MUST THE POOR BE CLEAN?
First posted on 10th January 2021
Attempting to comment on the last few weeks seems largely futile, save perhaps for the apocryphal remark attributed to Chinese premier Chou En Lai, that âit is too early to tellâ, when asked about the impact of the French Revolution.
We suspect the markets are a little too relaxed about the assumption that Biden will spend furiously, effectively and in a way to spark inflation, but without any significant extra taxation or regulation. Lost in the exuberant desire by the market (and voters) for yet more debt are those inevitable downsides. While clearly the amount of speculative froth in the US market, is a clear warning of disaster to come; it never ends well when valuations get this daft.
As for these shores, it is not clear why it is almost mid-January, before the blindingly obvious need to vastly ramp up vaccination rates, for drugs that were available weeks ago, has only just penetrated Borisâs head. We are all rather immune to his elastic grasp of promised numbers now. Like the Relief of Khartoum, I suspect they will have dithered into disaster. Vaccines by the barge load will be coming in, just after COVID has over-run our defences.
It is reassuring to learn that the seven days a week NHS so touted by David Cameron, still remains a distant hope. And indeed, that this is not so much of a crisis, that vaccinating people on a Sunday can be contemplated. Over the next fourteen weeks that will cost a further fortnight of unforgivable delay. Luckily for the government, the EU is even more hidebound and inflexible, so we can claim a comparative victory.
Environmental, Social and Governance â an active conscience at work?
So, to a wider issue, the dear old ESG (Environmental Social Governance) standards to which all fund managers must now adhere. This seems to be largely (well intentioned) greenwash, it will not surprise you to hear. But we do have to start somewhere. JP Morgan have conveniently set out a simple guide on this, around whose elastic edges they must invest. We will shortly clamber through this.
The risk in ESG cuts several ways. From a market view, the damage comes from the familiar âbuyers and sellersâ equilibrium, which means every buyer needs a seller and vice versa; where the impact is profound.
Assume that most big liquid stocks grow into their positions over a decade or more, and therefore once in an institutional portfolio, they will also hang about in it for many years, think IBM or GE. Now suddenly condense that holding period into a far shorter span to dis-invest and you will blow the subtle price balance apart. By the same token, a company typical grows, acquires, improves over decades, just as companies like Apple and Microsoft have, plugging away and expanding. Now what happens if the demand for all the buyers of a decade or more, are suddenly packed into a few months? Again, that delicate price balance is destroyed.
So, you can then easily model remarkable over or under valuations, based not on any core worth but on supply and demand. Now there is a whole new world of pain from this, if you get what is called âcommon ownershipâ which is the phenomenon of a trio of giant asset managers, who own 20% plus of the S&P 500 between them. So, if those asset giants decide to switch course, the volume of stock unleashed (or indeed acquired) will clearly be far beyond the marketâs power to react in a balanced way.
The Democrats are already nervous about this feature, and may well look harder at it, although probably after a nasty market crash, of course, not before, when it might actually help.
ESG In Action
So, in JP Morganâs definition, what is ESG? What does the âEâ constitute? Carbon pollution and emissions, environmental regulations and adherence, climate change policies, sustainable sourcing of materials, recycling, renewable energy use, waste and waste management. Seems OK. Under the S we have to look at human rights, diversity, health and safety, product safety, employee management, employee well-being, commitment to communities. Fine too. While finally G is Board structure, effectiveness, diversity and independence, executive pay and pay criteria, shareholder rights, financial reporting and accounting standards and finally a catch all of how the business is run.
So, it has become quite a narrow definition, although a little less so on the environmental side. It favours businesses that are not vertically integrated, those that just skim the last bit of others production. No direct mention of water or indeed of total consumption, in that part of the guidance for instance. Other areas also justify that late-stage business model, a focus on employees, but not workforces, on low skill workforces too (which are easy for diversity targets), no actual production (helps a lot on health and safety, to have no machinery), while ESG advisors love the soft option of âcommitment to communitiesâ, a couple of village halls and a sponsored half marathon and you are there. It is completely silent on fair tax.
