Cheer Up, They Said
After a pleasant summer, the dampness returns, exposing a quite enormous and unbalanced level of growth among the verdant thickets of both Middle England and the NASDAQ.
Markets must climb a wall of worry, and the next two months are not short of that. Forget interest rates and non-existent recessions, thatâs just the stuttering voice of old economic models, fed fouled data from the last century.
IT IS ALL POLITICS
No, the risks now all look political; the prevailing orthodoxy is the West can keep borrowing levels high, to fund bloated and protected wages and welfare weirdness, impervious to international competition, or indeed to inflation. It has worked so far, and with excess and free flowing capital, there may always be a funder, mainly of state debt or residential mortgages, as well as a buyer of a few anointed equities.
And so far, that has remained the trend and indeed, somehow, the centre has held, once exceptional debt has now become permanent. This is aided in part by centre and centre left parties collaborating to silence the right, often behind the somewhat specious argument of protecting democracy from the wrong kind of votes.
But markets are jittery, they know the sums donât add up, as do voters.
Debt as % of GDP, US in red, Japan in purple, UK light blue, France dark blue
 IMF data mapper â from this page.
The same defence of democracy continues to require the now usual never-ending wars, and divisive and punitive trade barriers and sanctions.
Both businesses and investors are quite happy to sit on the sidelines, until a few questions get answered. The UK budget is expected to finally nail the myth of growth, by heavy new taxation, although it has almost been oversold, the reality might be a relief. It is not just the severity (it wonât be that bad) that matters, but also the direction of travel. Will it hammer savers, investors wealth creators and employment or attack consumption and waste?
Labour denials of an extra ÂŁ2,000 a year tax on average incomes remains to us implausible and indeed we suggested  many would be relieved at only that. Well before the election we said it will need about ÂŁ20bn (economics is pretty simple really) and suggested the biggest chunk of that will come from fuel duties; we will see. Indeed, weâve always known that various fudges would be used to skirt round the creaking OBR defences too.
The main UK stock market indices are once more in slow retreat, and while sterling is strong, we attribute that to short term interest rate differentials. High government borrowing is after all good for lenders. While in the US, it remains impossible to tell where the legislature ends up. Although like Starmer, many voters are so convinced the alternative is useless, they will overlook the socialist taint.
EMBRACING THE SIDELINES
Just now, the sidelines feel a good place: hedge funds, shortish term, high quality debt. There is scant evidence that the normal run upwards for emerging markets and smaller companies, from rate cuts, with attendant dollar weakness, has started, although many areas have moved in anticipation. But why buy in September when November is so much more certain?
That switch to smaller companies and emerging markets also may not happen this time, emerging markets have a lot of china dogs that look quite fragile, and smaller company liquidity is dire, so if yields stay high and defaults low, why add risk? While the inevitable fiscal squeeze will not help the hoped for returns and dynamism of a monetary easing cycle; you need both to work.
India meanwhile still stands out long term, but both the centre and more starkly the states are showing a notable loss of fiscal discipline, unrest in Bengal does not help and the IPO market is frothier than a Bollywood musical.
ROULETTE AT THE TORY PARTY
Given the apparent penchant for gambling, how many of the six (now five) chambers hold live rounds? We should glance at these ever-fascinating trials. The party faces strategic questions. Notably when does it expect to recover the 200 odd seats it needs, and how?
Well, I suspect the group saying next time (2029) will still dominate, although it looks rather unlikely. As to how, the assumption, I assume, is by halving the Lib Dems, but thatâs only 36 seats, which leaves over 150 to get from Labour.
Interestingly every leadership candidate agrees that it was all Central Officeâs fault, not for instance the wrong policies or a foolish rush to the polls. Most also at least pay lip service to rebuilding from the bottom up through local councils. Indeed, they even accept associations might matter.
Although there is also quite a bit, still, of finger crossing and waiting for Labour to implode. Not such an obvious solution this time.
As for Reform, if they also fail to implode, but settle in to be a real alternative, like their French and German counterparts, they will at least deny the Tory party their votes. Who knows, David Cameron might even emerge, in twenty yearsâ time, like Barnier as the compromise leader, from a party of no current electoral relevance.
It is hard to get involved in the contest, which will be down to four from the original six by next week. With so few MPâs, the choice is not brilliant.
It is a very narrow electorate, just 120 survivors of the wreck, so calling it and the shifting allegiances it reveals is hard. However once decided, it will be clear if the party is going long or short and which seats it is targeting, which in time will matter a great deal. Is it still unaware that a missed target could be fatal?
SAVERS TO BORROWERS
As for markets, I tend to ignore summer and short week trading, and the switch from bonds to equities, from savers to borrowers is a powerful economic force, as rates fall, but while the direction is clear, the angle of descent is not.
I assume it could be worse, that is even more uncertain but wondering how. Roll on Guy Fawkes Day.
OUR OWN EVOLUTION
This blog is evolving - when we started Monogram was a fund manager in widely accessible products, but thatâs no longer the path - we are increasingly moving towards family offices and offshore clients.
