Black Headed Bunting
Flags should be flying, the COVID cycle is over (says Lagarde) rates are falling, currency wars are afoot.
Ignore the noise, watch the graphs.
But somehow gloom pervades.
Truly a black topped bunting.
MIXED MARKETS
Markets are designed to confuse and a lot of that is happening, with the worst of recent gloom a way back now. In developed markets it was April, after which the value rally got going, very much with falling rates. And they are falling - seven cuts (or was it Trumpâs nine?) in Europe. Less than a year ago rates were at 3.75% and are now almost halved to 2%. Thereâs a rising currency, giving an urgency to cut fast enough to stop the damage from competitive devaluations.
India also did a surprise double cut (so 0.5%) this week.
LatAm is behaving oddly, it has been a top market, year to date, but largely because it hit a low at the turn of the year; year on year it is not up. Brazil is almost in lockdown with rising rates (14.75%), and no surprise, a year-on-year market fall. Mexico is well into rate cutting, at 8.5% from a post COVID high of 11.25%. That market is up 17% this year.
Another year-on-year top performer is the Hang Seng, up 28%. Why is that?
Aubrey Capital kindly hosted an Emerging Markets conference in the City this week. A speaker noted that as China and Russia now avoid the USD, many traders are ending up with, or need access to, a non-convertible currency.
The PRC therefore apparently facilitates global gold exchanges, as a substitute, in three new offshore hubs (as well as Shanghai). This is perhaps helping to ramp the gold price.
But that has physical limitations. However, China also has a convertible currency, in the Hong Kong Dollar.
If that gets used more, demand for it also rises.
The actual twelve-month top performer is the DAX in Germany, up 29%. But just across the Rhine, the CAC 40 has fallen over a year. If nothing else, easy terms like Emerging Markets, Developed Far East, LatAm and even Europe, are hiding some very mixed performances.
MISTS CLEARING
But the common theme does look like rate cuts, and thatâs a cause for optimism. The UK now needs to be very careful that Labourâs fiscal ineptitude is not forcing rates to stay materially higher than in Europe, (still at 4.25%). Â As a result, sterling is strong and in danger of getting stronger, helping inflation, but hurting growth. UK exporters are getting kicked enough already.
It hurts housebuilders too.
Compiled from the ECBâs recent publications
The UK market rally feels a lot about beaten up, high yielding stock, sensing some relief is inevitable, regardless of the Bank of Englandâs posture on inflation.
The strength in UK banks (a big part of that outperformance) is partly their attractive yields (as rates fall) but partly the belief that as rates stay high and weak demand persists, surplus capital allows them to buy back shares and reduce deposit rates, both of which the sector has been quite aggressive about. Thatâs nice, for banks, but it is a Goldilocks position, either rates now fall, or bad debts rise.
For all those caveats the Europe, Value and Emerging Markets rallies are real. And if rate cuts go on, we expect these to persist. Along with this, at some point, a currency reversal when the Federal Reserve finally moves.
Our work still does not suggest an outflow of funds from the US, just as it does not suggest a recession or pull back. None of which makes much sense, given the weaker dollar this year. Although it may simply show a reduced inflow rate into the US.
So, is something moving, that we canât see? Â Rising long rates are giving the same signal, of assets unexpectedly moving, out of fixed interest.
While I expect political chaos under Trump, amplified by an obsessed UK media, I do wish for some days of calm; could he not play more golf?
Some of us take no notice, of course.
OFFENSIVE FUNDING
Back in the UK, the defence review - a helpful two-page summary is available here; sounds like something for everyone. (If the Tory party had the intellectual depth to suggest this, both the profligacy and militarism would have raised Cain). But it is all (as ever) fabrication, there are no available funds, even though the serious work of building inventory, finally starts.
We are promised six new energetics factories, which sounds like a modish protein bar, but just means lethal explosives. It is the logical move, but only accountants can deliver it. Year to year accounting means we must accept (and hope) that 80% of the energetic output will be made, stored, and then destroyed, at a vast annual cost. This stuff does not keep well.
I have yet to find a minister that can allow that annual profligacy. Creative accounting is needed.
I also canât see how this hybrid Truss/Reeves can borrow (and tax) another 3% of GDP for defence. She has already rewritten the rules to add billions of spend, loaded the tax burden on companies, and now like Trump, wants to spend her way out of debt.
It simply wonât work.
KURD YOUR ENTHUSIASM
We noted last week (along with a speculation on tariffs, a mugâs game, I realise) how Turkey is surviving unconventional economics. It does sit in the Emerging Markets universe, and is owned in emerging EMEA funds.