Indeed, you can almost see this definition leaning into the big distribution, tax avoiding, gig economy US firms and most strikingly into fin tech. Maybe ESG is the after all the revenge of the bankers?
There are some traps in the G section, Board diversity and effectiveness are easy enough to fix, thatâs what chairs of audit and remuneration committees and indeed HR directors are for, while Board effectiveness is always assessed by consultants they themselves appoint, we have seen some right turkeys âassessedâ as absolutely fine.
Independence used to mean something, but Cadbury et al have made that vacuous box ticking just related to tenure. Pay is sorted by a very low (or zero, for high grade virtue) basic salary and generous yet soft bonus targets, with personal targets again a great loophole. Mine are to try to do a good job (and yes, we have seen that actually used). I can certainly meet that before the year even starts. As long as you donât set pay upsides too eye wateringly high, most things on remuneration still get nodded through.
A hollow laugh then follows for shareholder rights, with so many of the big tech stocks having odd voting structures. Financial reporting? Well, âadjustedâ profits allow pretty much everything on that side now. Some conspicuous angst over valuation of goodwill or deferred tax or lease accounting, none of which have any impact on cashflow, also apparently counts for good accounting compliance.
So, the ideal ESG business would be something like PayPal, Visa, Verisign, Alphabet, Autodesk, Charles Schwab, in short fintech is simply delightful as it has no factories and makes nothing. Distribution is not too far behind. All cracking market performers too.
Is ESG then just convenient âtaggingâ?
Now that gets us back to âcommon ownershipâ, if enough big managers decide thatâs the way to invest in what they like already, but they now simply tag it as sustainable, then there is a rush into those same stocks, which as we know then go up, more buyers than sellers time again. Magic, you have created both a market outperformer and an ESG winner and yet not stepped an inch beyond your comfort zone.
Well, each of those listed stocks above do indeed feature in the top ten of our very own sustainable fund holding, what a surprise! That also gives us performance, and we know exactly what our holders hire us for. Get enough buyers in line and any stock can be made to shoot up like a rocket.
While just as ESG has been a perfect template for the overvalued US tech stocks and the cleverly presented top slices of the real economy, investment in that part of the globe where the 30% of the poorest people on earth live, has also dropped remorselessly this decade, helped down, by yes, ESG.
Just like the Victorians, we seem to believe that the poor must be clean to be helped, both literally to enter the workhouse, and figuratively to justify our assistance. If you ainât clean, free of drugs and vices, and suitably docile, you are simply not the deserving poor.
So, we reject those dirty countries whose firms make up 5% of the worldâs listed profits, but only 1% of investable assets. In other words, we are all 80% underweight in those so-called Frontier markets, you can guess where the compensating overweight is, of course.
Many such holdings are rejected because they run vertically integrated, job creating, people hiring, output generating, dividend paying businesses which are exactly those that are so despised by the neo colonialists on ESG committees, because they are both poor, and not yet clean. Only sinners that have repented can be helped, we do remain Victorian at heart. While their output, once sanitised by distance, can happily be the base for clean, ESG compliant, fintech services or advertising.
When judgment is made to look like virtue
There are few better tools of subjugation than denial of access to capital and banking services, there are few better ways to keep colonies in check than protectionism, preferably founded on opaque, subjective rules. Just ask the British Raj about those devices.
Somehow that awareness has now crept into how the âghettoâ poor are to be treated, but not into how the poor are treated globally. Yet we also know that the one remorselessly feeds into the other.
ESG has become a means of protectionism, of restricting access to capital for the poorest economies, but also a path to destabilizing our own equity markets, piling on volatility, mis-allocating capital. Well, you canât fault good intentions, but as Boris so often demonstrates, good outcomes are not quite the same.
What the global poor need, is a shot in the arm from unfettered capital markets and an end to protectionism.
Keep an eye on what Biden achieves, with his âsummit of democraciesâ, as colonies, much like ghettos, always adore being preached to with evangelical fervour about their own morality, especially by a country with such a vibrant, exuberant, healthy democracy.
