Sea change
A trio of influential knaves to worry about this week, united by a belief that âthis time is differentâ. Well pantomime season is behind us, however we can still all shout âoh no it isnâtâ.
Boris seems to be the least of our problems, if the greatest of villains, for the scurrilous crime of enjoying himself, what a rat. While Powell is providing an increasing threat to the poor and exploited across the globe by generating financial instability, and the lamest of the lot, Lagarde is just repeating a political line. The Euro zone debt figures look like this. A sharp rise from an already overstretched position, but still benefiting from falling rates, so when that rate line turns, the problem will really bite.
Will markets ever trust the Fed (if they did this time, outside the gilded denizens of Wall Street) again? Hopefully not, the trouble with putting administrators in charge of Central Banks is they rely only on historic facts, it is in the job description, thatâs what they polish, hone and serve up.
But the economy is dynamic
The mismatch is that the economy is dynamic, and has no printed rule book, beyond that of the rocket; what goes up, must come down, immutable like gravity. And you simply canât wish gravity away.
So, this Fed is programmed to repeat what it can see looking backwards, and all the obedient commentators on Wall Street who simply echo its nonsense, are of little use, except to fleece the gullible and to signal false comfort to one another.
Having said for most of last year âthere is no inflationâ they have turned on a sixpence, to say inflation is now out of control. Talking of six or seven rate hikes; they wish, just bankerâs fantasies. Although markets, not surprisingly, are now suddenly jittery.
Investment implications
This week we went from feeling over 20% cash was too cautious, to feeling we had missed the boat on value stocks, back to feeling 20% cash was really just fine, all in the space of four short days.
So, because that sea change in inflation expectations was so abrupt, this is a genuine dislocation, we do see the NASDAQ and both the concept stocks on infinite multiples and the mega tech stocks on thirty- or forty-times earnings, as in some trouble, in a process that does not feel over yet.
There is a ton of selling, and the spoofing assets, including crypto, will be heading down, in a dip that feels likely to be around for a little while. But two things stand out, firstly until rates start to top out, this excess money simply canât go into bonds, so what happens to it? Secondly if the market assumptions about Powell and Lagarde are both right, you are going to be paid handsomely to hold dollars, while simultaneously being charged to hold Euros. We donât see that as sustainable either. One must be wrong.
Looking ahead
This is why Lagardeâs confidence in no rate hikes, feels like a lawyerâs bluff, as if currencies move, it wonât be her choice for long. While uninvested money, on which fund management fees are still charged, always makes asset gatherers nervous; it will all go somewhere.
That also leaves the question of how much growth we will actually see, as if it is below expectations, then inflation will be choked off, labour force participation will fall, US rate rises will run out of steam. There are already signs of that. While given the scale of market movements, the ending of bond buying by the Fed (long overdue) and even a modest run off of the balance sheet, will be pretty irrelevant, both are really drops in the financial ocean.Â
The froth blown off
So, the good news is we will see normal investment conditions, the froth blown off, bonds producing a yield, along with slower growth and moderating inflation, which we do feel will be backing off by mid-year. All of course will rather depend on the progress of COVID, because we still see (and have done for nigh on two years) this inflation is directly caused by COVID responses.
Reducing the output capacity of the economy, with no cut in demand, has to cause price rises. These price rises will exist everywhere COVID does, so trying to pin them to a single cause or location is not easy. They will persist until the demand/capacity equations correct, which with COVID is a multi-year task.
The FTSE finally gets a look in
So, a sea change yes, a market dislocation yes, but if it is as bad as is currently feared, with some big winners resulting in the financials, real assets and energy. All of which, on those fundamentals, still look to us good value, hence the visible support for the FTSE 100.
While if it is not that bad, sufficient money will flow into US Treasury stock, from low interest areas, forcing the dollar to rise, and rates down, until other areas are simply pulled along. So no, we wonât then be getting seven rises on this data and equity markets can start to relax.
And what of Boris?
Finally, Boris, now degenerating into farce, but much as we hate what he has become, we recognize one wing of the Tory party feels he is too right wing, while another feels he is too left wing. Both dream of replacing him with their own, but in so far as he splits the difference, the risk that the other faction wins, should keep him in office.
Either faction will demand more of his replacement than they can ever deliver, given that core fundamental split, so such a divide simply hands Downing Street to Keir Starmer. For now, I still feel he survives, and given his nature he will remain impervious to change, but remarkably adept at promising it.
Sterling seems notably unfazed by it all.
Charles Gillams
Monogram Capital Management Limited
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 heâs 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 âemergency measuresâ. 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 thatâs 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 wonât 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.