Notably, while for some of those countries, the holdings are dominated by banks, for Turkey, it is all real manufacturing, distributing and retailing outfits that attract investment. The odd impact of high inflation.
Although much more tourism will put out more buntings, including those gracing the ruins at Kars.
Where will the cards fall ?
The half year approaches - what has happened? Two very different quarters so far. And Investment Trusts complain too much, having stuffed their boards with placeholders with minimal stakes in the shares and multiple appointments. In markets many things still depend on how the cards (and ballots) fall.
THE FIRST HALF
With current interest rates for hard currency, high yield bonds, around 6%, you would expect riskier equity markets to be giving you over 10% a year, made up of a mix of capital and dividends. Thatâs the bar; it is quite high just now.
Looking back a year, only Japan and America comfortably achieve that, the S&P up +24%, NASDAQ up +30%, Nikkei up +14%. Germany creeps in at +10%, neither France nor the UK do. Outside developed markets, it is largely dire, only India at +25%.
Then looking just at the first half, all of Japan and Germanyâs gains came in the first quarter, so they are now sitting well off their twelve-month highs. While as we know the big three, S&P, NASDAQ and SENSEX, are now close to all-time highs, they powered through the second quarter.
So, the challenge is, do they go on up, do the markets that have fallen back, after a good first quarter, come back to life, or do some of the dogs perform?
Some major markets, Friday close and intra day
I have no great faith in the UK market, nor in a new government being much better at growth (it can hardly be worse) than the current mob. But there are cheap looking international stocks in the UK and the punishment meted out to real assets, by interest rates and shrinking bank balance sheets, might be finally ending.
While quite clearly the good middle tier stocks are easily cheap enough to lure in bidders from abroad or private equity, in some number. UK valuations are in short OK, not something you can necessarily say about the US.
The residual underperforming markets do often have a nice yield, but who cares? With bond yields high and staying high, in an appreciating currency, why take a cut in yield in order to buy equities? Plenty of time for that later.
Anyhow in most European and Emerging markets, equities seem not to be able to get out from under their own feet, endlessly tripping over their own fractured politics.
INVESTMENT TRUSTS
We are hearing a lot of moaning about Investment Trusts, which the FCA really do not like. EU law always struggled with the trust concept anyway. That the FCA has shown no interest in freeing us from those shackles is not a surprise, it seems they too would rather channel money to Nvidia than invest in the UK. Here is their Lordshipsâ briefing on what EU rules we might be repealing. Nothing for Investment Trusts.
I am on balance on the Trustâs side, I do think closed end structures (as they all are) allow long term decisions, while protecting daily dealing, one of Europeâs quirky hang ups. Daily dealing is fine in deep markets, but an illusion in many medium and small equity markets. With liquidity ever more narrowly focused, closed end funds seem more, not less, important, for balanced capital allocation, competition and growth.
Trusts directors should also protect investors from over mighty fund management houses, who treat closed end funds with disdain, as captive funds, with often high fees. Their greed lets in low-cost passive competitors. Instead, their permanent capital should come with an obligation to hunt down good, index beating performance.
Sadly, the FCA has perpetuated a system, where the fund management house appoints the Boards, not, in reality, the other way round. So, they are decorative, good for marketing, and highly unlikely to fire the manager. Too many are industry insiders, serving on multiple trust boards, often in sequence. Seldom do they have an investment of at least their annual pay cheque in their current Trust, and often, little investing expertise in the relevant area.
So, Investment Trust boards hardly ever sack fund managers for poor performance. David Einhorn explains the bigger issue very clearly, noting benchmark hugging over time is what investors now get. There is a clear link to poor performance and bigger discounts, and to big discounts and treating shareholders badly: One area where big certainly does not mean better.
Rather than sabotage the sector with old, irrelevant EU law, the FCA should be hunting down poor performance, and making the âindependentâ directors just that, including banning directors shuffling around a set of one-manager trusts.
INTEREST RATES
We have just had Powell hold US rates, saying it is all data dependent, and slightly oddly he conceded the expectation is for a pick up in inflation, on the technical grounds that the abrupt drop in inflation last year, creates base effects.
Although he rules out more hikes; you get the feeling if he had held his nerve last summer, and added a bit more, inflation could be beaten by now. Not that he wants to or can add such instability now, so he is stuck, and we with him, watching paint dry.