Charles Gillams
Monogram Capital Management Ltd
Some Big Calls
First posted on 7th February 2021
US Markets: The âno-Trumpâ response
We may learn a little about markets from the curious absence of Trump.
We had been confidently told that without him the US stock markets would fold, and as US markets collapse, these days so do global ones. Indeed, not just relying on the US, has become the fund management challenge of the last decade.
Well, he went, admittedly in a two-stage collapse, but he and the Republicans are out of office, yet the apparent upset in Georgia passed with barely a market ripple. Markets just went on up, unconcerned. Now some of that is their appetite for short term debt fueled spending, which even if you know makes little sense, it is folly to stand in the way of.
But beyond it, higher taxes and lower growth must be the consequence, if you are buying stocks on a 6 times multiple of earning the next two years matter a lot, but when buying them on the current S&P 500 forecast of 25.35 times earnings, that implies those later high tax years must surely be in the equation too.
Has the market priced in the downside?
So, what seems to have happened, is the downside of future years has been calmly offset against the short-term gains of a stimulus package: is that logical? It seems unlikely, if nothing else a big corporate tax rise is due, to notionally pay for it all, plus a fair slice of traditional âstick it to the richâ revenge legislation.
The assumption seems to be that the winners in the higher consumption aisle will be neatly offset by those who suffer from the new regulations. We are less sure and do feel the ultimate impact will inevitably be lower US growth.
Of course, tech might solve all, but then it is very richly valued already. It might solve the growth problem, but could still be loss making for investors, at these levels.
That is not to say that Biden put on a poor show in his advocating a âgo bigâ package, he did it lucidly and with passion, a good speech.
For all that, when a new leader arrives and confidently asserts lots of economists (but notably not including The Economist this week) think heâs doing the right thing, it means trouble ahead. While his near certainty that the US would consequently be back to full employment by Christmas was touching, but absurd. The excess stimulus might get growth back to pre-pandemic levels, but thatâs really not the same as employment.
The China issue remains big.
Another really big asset allocation call:
We are hearing ever more gruesome tales about East Turkmenistan, following on from decades of horrors from Tibet, both sovereign states seized by China in the political chaos after WWII.
If you see them like the other nations seized by Maoâs fellow imperialist Stalin, at much the same time, you will understand the repression. Although as ever with China, with a big dose of racism, against the 7% of their population who are not ethnically Han Chinese, plus of Communism, which still stands against any form of religion, be it Buddhist (Tibet) or Islam.
Will Biden care more or less than Trump about human rights? Well obviously, he will care more, as something is more than nothing. But will he be more effective than Trump, indeed do the Chinese find an unpredictable enemy with a penchant for sudden tariffs, harder to deal with, than a believer in the international order and gentle fireside chats?
Well here cynicism prevails: these are nations caught between empires, like Poland was for centuries; any tension in the international order will always see a land grab by their bigger neighbours.
I also believe Biden will find the proposed attacks on American consumption through both higher taxes and the removal of cheap energy and labour, can perhaps withstand also keeping Trumpâs price rising tariffs in place. As notably he has done just that, to date. Indeed, he seems to be out-Trumping Trump on Federal procurement and protectionism.
But I still donât think cutting China out of global trade, however barbarous their actions have been, is a runner. I think the vile abuses of power can go on, just as the EU has already handed a free pass to Chinaâs torture chambers to plough on, by agreeing a new trade deal with no human rights teeth. So, in time, realpolitik will triumph with Biden.
It was I suppose nice to see China (after a pause for thought) suggesting locking up elected politicians in Burma, after the Army grew tired of holding all the cards, but getting no thanks for it, was a poor move. But there was a long enough pause to just tell the junta they didnât mean it and were really rather pleased. A little more discord, more repression of the âtribalâ areas along their shared border, more sanctions to exploit, a few less pesky journalists, all are very much in Chinaâs interest.
