LOCATING THE ELUSIVE BASE

the investment impact of recent events

CRANES

I spent last Sunday in the elusive pursuit of grus grus, in the upper Marne basin, East of Paris. For some reason the Common Crane had already left in a bid to cross Central Europe, heading for the Artic, weeks earlier than in most seasons. Clearly, they knew something about the airspace ahead of them.

While the largely empty Lac du Der, also had lessons on levelling up; here was a vast and disruptive engineering scheme, it seemed executed without too much controversy, operating well and with the surrounding villages wealthy, quietly prosperous and largely content. Or so it looked in the February sunshine. It was all in pretty harmonious concord with nature too.

THE FRENCH MODEL

It seems the French can see the grand scope of government, the need to provide top class infrastructure. Here is their France Relance plan up to 2030. Up to 3-4 billion Euro is likely to be spent in 2022 alone.

The issue is perhaps not just politics, but the unspeakably low quality and lack of vision of the UK governing class. The French cities have retained their great buildings, the administration is a high profile and visible force, not something to park in the burbs, having ejected them from city centres to grab their assets for still more rentier housing. Nor does the state foolishly aim to do everything, the peage (and TGV) enable high class fast communication, but certainly not always for the lowest price. Nor is health care completely and absurdly free, irrespective of demand. But it is effective.

Power is cheap and plentiful, no hysteria about nuclear there, and the military proud and visible, even the transport police are packing heat. So, watch that off peak ticket schedule.

Of course, not all is rosy. COVID hysteria still ruled, masks and vaccine passes were required for everyone, for everything.

Yet if any UK government is serious about leveling up, (as in the recent White Paper) here is both a lesson, and an indication that Gove’s piffling attempts are a mockery; he needs more like £48 billion to start it, not £4.8 billion.

You feel they just picked up the easy option from the choices their tired civil servants had suggested. Perhaps it was the one that said, “No real impact, but sounds OK for now”.

UKRAINE - Did Putin miscalculate the West’s indifference?

Ukraine? Not a lot to add to that. We were wrong that Putin was not stupid enough to do it. Wrong too that it would be over in hours. So, treat our topical ignorance with care. Also, wrong that the West would shilly-shally over piecemeal sanctions. Whether we are wrong yet again in assuming that without a quick win, the sanctions will now damage the global economy quite badly, remains to be seen. I also suspect seizing Central Bank assets can only be done once and once done, global finance and investment will become far more fractured, forever.

But in truth, it was going that way already.

However, this blind market panic seems absurd. I really doubt if Putin, at this point, wants to line his battalions up on a border to provoke NATO, who are I suspect closer to an aerial counter strike than he thinks, and would indeed now love the excuse of any incursion on NATO soil.

He has made it into a popular potential war for the West, the most dangerous sort.

War Tactics

It looks to me as if Russia wants a pincer movement, to isolate Ukraine’s forces in the Donbass, plus a threat to Kiev to topple the government, but has he the muscle to take and hold all of the vast country? Even if he does, that does not suggest he will go further than Ukraine, just now.

While his aims are so blatantly false, success can be easily claimed for almost any outcome.  So, a collapse in currencies, and stock markets across Eastern Europe, looks an exaggerated response. True, this is Germany’s worst nightmare come true, no competent military and a gun-shy US, so they must now realign fast, and where Germany goes, so goes the EU. It is not going to fold or fissure in the face of this explicit threat. Although Germany at heart is much more like the UK than France; rapid execution will not be quite as easy as simple announcements. Remember the farce over moving Tempelhof airport?

(link to the article)

As yet, the final step of directly locking in Russian energy supplies, large parts of which go to German consumers, has not been taken, but that would, in the short term, be very costly.

Although high taxes on energy give governments a great incentive to let prices rip, (and demand destruction is great for the climate lobby too), but they are rather less popular at the ballot box.

Interest Rates

Meanwhile Powell remains determined to stay behind the curve on rate rises, it is as if the received wisdom on rates, indeed on Central Bank power, has been quietly ditched, and instead he is hoping inflation burns itself out through demand destruction/supply creation. Well, an interesting experiment, but if that’s the game, as we have predicted for a while, inflation will remain gently smouldering, but rate rises will still be very gradual.

The Fed should have turned off the monetary stimulus and reset to ‘normal’ six months ago, by the time they finally move, it will be a full twelve months late. Real rates are deeply negative, levels not seen in decades, and moving fast, this is really not quarter point stuff.