With a less domestic focus, it seems time to move this to a stand-alone blog. Which brings with it a touch more freedom. It will continue to remain fascinated by the world of economics and politics, and indeed fund management. But may be happier to poke about in the mud for sustenance, or sound a startled alarm, as we become the Campden Snipe.
Whistling in the Dark
Too much uncertainty, too much introspection; while the world roars by.
Expecting either Blair Mark II or Trump Mark II still feels unwise. As does the Franco-German led ostrich ensemble, burying its head in debt, not sand. And CrowdStrike highlights forgotten fragility.
Which leaves me uneasy. Markets have done very nicely since last autumn, but now feel as if theyâre too dependent on delayed gratification, too relaxed about political earthquakes. I could do with more visibility, not just on who is elected, but what they do after elections.
So far this year, performance has come from the US, especially NASDAQ, which our momentum model recently sold for the first time in a year. Admittedly simply to correct an overweight, a substantive sell appears a way off, but a reminder that the ability just to buy US tech is diminishing. And markets need buyers to move up.
The market assumption seems to be the rally will broaden and move into the smaller stocks and round the globe. Possibly, certainly liquidity is plentiful, bitcoin and gold look high, a good indicator that there is excess cash about.
But the other source of cash, shifting out of term deposits and money market funds, has to now be slower, if we have replaced six US rate cuts this year with two. There really is no obvious reason not to just stay liquid, for a while. The dollar is also weaker, it has slid in fits and starts, but that also mounts up. Owning a depreciating currency is never great. It remains quite sensitive to short term rate differentials.
The global position is still inflationary, with no major developed economy addressing itâs out of control spending plans, all hiding behind each otherâs failures.
Trouble comes when rational investors no longer accept out of kilter valuations, including for all three favoured assets, gold, bitcoin, US tech.
The US outlook â conflicted?
I also, I confess irrationally, do not expect either Trump or Biden in the White House next year, nor do I expect that much change down the ticket now. So, to the degree that the US market is rallying on Trumpâs current resurgence, I find that dangerous too.
Polite society, and especially the UK fund manager, is caught between the social need to say Trump is evil incarnate and the reality that investors quite like the prospect. So, they concoct lists of the harm he will do, like cutting taxes, cutting regulation, boosting energy supply, enhancing security and decide that it is all terribly inflationary and so quite bad. But after that, conscience cleared, Â they amble over to their trader and buy a bit more.
This is an approach which is quite vulnerable to Biden getting turfed off the ticket. Especially with the need to then explain why the new Democrat candidate will raise taxes, reduce security, add regulation, reduce energy supplies, all of which is suddenly good for investors. An interesting pitch.
UK - Unmoved by Starmerâs Start
While in the UK, the large market indices are remarkably unmoved by Starmerâs start. At one level his Kingâs Speech was unremarkable. No surprises: Labour followers and unions given what they were promised, manifesto pledges kept.
Indeed, it was as if Gordon Brown and the Tories were all a bad dream, and Tony was at his desk, in 2007, working on the Queenâs Speech, which he dropped in a folder, and nailed to the back of a wardrobe door, for Keir to pick up 17 years later, change the pronouns and off we go.
How will housing engender growth?
Take housing, although how it is suddenly the engine of growth escapes me. The chances are the private sector could be the instrument to build them. But the timescale for that effort to cut prices is very long. Although the focus on land costs is good. Faster, cheaper consenting is also needed, based on where houses people want, will sell.
While the suggested mandatory targets didnât work under Blair, they wonât work now. They just let the blame be shifted from local planners, to Whitehall mandarins. Stuffing more and more subsidised housing into new build sites, just raises prices (someone has to pay for them).
The Tories (oddly) had a viable idea: rather than identify where you can build, first identify where you canât. But there is no sign of that scale of thinking, or speeding up the interminable appeals process.
The Commanding Heights
I assume the long-term plan is to demonstrate this old approach doesnât work, create a crisis, then privatise something. I doubt if that weird solution will be confined to the railways, and almost certainly now to water. Just like Railtrack and British Nuclear Fuels under Blair, you legislate impossible outcomes, the private sector invariably fails, you take ownership and allow far worse outcomes (and need bigger subsidies) instead.
It also needs capital, which is being scared away from the water companies, by new harsher laws, the exact opposite of the current need.
It is as if lots of laws and smiling nicely at deep seated structural problems helps to resolve them. Here we see the old failing of opposition parties getting into power, but then wasting it fighting the last election: at least Blair, in his own right, innovated.
Stock markets simply didnât believe the Tories and donât believe Labour either; words alone wonât improve matters.
Although as ever because the index is so hated, that leaves some very underpriced stocks for sale.
We have no clear view of what the autumn brings, either in the US, or UK (the first Reeves budget), or Germany (although a budget has been concocted there, but seems impossible to deliver) or France, which one hopes will have sorted out a government by then at least. Macronâs current re-appointed appointee, looks highly unstable.
A lot of patches have been applied, a lot of whistling in the dark, but the money is running out. It has been for a while, but you canât fight a war on several fronts : so, one of defence, welfare, health, or renewable energy, is not getting the funding splurge it wants.