So, I see a curious dichotomy, in the Han Chinese areas, Tesla car plants, Apple phone stores, Starbucks a plenty, for a sophisticated technologically advanced middle class, will all thrive. While the minority non-Han areas will be pillaged for resources and labour and if they are good, be re-settled and re-educated and polished up for tourists. A bit like California in the 19th Century. So perhaps Xi is right, only China can split China, but then history suggests, it will, one day.
But not any time soon; you can take a moral position on Chinese racism, or an economic one on Chinese dynamism, but I am fairly sure the market will easily favour the majority.
This of course does create another ESG contradiction, the US high flyers rely on selling to the Han Chinese but are keen to exploit minority Chinese labour forces and natural resources. We can look forward to a great deal of sophistication in somehow disconnecting the two.
Efficacy of the Astra Zeneca / Oxford vaccine
Finally, I should mention the battering the EU and even perhaps the Euro (at a nine month low) has taken from the principled resistance to fudging the data exhibited by German scientists. The scientists are right, the evidence base for efficacy in the over 55 age group is indeed absent. Excitable politicians, including the normally precise Macron, have said it means it is ineffective, which it does not, only that proof is lacking.
Now that is presumably in part to cover the arrogant and inflexible EU procurement process, so full of checks and balances it strangles itself.
Borisâs vaccination stance
While Boris (faced with the same data) decided to wing it, correctly seeing that to save the NHS and his own electoral chances in May, he would rather give a potentially useless but harmless jab to millions of elderly disease vectors, than talk about due process. For once his disdain for the experts paid off.
The opposition in the meantime pleaded for a longer deprivation of our liberty by a longer pointless lockdown. Thank you for that suggestion.
Call it luck, if you will, but Boris has spent a long time practicing that ex tempore talent.
Proof might have been lacking, but it looked a jolly good bet. It sure was.
Charles Gillams
Monogram Capital Management Ltd
Time to Plunge into the Property Sector?
First published on 21st February 2021
As stock markets seem to hit a pause, the implication is either that they are too richly valued, so the marginal client will not buy, (perhaps the Tesla case), or that everyone who wants to buy has already done so, so there is no demand at any higher price, (the UK value stock case).
One I suppose is active, yes, we want it, but the appetite is not here just now; the other passive, no, and not here, as we are already satiated.
So as investment performance comes from either accruing income gains or from prices rising, we are looking for new places to make a return. We are therefore asking âwhen does property become attractive againâ?
Being driven towards property?
Property as an asset is largely about demand; as an expensive item buyers usually only acquire the rights over a space in order to then utilise the asset. So that comes down to rental demand, where in theory you will rent a space if you can make more money by so doing. Otherwise, why bother?
Developers meanwhile will add to available stock as long as the cost of doing so, less the costs of funding, plus the resulting discounted rental stream, is greater than zero. Simple economic theory.
Yet this is one market area where taking a thirty-year view on valuations, which of course allows you to fully discount 2021 and even 2022, seemingly just does not apply. Those earlier years are instead looming very large over current prices even for long life assets.
Another problem is that a lot of stock is still being held off the market, but not used for various reasons. Some is the inequity that landlords can leave a property empty, refuse to assign the lease and then demand an uncommercial surrender premium.
If you are the landlord, that seems fair, to everyone else it looks monstrous. More advanced legal systems, such as in France, effectively ban the practice.
Is suspending evictions effectively seizure of private property by the government?
Then there is the equally odd suspension on evictions and the extended mortgage holidays, which is in essence the government seizing private property, without compensation or due process, and requiring it to remain either empty or non-income producing.
This happens to be a curious feature of this health crisis, but one that they are happy to keep extending. I am looking forward to the inevitable litigation on this, and I suspect a rather large bill to HM Treasury will inevitably follow (so thatâs one payable by us).
In some areas (warehousing for example) by contrast this is not an issue, demand is strong. In others, like residential, enough of the market still operates to give pretty good price indications anyway, although the impact of empty property levels from an extended mortgage holiday, or voids that canât be repossessed, may still be significant in some areas. While other areas, like Central London, where high priced short tenure deals had become too common, (also known as Airbnb) the flushing of the system came quite quickly.
