The Glass Bead Game
We look today at a domestic version of a complex, rulebound meaningless pursuit that too many of our brightest and best waste their lives pursuing, and whose twists and spirals ultimately signify nothing. Â I mean the UK Office of Budget Responsibility (OBR), of which I took a tour this week. Almost nothing there is as it seems.
Meanwhile markets reprise 2023, with tech or bust once more. Although tech and bust is the market fear, as fiscal stimulus and services inflation hold rates too high for some to survive.
UK OBR
The OBR was an explicitly political creation of the coalition government in 2010, with a remit to somehow restrain the ever-increasing debt governments take on, to bribe electors. They were also keeping half an eye on the much older âdebt ceilingâ style US legislation. It failed; so now the OBR just thrives on telling the government how much more it can spend or not collect, with spurious accuracy; purportedly managing public money.
It doesnât forecast anything as a forecast is an expected outturn. All it does is crank the handle on the old, discredited Treasury model, creating projections. A projection is 1) a âwhat ifâ assuming all other things are equal and 2) only as good as its underlying model.
One clear flaw is the requirement to take government spending plans as viable when they are usually not. They also have no idea where public sector productivity is heading. It has no remit to look at how productivity might be helped and no capacity to look back at how wrong its old âforecastsâ were. That is the job of the National Audit Office, it seems.
It also wonât talk to the Bank of England, as that organization has executive powers (to raise or lower rates) and the OBR apparently must just be a commentator: more glass bead rules.
So, it fiddles with the model and its six hundred inputs and countless equations to give precise answers to pointless questions, because each answer sits in its own vacuum.
Thereâs a heavy focus too on tax revenue, but with quite a thin staff, this results in excessive reliance on HMRC, who can be hopelessly wrong (and typically over optimistic on tax yields). But again, if the tax bods claim some complex, job destroying, arcane nonsense will raise income, in it goes. The side effects of such decisions must also be ignored.
It has no remit to assess how taxes impact productivity, which partly explains many of Huntâs blatantly anti-growth measures. As a result, the economy is locked into low productivity, getting steadily worse.
From the ONS flash report here
For all that the financial press will be full of the OBR cogitations on the forthcoming budget (March 6th). One little bit of power they do have involves a requirement for the Chancellor to give ten daysâ notice of the budget contents (hence no doubt the usual leakage levels) and for two months before that, they sift through proposals and indicate how each, in isolation, would work. The economy is an interconnected entity, they know, yet there is no attempt to give us an overall view.
THE LOST RALLY
I have few rational reasons why anyone would lend the UK Government at under 4% for ten years, were it not for some foolish faith in the OBR projections, without reading the small print.
Which brings us to markets: back in November the UK ten-year gilt yielded 4.5%, by about Christmas falling to 3.5%, and now it is back over 4% and headed higher.
Chart from this website
Quite a spin in ten weeks for a ten-year duration instrument. This is why that Christmas rally in value stocks was ignited, and indeed started to push out into Real Estate, various Alternatives and certain smaller stocks.
Although it didnât move those stocks most sensitive to the credit markets, who will need to rollover/refinance current debt. This affects for example, the renewables, private equity, and office property. The problem there is of both rates and availability. With the scale of asset mark downs, whether interest is 6% or 8% is not the issue; there is no funding appetite even at 20%.
The year-end rally moved a wide group of stocks, from extremely cheap to still very cheap. We then realized that it was not yet safe to go back in, so buyers evaporated, and prices faded. With state debt at 4%, against persistent inflation, fixed income is also oddly unenticing. So, the market default has been to pile back into the biggest, most liquid, US tech stocks and similar easy-in/easy-out momentum trades, like bitcoin.
There is little sign of deflation in services, no evidence of it in housing, where supply issues dominate, and little in financial services; indeed, all the supply side mess of COVID and excess regulation, is simply getting worse. Public sector pay inflation is also high and going higher (donât tell the OBR).
This does not dent the 2024 story of cutting rates and hence higher stock markets, but it may require some patience, and that delay may itself create more pain.
The Glass Bead Game and the âlost marblesâ qualification for office
Our games of self deception are not to be confused with lost marbles of course; it turns out that the onset of senility is now a bar to being prosecuted for storing secret state papers and also, somehow, a recommendation for re-election for four more years, to the most powerful post in the world.
If that ends up giving us Trump again, by default, presumably he will at least have a defense in future years, against those same crimes? He does not have the âBiden defenseâ available at present, perhaps thankfully.