With no real distress there is no pressure to cut prices, service inflation remains too high, energy prices are still quite strong, so no longer giving a deflationary boost. Both the AI boom and the resulting stock price gains, encourage consumer spending and keep (in most sectors) a strong labour market.
Markets are evidently OK with that, falling rates, no recession, growing earnings, is almost ideal. Meanwhile we are all hoping that Congress will keep either of the two old men from doing anything unusually silly, and the electorate will keep Congress on a tight leash.
Quite a lot of hoping and several months still to go.
DREAMERS
What would Trumpâs high tariff isolationist world look like? What would the mirror image be in Xiâs China? Not now, not next week, but rolling into the next decade.
And whatever portfolio theory says, and whatever the optimistic investor believes, 80% of my own portfolio is flotsam, drifting up and down on Pacific tides. Stocks I both like and which have compounded over decades are remarkably few. Oh, and a brief word on African housing.
GOING IT ALONE
But first, to give it the grand name, autarchy, or self-sufficiency. A bit of a joke - the Soviet Union tried it, Iran tries it, China famously only revived after ditching it.
But it is back in fashion, and not just in strange places. The EU industrial and agricultural policy is starting to look like a version; beyond their four walls they need carbon and chemicals, but within them they donât, nor will they allow imports of them (or products including them). Quite fantastic.
Trump is on his 60% tariffs line. Xi clearly wants to cut off foreign capital, as it arrives infected with democracy and transparency, and the associated foreign reporting or verification.
So, could they? Yes, the US could - it is big enough, can do most things, and largely trades internally. While at least in Trumpâs imagination the commercial borders are sealed, and so enforceable.
What goes wrong? Well at some, quite distant, point people stop expecting to trade with the US. So, at its most extreme, if China canât sell to the US, it wonât buy from them either. But that is decades away, most Chinese production can probably take a 300% tariff, and still sell at a profit.
The flip side of the tariff is the huge salary for a barista, or a trucker. The latter is not so far away. Prices of domestic US production must rise, to allow the blue-collar Mid-West to rejuvenate. US consumers of course (including that barista) will pay vastly more for US goods, or will get hit with the import tariff; this of course is a tax on them.
What about Xi? Well again it is possible - thatâs how China ran for much of his life, with a lot of new infrastructure, industrialization, since installed. He can do it all again. There, unlike in the US, the issue is capital. As a big net exporter, an area that will itself be under pressure, money will be harder to find; it already is.
THE NIGHTMARE
Countries that go through this closing cycle typically also do default (as the Soviets did, as US (and UK) railways did,). Folly, but it can be done.
The US has been going down this route since Obama, Trump talked a lot about it, but Biden too sees the resulting wage inflation as a good thing. So, it is the next US Presidentâs policy either way.
Obama was keen on hitting capital markets (FATCA was and remains both a non-tariff barrier (I am being polite here) and a tariff on external capital) and I suspect a Biden administration must do the same, to balance the books.
While Xi never really left protectionism, WTO and GATT were mainly honoured in the breach.
And Europe? There is quite a strong strategic need to expand to the East, although as that goes through (and we are talking the mid 2030âs here) Ukrainian farmers, like Polish farmers today, will buckle under the rules; it barely matters about the Donbas, the EU will shut those heavy industries down too.
So, I think autarchy can work for all three, it will support a large uncompetitive labour force, and consumer choice will vanish. In many cases there will be lower quality and high prices. All three will attack (or in some cases keep attacking) capital flows.
And in the end, the entrepots will survive, those not in any such block, like the UAE or Singapore today, Amsterdam in the 17th Century, Yemen under the Romans and Victorian Britain.
The winners will be flexible, a tad amoral, assertive, in fluid alliances, but reliant on gold not steel to survive. And they will suck in entrepreneurial talent too. At a strategic level, that feels the place to be looking. Although buying uncompetitive heavy industries before their brief period of tariff induced profitability, has a short-term allure.
DOGS OR GREYHOUNDS ?
The ludicrous halving of CGT allowances, based on some fantasy âyieldâ number from the equally ludicrous HMRC, via the OBR, means once again the tiresome process of harvesting losses is upon us. No longer can they sit unloved at the back, snoozing; out they must come.
And what a tale of dross they reveal, and scattered amongst them so many once âgood ideasâ and busted yield stocks. Well, it sticks in the throat, but perhaps sticking it in a US wonder stock for six months is better?
Of course, if I knew when I acquired them that the FTSE was moribund for two decades, I would never have bothered. Seems it is time to simplify.