Nevertheless, I think the end of tax incentives, plus the release of frozen stock, plus builders using the summer to restock (a number of housebuilders saw stock levels swing alarmingly low, as restocking stopped last spring, in the peak build season) will cause excess supply, for a while, later this year. However, such is the extraordinary level of excess liquidity and the pace of household formation, it does not feel a significant threat to residential sector pricing overall.
Office and retail sector â commercial property
So, what about offices and retail demand? Well, when we have looked at these areas, we have simply said they are uninvestable, like cinemas and airlines, we know far too little about the end of lockdown. There is a great deal of valuation angst about high priced office developments and clearly some distress in the over-priced short tenure deals, (so WeWork and its precursors). But there is relatively little sign of extensive non-payment of rent, certainly compared to retail, where an effective rent strike is visible.
Meanwhile retail tenants are well aware that they will be able to pick and choose prime sites in future and that landlords have a slim chance of finding a bigger fool, to take on their current inflated terms. While the judicial innovation around the CVA option, has allowed courts to ignore the future rental income stream as a valid current claim by property owners, on the rather logical grounds that the service has yet to be provided (so it canât be current).
Valuations of office space
So, pressure on office values will come from excess supply still arriving (this stuff has a very long lead time) and a mix of non-renewal of leases (which takes some time to work through) as well as downsizing, is likely to follow as bosses realise that hiring their employeesâ spare room for free is a good scheme: no business rates either, nor season ticket loans.
I think this is the office pressure point, that is âwhere is long term demand going to settleâ? On that I tend to be optimistic, London with far fewer commuters, tourists, and also cheaper rentals, seems a rather nice thought, just now. It will take time, but from my experience post crisis London, once the coffee shops reopen, has always been rather attractive. Whether it was caused by the Luftwaffe, the aftermath of Big Bang, Irish Republican terror attacks, the Dot Com bust, the GFC â all of these saw life improve in London after the smoke cleared.
Retail premises
Which leaves retail and retail services as the âunknownsâ.
Now that is driven by footfall, and by the ability of online to undercut the physical stores. Here I do see the online world as slowly hitting more and more problems.
Much of its delivery advantage has been attacked this week by the UK Supreme Court, in typical countercyclical fashion, just as we are desperate to create more work and revive the economy, they have ruled the flexible, self-employed workforce involved in on-line retail, are actually high cost, inflexible, unsupervised employees. Nice one. Zuckerberg has also decided to delete Australia, (and China to ban the BBC). While even without that pressure on media content and advertising and on delivery costs, there is a lot of unprofitable cap ex chasing a finite on line market.
So, some retail still looks oddly shaky, stocks like Shaftesbury and NewRiver were stock market darlings, but now look very subdued, and oddly much more so than their typical tenants; both rely heavily on the restaurant trade for instance, but seem to have done worse than a typical volume operator in that sector, like Wetherspoons. Or indeed the discount grocery sector, which currently seems fine.
Commercial property â property investment trusts
The problem one assumes is that the commercial landlordâs costs barely move, but the tenants have been able to not pay business rates, and to furlough staff, turn the heating off, stop marketing, and stop paying rent. Indeed, in Shaftesburyâs case, the one fixed cost that mattered, finance, has rather gone the other way, interest rates have risen and âcovenant repairâ costs are rather high, as their creditworthiness apparently slips.
While putting this all together, property investment trusts, like TR Property, are therefore sitting well below pre COVID levels, the vaccine recovery trade has yet to arrive for them. Their prices were pretty flat from June to November last year, before a spike up in November, which both in their NAV and share price, has now just dissipated.
Yet so much is now in their apparent favour, compared to in June 2020, we must be much closer to the end of the COVID recession, or at least vast areas of the stock market are saying so. Property does also have that bit of gold dust, a solid yield well above inflation. But no, the property investment trusts (PIT) are apparently stuck at this level.
The blight over the sector is the NAV, of the underlying stock of REITs (Real Estate Investment Trusts) which are not the same thing, but a classic piece of passing off, but thatâs another story. Anyway, a PIT largely owns REITs, just to be clear.