As the OBR shows, very clever institutions can come up with very silly solutions.
By their works . . .
The November bounce in markets was a bit of an illusion, as interest rates may no longer matter, but foreign exchange still does. Inflation in commodities is probably sorted.
Meanwhile, Jeremy Hunt tinkers.
EQUITY MARKETS and the FABLED FIRST RATE CUT
The dramatic November rally, only looks that way if you are a dollar investor and for some weird reason the archaic Gregorian calendar matters to you. Sticking with the even older Julian one would have made October's performance much better and leave us ten days more of November to enjoy. Plus, lots more shopping days to Christmas.
While it was great for the big US indices, almost (but not quite) hitting the year's highs, in the UK, it was rather less so; the FTSE hit 8,000 in March and has slid down since, back to pre-COVID levels around 7,500.
The November US rally was also dented for sterling investors by a dramatic 4% slide in the dollar.
So, while it feels attractive, the fascination with the first rate cut date is pretty spurious. That is not the market driver. Markets have so far given us nothing this year for avoiding a global recession and seeing the last rate hike of the current cycle.
Surely that is worth something?
AND LONG BONDS
In a like fashion long dated bonds are giving us very little for having nailed inflation, and having (at least in the US) a credible inflation fighting stance again. So those, if you trust the US Government's credit, are not looking bad. This patch of inflation may have stretched the meaning of transitory, but it clearly remains just that, not a 30-year phenomenon.
Instead we see the recent fall in yields as being more driven by relief that rates have topped, and a desire to lock in nice returns in the global reserve currency, attributes which seem likely to overwhelm domestic US worries about high levels of issuance.
COMMODITIES
Commodities are where economics in the raw is most visible, especially soft commodities. High prices will always bring in marginal land, and there is no shortage of land on the planet. It may take a planting cycle or two, but food inflation always was transitory. Corn is now below pre COVID prices, let alone pre-Ukraine.
We believe the same is true for energy, for two long standing reasons: the first is that sanctions don't work, certainly not against enormous blocks like China and Russia. The second is that high prices create supply and in a highly tradeable commodity, they do so quite fast.
So, the idea of shutting in energy to manipulate the market price, is in the end self-defeating. It has to be. So however much the anti-carbon lobby and OPEC desire high prices, they are not sustainable. Indeed, it feels as likely that we get one of those crushing late spring drops in prices designed to flush out over-geared operators. That weapon works best, when interest rates are high and storage tanks are full. So why not use it? Â I remain far more nervous about the oil patch than most, it has yet to see the post COVID, overstocking crisis, that has rippled through so many sectors. Held off by the Ukraine war, oversupply is still around.
The World Bank October commodities forecast base case is for continuing declines.
Look at Healthcare stocks, still suffering from the COVID bubble deflating, despite new wonder drugs.
A stock like Worldwide Healthcare Trust, peaked in summer 2021 and has then slid remorselessly lower.
A LOOK AT HUNT'S TAX FANTASIES
Well, why bother, his tax give back is rightly mocked as trivial. His vague attempts to get welfare under control are painted as draconian, when they are anything but. While his games around a set of unrealistic self-defeating assumptions that he gives the OBR to produce nonsense projections in return are just absurd.
Full expensing for corporation tax is clever in only one sense, it is certainly not a tax cut, whatever he says, it is just bringing forward deductibility from after the next election, so off his watch. It is not changing what is deductible at all, and there will be loads of complex rules against deductions still, as ever.
While to most sensible cap ex modelling, the tax treatment remains damaged by last year's massive corporation tax hike. The long-term tax profile simply does not change, so it does not encourage investment, whatever he claims.
Oddly the real tidying up, as ever, is handled by Gove, quietly putting in place critical and very welcome new political funding measures, which reverse some of the long slide into democratic absurdity inflicted by inflation.
And he pops up in odd places as the fixer still, like Dublin trying to get the Ulster Assembly back in action - a vital if unpleasant piece of plumbing too.
Those are late but worthy actions, as a career ends.
The efforts on investments, while welcome and overdue are still tinkering, and the games with ISAs are as boring as ones with capital allowances. We see no real effort to simplify matters for domestic investors. The joke slashing of capital gains allowances (far from indexing or freezing they are still going down) shows a profound dislike of investors and investment.
Instead, a we get a work round to help UK investors buy fractions of Nvidia, - really?
Charles Gillams
3-12-23