COLLATERAL
And lastly African housing. It was one of Gordon Brownâs (and the PRAâs) great achievements to get UK banks out of overseas assets, far too volatile, currency? foreigners?- Who needs them? Bring it all home and inflate the UK housing market with safe, cheap, mortgages.
So, Citizens went, Barclays were hounded out of South Africa, and so on â although their post-sale performance has really not been great either. Africa now just does not have proper mortgage financing for the vast bulk of the population. This is at a level I had failed to fully comprehend.
You think that despite everything, Africa must have got better. But no housing, so less health, less stability, no financial security. Safe recycling of profits in the continent is still hard. Aid canât create institutional reform, but thatâs the need.
If you look for the breakout into developed status, it starts there.
All mimsy were the âborrowgovesâ
Away from all the shenanigans with base rates and currencies, earnings seem to be showing a pattern. We look at the possibility of an unshackled NatWest and Indiaâs renaissance after the Hindenburg disaster.
START OF EARNINGS SEASON
In so far as reported earnings have a pattern, it reflects the actual position, not the fears of a hidebound analyst community imprisoned by useless economic models. Statistics are not predictive.
There is no recession, whatever all those clever models predicted, never could be one with the extreme fiscal stimulus (quite unlike the private sector fuelled inflationary blow outs of previous downturns), high employment and plenty of liquidity. So, real life earnings are in a purple patch, high and in cases rising demand, with falling or stable costs.
Meanwhile wage costs are perhaps stabilising and the labour supply position seems less frenetic.
In-house graph from published UK Government statistics – real time statistics
But dividends are generally ticking up, a nice bonus to collect when interest rates do start to fall next year, and valuations based on yields look low again.
FLAVEL OF THE MONTH
Nat West really is a sorry tale. The government stupidly sold off the crown jewels at give-away prices, and it now seems to be clinging on to the chaff for no good reason. The dead hand of the state permeates the place, and given the huge interest being paid on the vast national debt, surely a sale of all the government holding is long overdue.
You read the voluminous annual accounts and somewhere about page 180 the PR guff gives way to the reality of declining business lending, a worsening net promoter score and that ultimate civil service fudge, of combining two corporate departments to obfuscate.
Does NatWest actually dislike its customers?
I speak from experience – NatWest seems to dislike small business: we moved the last of our corporate accounts from there this year. Why? In striking contrast to the PR flim-flam that dominates the annual accounts, it seems that making life easy for us, is nowhere on their agenda.
At some point, it was just easier to go than fight – somewhere around the twentieth demand for the same details, and the endless Orwellian (âdoes not agree with other dataâ), even after the written confirmation that they were now content; so we quit. Always there was that threat to close the account, but not release our funds, for some arcane procedural reason.
I found the bloated pay packet for the CEO (and CFO) pretty hard to swallow for that performance. It just seems that they donât attract good staff, and like the slow pacing of caged animals wearing their lives away, those that remain pick away at the residue of their customers.
As for valuation? Nat West would still be cheap, but I felt if it broke above ÂŁ3.00 (as it did earlier this year) again, on present form – thatâs not a terrible exit.
Letâs hope this starts a basic rethink and some real value creation.
RISING IN THE EAST
We noted when the Hindenburg short-selling started in India, and we doubted that it was much more than a clever speculator, despite the sad sight of the neo-colonial British press (and a few Americans) lining up to say âI told you soâ.
Fridayâs FT was discussing India and still called it âlow-growth⊠dependent on commodities⊠hampered by political dysfunction and corruptionâ. Extraordinary – stale, lazy, stereotypical.
The reality is as we predicted: after a pause while stock markets looked for a systemic problem, and the short sellers booked their profits, the Indian market strode on to a new height.
From Tradingeconomics
Not that the biased UK financial press would ever mention that story. Far from the mud hut image they seemingly seek to portray, plenty of IPO (and deal making activity) is showing that India, not Europe is becoming the true challenger in high tech.
The SENSEX started this century at 5,209, the FTSE 100 started at 6,540. The FTSE 100 has made it to 7,694, and the SENSEX? It has powered past to 66,160. One is up some 18% in 23 years, (not enough to even cover advisor and custody costs), the other 1250% in the same time.
No sensible portfolio can have omitted India this century, but the UK press will have worked hard to ensure most UK ones still do.
Well, thatâs the half year done, we will resume on the 10th September, expecting markets to be drifting sideways, but that gives plenty of time for the traditional summer bursts of excess or despair.
Although if it is performance you want, getting the big moves right, and the right markets, is far superior to the timing of most individual stocks.