So even as valuers take a big slice off values in the worst sectors (about 20% is not uncommon) no one knows if thatâs really it. They have been slicing those retail values for a while now. They donât trust the few actual transactions, claiming new tenants are exceptional cases (for which read fools with too much cash). They donât trust the lenders, as nearly every interest coverage covenant is blown, and they know new supply is immense (from slowly finishing development and rapidly collapsing store groups), and so the answer is just no.
In other words, they really have no idea where values are. Or if they do know, the stock market simply does not believe it.
How long will this be true for? Indeed, is that a rational market position? I suspect it is mainly the unknown part of this that currently holds prices down, whilst if you think you can see through all of that confusion, or you do trust the valuers, you might take another view.
In particular you might do so, if you can find areas not so exposed (or even benefiting from) the Amazon firestorm.
Charles Gillams
Monogram Capital Management Ltd
Fiasco
First Posted on 7th March 2021
WHY SYSTEMS FAIL, AND IT IS REALLY NOT ABOUT MONEY
A winter lockdown forces us all to examine our domestic interiors, with in my case perhaps a superfluity of paper, which led me to âFiascoâ, by Thomas E. Ricks. It is a seminal description of how complex systems create monsters and then fail, not for lack of effort, nor goodwill, nor money, but from thrashing about with no coherent strategy.
Indeed, arguably all those three inputs make matters worse. The tale simply told, in a largely deadpan tone, is of the greatest failure of American foreign policy since Pearl Harbour, and the greatest crime perpetuated by a British Prime Minister, since the Bengal Famine. It is how Bush, looking for revenge after 9/11, has spawned the disasters of the modern Middle East and locked us all into an unending cycle of terrorism and for the millions of people in the Middle East and beyond, brought poverty and despair.
Strategy matters
How? Well as Ricks tells it, they used the wrong tool for the wrong job: the strategy was hazy, mission creep endemic, the reporting system mangled everything to suit those making the reports. In the meantime, the aims kept shifting, and staff rotation and comfort swamped the original purpose of simply executing the mission.
While those they were sent to save, service and otherwise succour, were embittered and made hostile by the sacrifices they were expected to make, in return for specious, obscure propaganda.
So that led to the USA seeing the Iraqi people as the enemy, not just their crazed leader, while the entire Iraqi government was blamed for funding and concealing these non- existent weapons. Read it. Because from that flowed the failure of Phase IV (the post conflict reconstruction), the hostile occupation (not liberation) of Iraq, the idiocy of making that occupation subservient to Pentagon (not civilian) demands, the destruction of the fragile sectarian balance between Shia and Sunni, the rise of ISIS, the Syrian nightmare, Yemen, and the Iran nuclear programme.
Meanwhile, the attendant loss of money, the coming to power of the isolationist and militia based right wing in the US, the triumph of China in the emerging world, the resurgence of Russian thuggery all remorselessly followed on. Simply unbelievable. As Hicks writes it, you can hear the quiet click, as the lid of Pandoraâs box was ever so gently released; beats bat breeding labs in Wuhan for the sheer laconic horror of it.
They did start the fire.
I do not know what the Pope going to Baghdad shows, beyond a startling personal courage, but it is no ordinary trip. The story also shows how in the modern world massive complex heavily manned delivery systems just canât operate. They are dinosaurs. There was nothing inherently wrong with the US Army, but yet it created its own defeat.
WHY THIS SYSTEM WILL FAIL TOO, AND AGAIN, IT IS NOT ABOUT THE MONEY
So, to the UK budget, another set of tactical responses to poorly understood problems, hemmed in by contradictory rules, horribly distorted by politics. Sadly, the government really does believe it is the presentation that matters, not delivery. So, we had Rishi, spooling out unending largesse, and crudely claiming he was going to level with us, and level up North Yorkshire, and hand out freeport concessions to his chums and give Ulster another ÂŁ5m for their paramilitaries (oh, you missed that one?).