Link to source article

All of the above implies on-going nominal economic growth, ongoing share price appreciation (at least in nominal terms) and an ongoing reward for borrowing to excess.

But despite the rush to safety currently supporting the US dollar (and US assets) the danger to markets is not just from the noisy, tragic, East but also from experimental monetary policy in the US.  


DETONATION OR ROTATION

Two big market forces are at work just now, one is rotation out of the low interest rate winners, to wherever we go next, the other might be something more spectacular.

Enough of the market still sits in the “don’t know” category, to make everyone uneasy. The VIX is high.

So, what would cause the more explosive outcome? Traditionally higher rates divert more of the profits of indebted companies to banks and bondholders, so the theory goes, reducing dividends. Or at the more extreme level, this also makes refinancing debt harder.

This comes with a ‘second order’ impact, in that consumers or buyers also shovel more towards the banks, less towards the producers.

But none of this seems remotely likely yet, the world is awash with cash, and savings levels and interest rates have barely stirred from their COVID slumber.

Markets seem to be just talking about normalising, not slamming the brakes on.

Will we grow regardless of inflation?

The other big risk would be a failure of non-inflationary growth, which also seems unlikely. There are few practical signs of governments enacting the type of supply side restraint needed, we know. We still look for some self-restraint on how much governments seize in taxation; with high inflation taxes should be being cut, or thresholds systematically raised, but that’s also not happening.

The ‘idiot populace’ as curated by the media, constantly wants more supply side restrictions, greater consumption and lower prices, as if this was all somehow available; it is not. The worry here is that governments having messed up the big issues, give way to yet more populist demands for the impossible. At the same time, markets are also getting a little less keen to finance such nonsense or, being markets, raising the price at which they do so.

Well, all that is possibly true and has been happening for a while, but the old theory was that innovation was too fleet footed for any of that stuff to matter much. This is getting a bit tired, but broadly still seems to hold.

What if Ukraine does erupt?

So, the third detonator is in Vlad’s hands. Is a reverse Barbarossa coming down an autobahn near you? Well let’s assume yes, because he’s finally lost it. It is still fairly clear that if he steps onto NATO territory his army is in trouble, US and NATO airpower will rapidly outgun him. So, I discount that. But perhaps Ukraine does indeed end up like Belarus. China will support Putin, so the UN is irrelevant.                    

Then what? Well, a nation the size of Spain gets locked out of European commerce. Not important. Defence spend goes up? Well, some would say ‘about time’. Germany can decide to burn coal or nuclear or freeze, see previous answer. Come to that, so can we.

Given Russian gas must go somewhere, a bit like Iranian oil, it probably goes to China, which then trades it or cuts back its own Far East imports. Gas as we all know, can’t be stored for any useful length of time. Russia needs the earnings from it, so it will emerge on the market somewhere, at pretty much the current price.

It will be messy, it will create hard choices, but Russia is well on its way to autarky already, it can certainly live without dollars. Is this really a detonator? On its own, I doubt it.

Where is the rotation?

So, we still conclude all this market reaction is rotation, and it is out of overpriced US equities, where Biden created the biggest inflation bubble by far, and where interest rates are rising faster than elsewhere in the OECD. Hence, we see the hazard as mainly still on Wall Street, and to a lesser degree to the US economy. We’re looking at rising rates, a strong dollar, increased detachment from the global economy, and none of it helps earnings, but nothing is catastrophic either. The US (unlike the UK) wisely seized the chance to be energy independent.

But even so, we are not yet that concerned, valuations in the US are still extreme, as many sets of earnings seem to show, once the market looks at forward guidance, it shudders, and prices fall. A lot of built-in growth is needed to get price earnings ratios back down to earth, and that’s what’s being hit just now. To use a forty or fifty times earnings multiple, needs a lot of confidence about the future. That stretched temporal certainty is now lacking.

This is not that unusual for a rotation, but in that case, markets will bounce, and that will suddenly move a lot of funds off the side lines and back in. Where is that process now? Well going back to the Jan 27th low is causing some excitement. But we are not sure even that’s a disaster. Overall, the taking out of that and the October 2021 S&P low, won’t be fun, but the market still had a heck of a run up last year.

