures, not an absence of global grain. Nor is energy a problem; our self-imposed constraints on its use are. Those are political, not physical.
Cold Comfort for Change - inflation, voters and price trends
Inflation, as we all keep hearing, is a supply side issue, which if true will always get sorted by either demand destruction, substitution, or new supply. But sorted it will be. The good thing about energy and food is that they are universally available, we favour one source or another because of price, convenience, fashion or dogma.
So, at some point they stabilise, it all depends on where the greater political heat is from; currently most Western governments fear lost âgreenâ votes more than high prices. Or indeed they may be simply locked into the Orwellian power surge of a foreign villain to fight, using young menâs lives.
However, history says that at some point jam tomorrow is less attractive to voters, than simply living today. We are not there yet. But either prices will ease, or we will ultimately take a pragmatic route and use our abundant low-cost resources.
These problems are not like microchips, with genuine supply issues; the extra chips simply donât exist; extra food and energy supplies do.
For grain there are vast swathes of the planet where it could be grown and is not, from the field margin just over my hedge, to parts of every other continent, outside the polar regions. The rest of the neighbouring field has spring wheat, an early sign of switching (a winter wheat crop would have to have been pre-planted). Yields may not be great, machines may not be efficient, but thatâs what price discovery does, if the cheapest producer drops out, the marginal one steps in.
In global terms lost planting land in Ukraine is trivial. And every year land is left fallow due to warfare or natural disaster, thatâs why markets exist. As for Russian surpluses, they will simply get stored or eaten in the half of the globe, that does not think as we do.
So, prices will sort themselves out.
Blue Skies from Pain - insurance and government borrowing
To reiterate, the big win is the defeat of the zero or negative interest rate world. The effect of that is quite tangible, in some cases: we wonât have insurance companies forced into a negative discounting of their liabilities anymore, nor will every defined benefit buyout be able to pretend there is no time value for money, releasing a fatal burden on pension schemes. Discounting will be back.
Time once more exists.
But the greater victory is against Government debt, the intergenerational horror of saying we can incur infinite debt for our children to pay down, because look, it is free! No more. Once more jam today means dry toast tomorrow.
Capitalism cannot work without price disclosure, and without prices, populism can roam free to destroy everything. At last, it is back in chains again, much as it yearns to fracture them.
The political price maybe high; I doubt if both Lagarde and Powell can keep their jobs. They still grandly support ever greater restraints on supply, almost as foolishly as they say they still believe interest rates wonât rise that much. An amusing deceit.
A Cold Steel Rail
Ploughing through the accounts of Glencore, one of the big resource outfits, I realise just how much of their recent good fortune (and it is spectacular) is tied to Governments forcing producing assets off the market and reducing the operational efficiency of installed plant. Demand is up, but supply (so the tonnages mined) is down. The production restrictions are state imposed, but there is little desire to invest anew, while they exist. Indeed, the CEO earns a bonus both for high profits and also for low capital expenditure: a strange way round. A critical supplier for the energy transition, that wants to be smaller, a fine tribute to governmental mishandling of our world.
For all that we still donât expect Powell to be that aggressive on rate rises; all along he has talked tough but acted soft, it is his comprehension of what âgoodâ market communication means. Many of us have another word for it.
So, we do see rates as having risen too far, too fast, and they now need to stabilise, Powellâs talk and the market need to get back in line. Although the collapse of the Japanese Yen reminds us where the void lies too. And that a host of market decisions all really just come back to your faith in the US Dollar. While sterling has juddered lower at the whisper of cowardice by the Old Lady, but she has talked mild, acted fierce, the right way round, and I expect the UK to keep raising rates.
A Walk on Part in the War
While the UK political scene hots up, two factions in the Tory party are tussling for power, the populists and the realists. Both incidentally dislike Boris as a sell-out and will speak ill of him to the media.
The populists have done very well, loading on taxes and regulations and fluffy aspirations. And they have chanted fiercely in favour of pouring arms into a foreign war, simply because it is what gets approvals on Twitter. As if that ever ends well. Their new-found blood lust is extraordinary. So too is their fierce advocacy of fighting inflation with hand-outs, which is so 1960âs and known to be altogether futile.
The realists meanwhile seem to know that is the path to doom, but lack the nerve or confidence to say so outright. To eject Boris therefore requires two swarms of slightly crazed insects to coalesce, and in a mutual fury sting him fatally, then try not to destroy each other in a fight for the spoils. Are Tory MPs that stupid, mindless or incensed? Interesting question. I suspect like Powell they seek advantage in talking tough, knowing they canât act.
While aware I may already be wrong as I write this, I feel compelled to say that I wouldnât expect Macron, a realist, to fall before Le Pen a populist, but you never know.
So, I do feel we are, after a long wait, where we should have been after the GFC; if so thatâs a great win for rational investing. It is odd, that one crisis (COVID) is treated with monetary excess, while another (Ukraine) with monetary tightening; to an economist the problems (supply destruction) feel quite similar, the responses feel oddly confused.
But as Churchill noted America usually gets it right, albeit after exhausting all other options.
Perhaps it now has?
Will the March lows now be re-tested?
In dollar terms that looks likely, but sterling investors remain well clear of that point. I suspect (for now) uncertainty is doing the real damage and making it too easy simply to stand aside. But a belief that yields are high enough would draw funds into US bonds (clearly is already) Â and by definition, the currency. This oddly will then help US equities to find their feet.
That combination of forces, for now, has meant un-hedged S&P 500 has been a clear (and stunningly simple) winner in our flagship MonograM sterling strategy.
The modelâs skill is in making that prediction, so that we were already correctly positioned, going into the year.
Were you?
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