Boris finally quits, and 'Quality Growth'
Boris finally quits: the loss of his Chancellor clearly made this inevitable. We also reflect on the London Quality Growth Conference, held in Westminster last month. It implies a very US bias, driven by two US universities, that seem to dominate much of UK investing and indeed public policy.
First as tragedy, then as farce
So, it is over. The absurd repetition of the same error and the same apology passed from tragedy to farce.
Clearly the belief that you fight inflation and unpopularity, by bankrupting the country with printing money, had also simply become too much for Sunak. That was the fatal blow. Let us hope the next leader is less of a deranged populist. In the real world what is popular seldom overlaps with what is right.
We will skip the look backward, over his flawed career, skip the look forward over the seven dwarves, and fervently hope for a different set of economic policies by his successor. It sounds as if there is plenty of time for a long summer of speculation. The likely candidates are less than attractive, let us say.
How might the UK market respond?
Nor can I fathom a market response to a change of leader in London: bullish that it is over? Or could it be bearish as we donât know what comes next, or indeed bearish in that it surely strengthens the opposition?
While we felt the Old Lady moved far earlier than others (late in 2021) because of UK fiscal laxity, we see no reason yet for them to back off their August rate hike. Politically it is hard to stop and start interest rate moves, while just repeating a previous measure in mid-summer will look innocuous. I suspect thatâs true for September too, but that feels a long way off. And I do note, that as we predicted, the great spike in corn and wheat prices has taken just one growing season to unravel, as farmers react quickly, by adjusting cropping patterns, knocking out another justification for any more price rises.
A weak pound is also importing inflation, and the Bank has to make a stand somewhere, but 1.19 to the dollar feels too early, 1.09? Pressure will start.
Alchemy Unchained?
We turn now to âQuality Growthâ, an excellent conference and well presented with a dozen first rate managers from the US, UK, Europe presenting.
But it led me to ask about the underlying assumptions of the âQuality Growthâ model.
Firstly, there is the Santa Fe school, which speaks of the ultimate failure of nearly all quoted companies. This is the old â99% of the S&P 500 stocks contribute nothing to returnsâ case. Allied to that is the Columbia (New York) mantra that some companies can beat the pack for ever, so the theory is find those âcompoundersâ with their âdeep moatsâ and your investors will win for ever.
It was surprising how much of current fund management practice is wedded to those two assumptions. They look remarkably shaky to me, but if believed by enough of the industry, are likely to become self-fulfilling.
Which adds to another oddity: we know active managers seldom beat index investing. But this year should be showing the exact opposite. Passive long only funds are destroying wealth at a terrifying speed. So true active managers should do well too, but oddly (and absurdly) perhaps because of this âa few chosen winnersâ theory, they too seem to willingly forget about valuation.
True Believers
You see these few companies are (after exhaustive analysis) the nailed-on winners, so if the market halves, they will still outperform - just hold on and they will come good, the fundamental long-term analysis says so. You will recognise Cathie Wood, Scottish Mortgage are, in some measure, exponents of this too.
What is not to like? Well, self-reinforcing buying propelling valuation is dangerous; ask the Woodward investors about that one. But we also get odd clusters (identified as the winners, or the winning group, or amongst which will be winners; choose your terminology, like Tesla or Palantir or Netflix), which cut loose from sane valuations, becoming for a while mere intellectual Ponzi schemes, moving only upward, fed by endless new money.
Until they donât.
And every time âbuying the dipâ gets burnt, there is less fuel for the next attempt, and less appetite to try.
Too narrow a view?
I am not wholly convinced by the âonly a few stocks matterâ theory; for a start, you have to be very lucky with your baseline, even if you can spot the gems.
But even less do I believe that you can really thread the needle to identify the great companies, and secretly buy them, without shifting their prices and then hold them, in public portfolios. If you are right (and success requires you to be right) then everyone else piles in, and valuations simply become a function of overall liquidity.
The belief that having found them, you can leave them in your portfolio for decades, feels somewhat quaint. There are some giants that do perform year on year, but we all know of plenty of giants that rise and stumble (see above), and many that have multi-year slumbers (most oil and bank stocks).
Fashion or Momentum?
So, at the conference, we had a hall of great fund managers, but also the odd IFA pleading to be told about current performance, which was simply shrugged off. Our clients are always keen to be told about our recent performance, I am sure in truth so are theirs.
Given the structure of the market, now may be the perfect time to buy Quality Growth, but that bigger question about rates and inflation trumps all. And investing, we know, is about fashion, thatâs why momentum (usually) works.
I do like some of these funds, and respect their hard-working managers, but feel investing needs a hybrid approach, quality, yes, growth yes, but critically valuation and momentum too.
It seems like public policy has also increasingly drifted in the direction of this âpicking winnersâ theory and backing what are believed to be high yield, clean, desirable industries, rather irrespective of their viability.
Public Policy implications
Once you accept fund managers can spot these, you perhaps accept governments can also nurture them and scatter tax breaks around them. This will, at the same time, destroy the rest of the commercial ecosystem, in part, oddly to fund the hoped for predictable and desirable elite. Look at what Tesla (again) has done, extensively subsidised by exchequers round the world.
Does real life work like that? I doubt it - but investing theory has clearly now tainted public policy too.