A more extensive piece will shortly be on our website. It questions whether we are building back better. To me this looks more like âbusiness as usualâ, no growth, no decent jobs, Londonâs supremacy ploughing on, the regions thrown scraps. Green? When you freeze vehicle fuel prices for the eleventh year? Hardly. So yes, the budget was a relief, but no it should not have been. I doubt if markets will like it much, just because the publicans do.
DEBT AND EQUITY MARKETS AND INTEREST RATES
Markets Well, there is another puzzle, I thought the august President of Queensâ College Cambridge was going to self-combust into his tache, such was his thrill at seeing the bond vigilantes shooting up the US ten-year interest rate, during the week. Biden must pay his electoral base the bribe needed to win those Georgia Senate seats, at the full inflationary excess of $1.9 trillion, pumped onto an economy that is already visibly and dangerously overheating. The one Game Stop we do need, wonât happen.
So, you have $27 trillion and rising of outstanding US government debt, do the maths, if the bond vigilantes push rates up by 1% for the average duration of that debt, 65 months, that will cost you some $1.5 trillion back. So sure, you can cough up on your election pork, but it will cost the American people $3.4 trillion to do that.
Well, we donât actually think that attempted rate increase can stick, for all the reasons it failed to stick over the last decade. Powell at the Fed then agrees with us, which on past form is perhaps an ominous sign of our approaching error (or possibly his gaining of wisdom).
Equity markets certainly felt unhinged; they started to whipsaw around in a frankly worrying fashion. On prior performance this does need sorting out, before it is safe to go back in. If (of all places) the US will lead on raising rates, it has to then pull up all other global interest rates, which we know will slow growth and take the wind out of the recovery. Indeed, it may threaten it, it has to cut (see above) how much governments can then borrow, has to start foreign exchange rates jockeying for position, has to question the whole free money basis of tech valuations.
I simply donât think this recovery and these valuations can stand that just yet, and after a decent pause, the Fed (like many other Central Banks do already) will have to act to somehow hold down rates. Whatever Governments say, money does have a time value, and behaving as if it does not, is rather unwise. But I think extend and pretend will still persist for a while yet.
Charles Gillams
Monogram Capital Management Ltd
Rising Tides
First posted 21st March 2021
Interesting times.
Bond markets are out of the cage, off the deck, ready to rumble.
This week feels like another one of those big calls that investors have faced over the last year, and in many ways much less obvious. Forget the chatter, it is the bond markets that are now back in charge. While upsetting Californian law makers and the SEC is now small fry for Musk and Tesla, the bond markets will just roll over him. They are the gorilla in the room, for all those frothy tech valuations.
Bond holders are just dumping their holdings as fast as they can; like tectonic plates they move slow, but like any earthquake, you get the sudden shift, then the aftershocks, and then it will all settle down. But the landscape will have changed.
What has woken them up? Well inflation and the conviction that the colossal election bribes handed out by Joe Biden will cause inflation to go over 3% and perhaps, as important, possibly stay there. It is the stay there or persistency risk, we are looking at. We can all see a short-term inflation spike, from commodities and logistics snarl ups.
Now, everyone (including us) have been focused on excess capacity and deflationary forces. Indeed, as we keep being reminded, over 10 million Americans are out of work; but for some reason the nasty bond markets have decided giving those citizens jobs is not the priority.
So, the naĂŻve equation Powell (at the Fed, who I keep reminding readers, is not an economist by training) is working on, is if you stuff circa 20% of US GDP in one end, all of course borrowed, out pops nationwide low paid jobs, focused on the low skilled workforce, by the ten million or so. Now thatâs the bit which is no longer credible.
It seems more likely all that stuffing is instead creeping into asset price inflation, with virtual currencies attracting a lot of speculative flows and likewise hot stocks, be it SPACS or GameStop. None of these areas provide much of the required nationwide low skilled employment.
A Detailed Look at the UK Employment Statistics
So, what is happening? Well, a more detailed look at the labour market in the UK (not the US), provides some clues. My source is the Office for National Statistics, February Labour Market report. Not a bad date, as the year-on-year figures are clean; from the March one onwards, we will have the COVID shocks in the annual comparator.