Graph showing how Monogram Capital Management has invested over the last 30 years
Monogram investment allocations

Have a look at where our MonograM investment model allocates funds based on momentum, over the last three decades, the US is absent for significant stretches. We rebalance monthly, the next one will be most interesting.

And inevitably, we do feel cautious too, but it is about levels, not wipe outs. Rotation not detonation.

Charles A R Gillams

Monogram Capital Management Ltd


a sea container with a building site beside it, illustration for article by Charles Gillams of Monogram capital management entitled 'sea change'

Sea change

A trio of influential knaves to worry about this week, united by a belief that “this time is different”. Well pantomime season is behind us, however we can still all shout “oh no it isn’t”.

Boris seems to be the least of our problems, if the greatest of villains, for the scurrilous crime of enjoying himself, what a rat. While Powell is providing an increasing threat to the poor and exploited across the globe by generating financial instability, and the lamest of the lot, Lagarde is just repeating a political line. The Euro zone debt figures look like this. A sharp rise from an already overstretched position, but still benefiting from falling rates, so when that rate line turns, the problem will really bite.

Will markets ever trust the Fed (if they did this time, outside the gilded denizens of Wall Street) again? Hopefully not, the trouble with putting administrators in charge of Central Banks is they rely only on historic facts, it is in the job description, that’s what they polish, hone and serve up.

But the economy is dynamic

The mismatch is that the economy is dynamic, and has no printed rule book, beyond that of the rocket; what goes up, must come down, immutable like gravity. And you simply can’t wish gravity away.

So, this Fed is programmed to repeat what it can see looking backwards, and all the obedient commentators on Wall Street who simply echo its nonsense, are of little use, except to fleece the gullible and to signal false comfort to one another.

Having said for most of last year “there is no inflation” they have turned on a sixpence, to say inflation is now out of control. Talking of six or seven rate hikes; they wish, just banker’s fantasies. Although markets, not surprisingly, are now suddenly jittery.

Eu consumer price index December 2021

Investment implications

This week we went from feeling over 20% cash was too cautious, to feeling we had missed the boat on value stocks, back to feeling 20% cash was really just fine, all in the space of four short days.

So, because that sea change in inflation expectations was so abrupt, this is a genuine dislocation, we do see the NASDAQ and both the concept stocks on infinite multiples and the mega tech stocks on thirty- or forty-times earnings, as in some trouble, in a process that does not feel over yet.

There is a ton of selling, and the spoofing assets, including crypto, will be heading down, in a dip that feels likely to be around for a little while. But two things stand out, firstly until rates start to top out, this excess money simply can’t go into bonds, so what happens to it? Secondly if the market assumptions about Powell and Lagarde are both right, you are going to be paid handsomely to hold dollars, while simultaneously being charged to hold Euros. We don’t see that as sustainable either. One must be wrong.

Looking ahead

This is why Lagarde’s confidence in no rate hikes, feels like a lawyer’s bluff, as if currencies move, it won’t be her choice for long. While uninvested money, on which fund management fees are still charged, always makes asset gatherers nervous; it will all go somewhere.

That also leaves the question of how much growth we will actually see, as if it is below expectations, then inflation will be choked off, labour force participation will fall, US rate rises will run out of steam. There are already signs of that. While given the scale of market movements, the ending of bond buying by the Fed (long overdue) and even a modest run off of the balance sheet, will be pretty irrelevant, both are really drops in the financial ocean. 

The froth blown off

So, the good news is we will see normal investment conditions, the froth blown off, bonds producing a yield, along with slower growth and moderating inflation, which we do feel will be backing off by mid-year. All of course will rather depend on the progress of COVID, because we still see (and have done for nigh on two years) this inflation is directly caused by COVID responses.

Reducing the output capacity of the economy, with no cut in demand, has to cause price rises. These price rises will exist everywhere COVID does, so trying to pin them to a single cause or location is not easy. They will persist until the demand/capacity equations correct, which with COVID is a multi-year task.

The FTSE finally gets a look in

So, a sea change yes, a market dislocation yes, but if it is as bad as is currently feared, with some big winners resulting in the financials, real assets and energy. All of which, on those fundamentals, still look to us good value, hence the visible support for the FTSE 100.

FTSE for the last year
FTSE for the last month

While if it is not that bad, sufficient money will flow into US Treasury stock, from low interest areas, forcing the dollar to rise, and rates down, until other areas are simply pulled along. So no, we won’t then be getting seven rises on this data and equity markets can start to relax.