It is Not a Pipe
A long view this time : Has the price of capital changed for good? How bad is the UK position? Oh, and the unusual universality of colonialism.
A Far Off Galaxy
Letâs start with colonialism. I have been reading about the benighted past of Bulgaria (R.J. Crampton, 2nd Ed, CUP). A Bulgarian I know said that the country âhas a knack for picking the wrong sideâ - a little harsh, I thought. However, it has always existed as a colony, aside from a brief imperial phase around the last millennium but one, and before that when it equated to Thrace, almost as far back again.
Given the option, Bulgaria recently opted to join the Western European empiresâ current formulation as the EU and NATO - the latter being the armed wing of Western thought. Bulgaria had suffered horribly under the Soviets, with a steady and ruthless coercion of an existing multiparty democracy, at a speed just enough to keep outsiders ignorant, or if not, passive.
That history gives me a whole new viewpoint, on the string of broadly similar states. The Balkans and The Middle East all appear in a new light, and indeed I start to comprehend the bitter sideshows (as they seem now) in both World Wars, over that same terrain.
The collapsing empires (Russian, Ottoman, Roman,) seem more influential than the current rulers in so many former colonial states. They are really not, as we think now, a series of nations fighting for âindependenceâ. In most cases that independence is fragile to the point of being mythical, while the internal fissures are enduring. The cracks of nations within empires, not of states within a world.
Now You See It
One passage in Cramptonâs work stood out âby mid-summer social and industrial unrest were widespread with strikes by civil servants. On transport networks, and despite the provisions of the law, in the ports and medical services. The government was forced to grant a 26% wage increase to all state employees, an action which weakened its attempts to control the budget deficit and inflation and which did little to impress the international financial organisations.â
Written about conditions just before another wrenching Balkan realignment last century, this rather made me stop and reflect.
A parallel with the UK?
Just how close are we in the UK to that edge? Lost in a warm feeling for individual strikers and their causes, and a very British willingness just to plough on, there still seems to be a real danger.
I am well aware of our great national strengths, in the arts, our language, higher education, science, heritage, even logistics and retailing - they are enduring causes for optimism. But long-term investors need to weigh up the recent damage, especially the loss of political capital by the âresponsibleâ right, the high levels of debt and taxation, which coupled with low productivity, could also spell trouble, the certainty of ongoing nationalism and the unhealed rift of Brexit.
There is danger too in the probability of a Labour government, which however centrist the leader is, will have left wing factions to assuage. It is equally dangerous to continue our recent experience of minimal ministerial experience. I hope the change wonât be as bad as I fear, but it will probably be worse than I hope.
This remains a reason for the FTSE to be anchored to late 20th Century levels, despite almost every stock I research looking cheap. The fear of being still cheaper tomorrow rules.
Do Markets Care?
On the other hand, re-pricing capitalism after the decade of populist nonsense by central bankers does feel pretty good. If you have no cost of money and no reward for savers, financial gambling prevails.
All of this raises a key issue: is the apparent resurgence of speculation (the greater fool theory of investing) permanent? In which case investors should probably just watch momentum. Or is this most recent re-run of the last decadeâs speculative phase, really transient?
For a better view, see this page on Statista
As long as inflation exceeds the cost of money, assets will likely rise; the widespread return of real interest rates (a point we are almost at) should slow that down.
After that point what matters is cash flow, and whereas gambling will favour growth stocks, real returns come about when interest rates are high, but inflation is also falling. The gap matters and we are not there yet.
This is probably the crux of the next two years, and we doubt that having had a serene and slow drift towards recession, there is any reason either to expect a suddenly faster descent now, or really to expect the corollary, a sudden fall in interest rates, to offset a deep recession.
If rates stay high, but have indeed peaked and inflation declines, value investors should be in a better place. If they get it wrong, they are at least paid to wait.
As we have seen in the last twelve months, growth investors fuelled by borrowed money really do need a rising market, they get hit twice if it falls: both through a loss of capital and then the need to fund loss-making assets at real rates.
The Monogram View
Overall, our position has been that fundamentals should win, but we suspect momentum will win. Spotting the next momentum shift early, therefore remains a powerful driver of returns.
One narrative of 2023 (so far) is that the SVB crisis and stronger growth combined led to far more liquidity than markets expected. This fed into the gambling stocks, giving them momentum.
So, although the first half was not what we expected, the second half might still be. But it is just one narrative, and it may still be the wrong one.
Note : Further reading, for those interested in Bulgaria :
See also, The Bogomils: A Study in Balkan Neo-Manichaeism, Obolensky, Dmitri.