The employment crisis is hitting the young hardest, under 25 employment is dire, of the job losses year on year, 58% were in those below 25. While we have both lower employment (so people exiting the labour market) and also higher unemployment (so not working, but available). Noting that furlough for these purposes remains classified as employed, which is a little moot.
But here is the paradox, wage inflation is also very apparent, hitting 4.7%, which is recorded as 3.8% above actual inflation, so a pretty high real rate. Now thatâs not causing deflation at all.
While the furlough impact, doubled to December (from 5% to 10%) of the workforce, and no doubt has now gone up again, with the arts, entertainment and recreation industries (sic) and food service industries, each having over half their workforces on furlough.
So, while the claimant level has been stabilized quite well, we see relatively lower levels of actual employment, but with the secure workforce getting good pay rises, well over inflation, and those in less secure positions, or who are younger or in the wrong sector, hit hard.
Should Preserving Capacity be the Real Concern?
The assumption then is that the labour market is clearing, indeed faces inflation, for those in work, but for those who are not, there is a big presumption that the leisure sectors will bounce back hard and take up the slack. You wonder if just more money across the board, is the right way to tackle this specific problem. Oddly if this was in banking or steel, a targeted approach aimed at preserving capacity would now follow. Time to rethink that? Although if everyone gets a âgiftâ, then fewer people will complain they missed out, given how politically charged both steel and banks became, you can see why; but it is poor economic policy.
This two-speed position is also apparent in other Government statistics, tax gathering is going well, the annual self-assessment returns were higher than a year ago, and total tax returns only marginally lower due to reduced VAT income from the leisure sector. The strain on Government finances is on the other side, excessive spending, not reduced tax. On tax receipts, inflation via fiscal drag, is already working its magic.
What the Bond Market is Afraid of?
So, the bond market fear is that more of the stimulus will go to the âwrongâ places, than the ârightâ places, creating inflation in areas that are already running hot. While Central Banks have apparently decided they no longer think about money, just the jobs market. Which is also odd, because they have so little control over it.
Indeed, the heavy political pressure in the US to sharply raise the minimum wage, must work in the opposite way, as must the surge in automation and home working. It is noticeable that when Trump tried to turbocharge labour markets with a tax cut, we had a pre-emptive rate rise from the Federal Reserve. Clearly this time round Janet Yellen has told Powell that if he tries that stunt again, he is out.
So, What do Investors do?
We did not expect this rise in rates so soon, but nor do we see it automatically stopping at this level, as Powell has clearly said he wonât intervene more to hold rates down, nor will he acquiesce by raising overnight rates.
Broadly rising rates, with rising inflation is good for equities, but the end of free money is less good for the out and out speculators, who can gamble on trivial things, without a great deal of care.
It is these periods of cross currents, short sharp movements, that are toughest to navigate. While the first order effects will be in falling bond prices and the badly overvalued tech markets globally deflating; so, all of that stuff with inflated multiples or no real sales. But the second order impact will be on equity markets overall and on currencies.
At some point if you can get a nice return in bonds, even better a real return for holding them, there will be a lot of money heading that way. It is a finely judged switchback, taken at speed, if they raise rates and then find inflation (and employment) actually starts to fall, the Fed can again wreak havoc by going too fast.
While elsewhere boring may in the end be best, especially in well run financials. There is an old market saying that a rising tide lifts all boats, but perhaps not the electric ones this time?
Our own Performance
Our own VT Global Total Return Fund has now had three distinct patches of outperformance, in the last year, as against behemoths in the Absolute Return space. All, as it happens, since Monogram joined the team, as investment advisors, although that really is co-incidence.
One such good patch would be fine for us. It is of course partly good timing (for whatever reason), but it may also be that small, focused funds like ours, can simply turn that much faster and make the needed adjustments more quickly.
Which then generates patches of outperformance, three in a row is starting to make a real difference compared to just âbuying IBMâ.
While we are now running unusually high cash levels, we know markets donât stay this kind for long.
Charles Gillams
Monogram Capital Management Ltd