And what of Boris?

Finally, Boris, now degenerating into farce, but much as we hate what he has become, we recognize one wing of the Tory party feels he is too right wing, while another feels he is too left wing. Both dream of replacing him with their own, but in so far as he splits the difference, the risk that the other faction wins, should keep him in office.

Either faction will demand more of his replacement than they can ever deliver, given that core fundamental split, so such a divide simply hands Downing Street to Keir Starmer. For now, I still feel he survives, and given his nature he will remain impervious to change, but remarkably adept at promising it.

Sterling seems notably unfazed by it all.      

Charles Gillams

Monogram Capital Management Limited


River Deep, Mountain High

Welcome back Mr. Powell - so what is a good response to impending inflation?

After nine months or more the newly reappointed Fed Chair conceded the blindingly obvious: we have an inflation issue, along with the equally transparent need to tighten monetary conditions to quell it. At least he’s fronted up to that, unlike the position in Europe.

What diverts us is what the right response is. Some things are perhaps obvious: gold at least in sterling terms now has positive momentum again. But there is a tremendous volume of liquidity to soak up still, while stimulus will keep being pumped in for a long time. But fixed interest just looks hopeless, credit quality is plummeting, rates are rising, and returns are poor, even in high yield.

Are we clear of COVID effects?

Nor are we really clear of COVID effects. We are yet to pass beyond all the “emergency measures”. So here in the UK, VAT is still reduced, commercial evictions banned, and government departments are still showing that odd mix of budget destroying costs and below normal productivity. So, spending pressure will stay elevated for a good while. Tax rises on corporate profits and on labour through National Insurance hikes, will therefore start to bite, well before the last variant has caused another pfennigabsatze-panik. (spike/trough related panic)

Markets have also been jittery. In general, the buying opportunities just after Thanksgiving have held, which is a good sign. The subsequent gyrations have (so far) indicated a good weight of money ready to buy the dips. But there is little doubt cash is fleeing the overhyped stocks, which are far more prevalent in the US, than in the UK. The shift out of basic commodities is also apparent. So, I would still expect enormous cash balances to build up into the year end in the banking sector, albeit maybe not always in the right places. Any Santa Claus rally will be strictly retail elf driven; the old man is self-isolating this year.

Characteristics of this inflation

Our view remains that the expected high inflation is systemic, simply because of the structural damage and inefficiency inflicted by COVID. So, it maybe transient, but multi-year transient. In this case while the seasonal moves down in energy prices will be a welcome relief, assuming Northern Hemisphere temperatures stay around seasonal norms (and that’s what mid-range forecasts are indicating) - it is not a solution to the inflationary pressures.

Nor do we see the any unwinding of the inventory super cycle caused by the holiday season and the ending of lockdowns, all at once, as having much beneficial impact on price levels.

Businesses all want inventory and will keep rebuilding it across their full ranges for a while. After all, right now holding stock has little financial cost attached.

See this article published by Markit.

Most corporates are at heart squirrels; it won’t be easy to break a new habit. 

So how should we play this?

The bigger issue is how to play this - the received wisdom is pile into the US, probably the NASDAQ, while having a side bet on bitcoin or some less disreputable alternatives.

That’s where most investors knowingly or otherwise have their funds.

NASDAQ may churn as dealers try to create some volatility, but the overall (and in our view inflated) levels will most likely remain.

This Omicron variant episode at least has halted the IPO madness, and the whole SPAC nonsense is washed up. Sadly, not a big surprise to see portly old London has just tried to catch a train that left the station last year.

The longer view

But it is a bubble we think - our icf economics monthly looks in more depth at how these played out the last couple of times. Not pleasant, but oddly familiar.

NASDAQ and Bitcoin may yet scale new peaks, but the river below is very deep. Perhaps that old affection for base gold is not just nostalgia?

Time for some year end reflection.

Charles Gillams

Monogram Capital Management


three pots - with the middle one lidded - denoting the investment pots of monogram capital management ltd

All kinds of everything

We move towards the end of the year with a great deal of challenging uncertainty and big calls to make, on inflation, China, US Politics, whether interest rates are pegged, and a few political issues. The temptation to sit it out and come back after Burns Night, is intense.