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Charles Gillams
Monogram Capital Management Ltd
Hard Landings?
Local elections tell us remarkably little about national ones. We reflect on those. Meanwhile US equity markets are in turmoil, and some big numbers are changing very fast - some further musings.
Do English local elections count ?
We start with the UK, or rather English local elections, the devolved governments (oddly) have a rather greater read through from local to national. But overall, nothing in the results changed our view that Boris will probably survive, unless the Tory party unites around an alternative, which is pretty near impossible: it has too many splits.
Nor has our long-standing opinion that all Keir needs to do is keep his head down and he will be the next Prime Minister changed. Although if Labour starts to believe it is a shoo in, and can pick who it likes as leader, it will also self-destruct. Which is just about the only chance the Liberal Democrats have of being relevant.
Just how politically marginal local elections are, is shown by the surge of support for the Greens, apparently the very voters the weird Tory infatuation with hard left environmental policies were meant to entice.
Indeed, a whole set of Tory policies designed to raise energy prices, have gone down like a lead balloon.
What voters want and politicians need to deliver
You do wonder if they will ever get round to realising voters really want just three things, a roof over their heads, bread on the table and a job. Deliver those and do so competently, and politics is easy.
The roof bit is a shambles; it turns out policies designed to enrich cabinet members and senior civil servants with buy to let portfolios, are not so good for anyone else. I suspect the job bit will soon turn turtle, and the bread bit is going off the rails too. See graph below:
Here is a link to the relevant page on Statista
We notice that the big Western democracies still seem hell bent on raising energy prices, which is universally unpopular.
UK local elections - a brief look at opposition policies
So, the other thing markets in the UK (and sterling) will be doing is wonder about Starmer policies, more critically does he have the âbottomâ to either appoint radical reformers, or have them lined up in key seats? Letâs say he does. He will still continue the headlong wealth destruction of punitive taxation and the assault on business investment. He will over-regulate (thatâs his background). The sole variable therefore feels like any plausible capacity to reform.
He is not afraid of hard choices, or of thinking long, both good points and incidentally he is not Blairite enough to be Americaâs poodle and get involved in picking pointless foreign wars. Although he will likely dismember the United Kingdom, either of political necessity or by accident. We really canât see much support for sterling in that package.
Central Banks - are they signalling a hard landing?
Inflation is spiking into double figures, and Central Banks are explaining
1) it is really not their fault
2) they are only responsible for âcore inflationâ (so without the important stuff)
3) but anyway they must still raise rates to offset the malign effects of other state policies.
It is looking truly absurd.
Not that interest rates are off the floor yet, although the US bond market seems convinced rates over 3% are now nailed on, while oddly the UK Gilt-edged market seems unconvinced of exactly the same thing. This of course is helping an on-going collapse in Sterling.
Meanwhile the possibility of ending negative rates in Europe has caused great excitement and the Euro to strengthen, at least against sterling. The divergence is related to a belief that the Fed which raised three months after the Bank of England is now more hawkish, a belief which seems more about wishful thinking than anything the Fed has actually done so far.
We are less sure on how high interest rates go. All three Central Banks seem to be hoping something will turn up, and inflation will ease. This is a view we share, but we really doubt the trivial rate rises so far, are the âsomethingâ.
Market turmoil - how far will they fall?
This leads on to the current market turmoil: With the US feeling very exposed, partly because it went up so high (relative to other markets), it has further to fall. Nor do we see the valuations on quoted US growth stocks as offering good value at these levels. They had become so detached from reality the gap is just too big, and the repeated attempts to buy the dips, just disguises a long-term trend down. The FTSE100 over five years is down, and the NASDAQ climbed over 100% in the same time. A 25% further US fall is at the least plausible.
Other markets will then get sucked down, and in Europe and Japan they are hard hit by their reliance on imported energy (the US is an energy exporter). While for now, their rates are not moving either, the resulting devaluation makes the value gap to US growth stocks, feel even greater. Buying overvalued stock in an overvalued currency, is not always great.
What do our models say about the markets?
Our MonograM momentum models suggest a turning point for both Europe (including within that bundle the UK) and Japan is close. It is only a model, we remind ourselves, and is quite able to give a false signal. It also sees this as true in dollar terms, not sterling. So, there is plenty of noise and last week had all the elements we dislike, a month end, plus a shortened market week, plus Central Bank meetings, created a baffling miasma of signals.
However, on current policies we anticipate a crash; the only issue now is how hard the landing is.
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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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 wonât or canât 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 donât 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 Russiaâs 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 wonât 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 donât 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 sideâs 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 Goveâs last hurrah on âLevelling Upâ 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
Sea change
A trio of influential knaves to worry about this week, united by a belief that âthis time is differentâ. Well pantomime season is behind us, however we can still all shout âoh no it isnâtâ.
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, thatâs 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 canât 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 âthere is no inflationâ they have turned on a sixpence, to say inflation is now out of control. Talking of six or seven rate hikes; they wish, just bankerâs fantasies. Although markets, not surprisingly, are now suddenly jittery.
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 canât 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 donât see that as sustainable either. One must be wrong.
Looking ahead
This is why Lagardeâs confidence in no rate hikes, feels like a lawyerâs bluff, as if currencies move, it wonât 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.Â
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.
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 wonât 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