Growth is the answer, but that, as Keynes noted, needs animal spirits. The animals look pretty caged just now, and Starmer is adding new bars to that prison.
So yes, the rate cut story holds, innovation possibly, but their heavy lifting is not supported by reforms which will help.
For our part sitting out the summer looks better.
We will resume these musings in early September. Under a new logo :
One suggested name is :
The Campden Snipe.
Thoughts, as ever, remain welcome.
In the real world, everything changes.
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.
The Glass Bead Game
We look today at a domestic version of a complex, rulebound meaningless pursuit that too many of our brightest and best waste their lives pursuing, and whose twists and spirals ultimately signify nothing. Â I mean the UK Office of Budget Responsibility (OBR), of which I took a tour this week. Almost nothing there is as it seems.
Meanwhile markets reprise 2023, with tech or bust once more. Although tech and bust is the market fear, as fiscal stimulus and services inflation hold rates too high for some to survive.
UK OBR
The OBR was an explicitly political creation of the coalition government in 2010, with a remit to somehow restrain the ever-increasing debt governments take on, to bribe electors. They were also keeping half an eye on the much older âdebt ceilingâ style US legislation. It failed; so now the OBR just thrives on telling the government how much more it can spend or not collect, with spurious accuracy; purportedly managing public money.
It doesnât forecast anything as a forecast is an expected outturn. All it does is crank the handle on the old, discredited Treasury model, creating projections. A projection is 1) a âwhat ifâ assuming all other things are equal and 2) only as good as its underlying model.
One clear flaw is the requirement to take government spending plans as viable when they are usually not. They also have no idea where public sector productivity is heading. It has no remit to look at how productivity might be helped and no capacity to look back at how wrong its old âforecastsâ were. That is the job of the National Audit Office, it seems.
It also wonât talk to the Bank of England, as that organization has executive powers (to raise or lower rates) and the OBR apparently must just be a commentator: more glass bead rules.
So, it fiddles with the model and its six hundred inputs and countless equations to give precise answers to pointless questions, because each answer sits in its own vacuum.
Thereâs a heavy focus too on tax revenue, but with quite a thin staff, this results in excessive reliance on HMRC, who can be hopelessly wrong (and typically over optimistic on tax yields). But again, if the tax bods claim some complex, job destroying, arcane nonsense will raise income, in it goes. The side effects of such decisions must also be ignored.
It has no remit to assess how taxes impact productivity, which partly explains many of Huntâs blatantly anti-growth measures. As a result, the economy is locked into low productivity, getting steadily worse.
From the ONS flash report here
For all that the financial press will be full of the OBR cogitations on the forthcoming budget (March 6th). One little bit of power they do have involves a requirement for the Chancellor to give ten daysâ notice of the budget contents (hence no doubt the usual leakage levels) and for two months before that, they sift through proposals and indicate how each, in isolation, would work. The economy is an interconnected entity, they know, yet there is no attempt to give us an overall view.
THE LOST RALLY
I have few rational reasons why anyone would lend the UK Government at under 4% for ten years, were it not for some foolish faith in the OBR projections, without reading the small print.
Which brings us to markets: back in November the UK ten-year gilt yielded 4.5%, by about Christmas falling to 3.5%, and now it is back over 4% and headed higher.
Chart from this website
Quite a spin in ten weeks for a ten-year duration instrument. This is why that Christmas rally in value stocks was ignited, and indeed started to push out into Real Estate, various Alternatives and certain smaller stocks.
Although it didnât move those stocks most sensitive to the credit markets, who will need to rollover/refinance current debt. This affects for example, the renewables, private equity, and office property. The problem there is of both rates and availability. With the scale of asset mark downs, whether interest is 6% or 8% is not the issue; there is no funding appetite even at 20%.
The year-end rally moved a wide group of stocks, from extremely cheap to still very cheap. We then realized that it was not yet safe to go back in, so buyers evaporated, and prices faded. With state debt at 4%, against persistent inflation, fixed income is also oddly unenticing. So, the market default has been to pile back into the biggest, most liquid, US tech stocks and similar easy-in/easy-out momentum trades, like bitcoin.
There is little sign of deflation in services, no evidence of it in housing, where supply issues dominate, and little in financial services; indeed, all the supply side mess of COVID and excess regulation, is simply getting worse. Public sector pay inflation is also high and going higher (donât tell the OBR).
This does not dent the 2024 story of cutting rates and hence higher stock markets, but it may require some patience, and that delay may itself create more pain.
The Glass Bead Game and the âlost marblesâ qualification for office
Our games of self deception are not to be confused with lost marbles of course; it turns out that the onset of senility is now a bar to being prosecuted for storing secret state papers and also, somehow, a recommendation for re-election for four more years, to the most powerful post in the world.
If that ends up giving us Trump again, by default, presumably he will at least have a defense in future years, against those same crimes? He does not have the âBiden defenseâ available at present, perhaps thankfully.
As the OBR shows, very clever institutions can come up with very silly solutions.