A lot of things will be clear then: the severity of the winter, and hence fuel prices, also of the EU COVID spike, the nerve of some Central Banks and who leads the largest one, and how the Beijing Olympics will go. All are potentially significant matters for investors.

Few of these issues are surprises, which is good, indeed we see advanced economies as being in fairly stable shape, but badly damaged by populist politicians, who can’t face telling voters that ‘nothing comes from nothing, nothing ever could’.

Inflation

So, on inflation, we took some flak back in the Spring for talking about 5% inflation, but we regard that as pretty conservative now.

From the OECD data here.

We see it as structural too, not related solely to excess demand, supply chains or energy prices. All of these matter, but the last two are indeed transient, and excess demand is within the power of the fiscal and monetary authorities to affect. The real trouble is both the lingering and severe harm COVID is causing to productivity, especially in the service sector and in a public sector still too reliant on overmanning and allied with that, the curse of politicians trying to exploit the pandemic to pay off their chums.

Our conclusion is that we will have higher prices at least for the next two quarters and possibly all of next year. Critically Central Banks will most likely be powerless to prevent or reduce that, without bringing the house down. 

Broken China?

One cannot but be envious of the performance turned in, yet again, by Scottish Mortgage. The half year gains are massively from one stock, Moderna, and then a broad raft of e-commerce and big data plays. So, really, they just continue to surf the NASDAQ run. By contrast their big cap China positions generally damaged performance but have not yet been visibly trimmed. Although China does drop from 24% to 17% of their NAV, which is significant, with North America rising from 50% to 57%. (I should also mention we don’t hold a position in this stock and have not had one this year.)

So, NASDAQ strength allows them to survive what for most fund managers has been the poison of owning anything in China this year. A decision we took, guided by our momentum models, very early.

We also note the manager’s viewpoint, which broadly aligns with a view that what Beijing is doing, is what the West should do as well, in attacking and controlling big tech platforms and their associated excesses. Telling the biggest companies to also do more to reduce inequality and cure social problems hurts profits; but they still see both as not unreasonable requests and they claim big Chinese companies are already willingly complying.

Yet for all the apparently cold rationality of the Scottish Mortgage viewpoint, we do understand it, and do see China trashing their participation in areas of global commerce and capital markets as an odd piece of self-harm, if it is really their aim, not just an ill-thought-out consequence of domestic actions.

So, we see the set back so far in China stock prices, as based on the possibility of the area being uninvestable, like Russia, but not yet on that certainty - see the how strong the trade figures are even with India, a so-called political antagonist. But tipping over to uninvestable would be a market shock and again we inch closer to that, with each diplomatic spat.

United States - and the Fed Chairman

The big US call, and again we signaled this as critical a while back, and actually well before the US Presidential Election, is about Powell. My sense is removing a competent Fed Chair for purely partisan reasons would be damaging to markets and the dollar. But the pressure on the ailing Biden to do just that feels intense, and I am struggling to see who in the White House will have the maturity to stop it, if Biden caves in.

Would a new Chair do things differently? Might markets push harder still for a rate rise and the dollar, short term at least, suffer? For now, re-appointment is still expected, but the odds on a shock are shortening.

Interest rates

The Bank of England is also, quietly in the midst of a storm, it is not actually independent however hard it claims otherwise, it relies too much on Whitehall just to survive, and, in a way, can’t do anything meaningful on inflation anyway. Still a rate rise, even a notional one, would show it is still awake. It makes little sense just now, but as a symbol might yet happen. To us it simply adds emphasis to the political chaos overtaking Johnson and the ongoing shift towards an institutional alignment with a Starmer government.

Material interest rate rises (so returning us to positive real rates) during 2022 therefore still feel impossible. Indeed, German rates have once more flirted with changing the nominal sign, only to collapse back into negative territory.

To sum up - where does that leave us?

Well curiously, mildly bullish. We may not much like the position, but who cares about that, our task is to make money for investors. We also have had a think about what rescued investors from the COVID slump, on the basis that a future sharp inflexion in interest rates could look much the same.

What we see is the power of real growth, not the flotsam of cash hungry concept companies that can never pay a dividend, but fast-growing, broad-based technology – following that has been the winner for a decade. We do want to call time on that, partly for the nonsense and scams it tugs along behind it, but we still struggle to see the turn. 

Charles Gillams

Monogram Capital Management Ltd