Thatâs 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
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 canât face telling voters that ânothing comes from nothing, nothing ever couldâ.
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 donât 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 managerâs 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, canât 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 â 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
A HARD RAIN
WHEN WILL MARKETS RESPOND?
Everything is in the end politics; it just takes a long route on occasion and rather like a frog in water, markets take time to realize that the pleasant feeling of warmth is a prelude to being boiled alive. We are well into the boiling phase, but how long before it all registers and an escape is finally attempted?
The purpose of politics seems ultimately to take an individualâs wealth and the fruits of their labour and give it firstly to the friends and allies of the confiscatory state and then use the remainder to buy votes. That bit does not ever really change, whoever is in charge.
So how does that truism impact markets on each side of the pond? Well, traditionally the UK state has been far greedier and done far more harm to the economy, than the US state has, which is why both GDP per capita is far worse than the US, and the FTSE has failed to rise, even in nominal terms, in two decades. Add back inflation and investing in UK PLC has been a long-term wealth destroyer. It enjoys that characteristic with the rest of Europe. As we have long said, lift the lid on any sensible UK pension fund, and you will find a lot of Apples inside.
In general, and this too is a platitude, well run dictatorships, especially those with access to world markets, do far better still, hence the rise of China. Of course, âwell runâ and âdictatorshipâ seldom sit well together, but nor do âpopulistâ and âwell runâ. In general markets are not greatly in favour of either populists or dictators, feeling the rule of law is not something either care that much about. But by implication neither are voters now too fussed about laws either.
LONDON OR WALL STREET FOR THE REST OF 21? - THE BIGGER PICTURE
So, the investing question is whether the US, despite being increasingly under the control of the populist wing of the Democratic Party, is a better bet than the UK? Or do we have the capacity to process a bigger picture?
And of course, we need to ask whether China is better than both. So far, the US is finding Biden to be no worse than the populist wing of the Republican Party, and the UK is feeling rather baffled, given Boris constantly talks right but acts left.
Put like that our current sentiment, that Biden will cause more damage than Boris, is at the least contentious. So, we should look for the good in Boris and the bad in Biden, to help justify that call. Not an easy balance, but what makes it easier is the relative valuations. In particular of tech, where the US has moved ahead massively, so a lot of the question can almost be reduced to asking if Tesla is worth it? Or if it is, what is the motivating force to make it still more overpriced?
Boris seems to be trapped by the doctors and his inability to fathom numbers, into driving us into a permanent state of fear and welfare dependency, which will keep the UK steadily in long term decline. If he can break free of that populist vice, we might have a slim chance.
The omens are mixed, banning travel to Portugal (again) looks like the familiar science trap, but of course might be a reaction to the EU also banning wider travel from the UK to the EU just before that. Given our relations with the EU, that oddly seems more likely (if childish).
By contrast the US is now operating near normally, a stark contrast, as we remain in de facto lockdown, tied up in fiddly, unpredictable, illogical restrictions.
CULTURE WARS AS INDICATORS OF INVESTOR SENTIMENT
Both the Queenâs Speech setting out the legislative agenda for the year and the visit of Viktor Orban, the Hungarian premier, may have been light on substance (they were), but boy were they heavy with Tory symbolism, coming hard on the heels of the local election wins.
Much of that proposed legislation was to placate the grass roots, I seriously doubt laws on de-platforming (of both the living and the stone hewn) will make much difference, but the Conservative base feels it is high time the left got some mild resistance, in cultural matters. There has been very little of that for the last two decades.
I suppose the brutal bashing of Bashir is in the same category, although from my own experience a BBC journalist who did not lie and cheat their way to a non-existent story, would have been the truer rarity. Although in that they differ little from the rest of their breed, but defenestrations at the National Gallery and revolt at the National Trust, have been a long time coming and indicate a new degree of solidity and confidence. This is long overdue since Blair assiduously stuffed placemen into those organisations. Neither Cameron nor May did much about them, having their focus on higher things, it transpires.
Does it matter? Well not really, to markets, but it is a counter to the reckless spending, and the chilling clarity with which Boris famously expressed his view on business during Brexit, so is a straw in the wind. Maybe other things will change.
DEFUND THE DOLLAR?
What of Biden, well so far the US markets have taken slow comfort from the slender political majority, he holds, but the view is creeping in, that he really is going for broke, he is happy to unleash inflation, almost keen to do so, that letting Wall Street blow itself up, in the meme stock nonsense, and suppressing interest rates (which is vital if you are borrowing so much) and as a result trashing the dollar, is all fine, all part of the plan. Note the recent measures by China to prevent their currency appreciating too fast and by Putin (of all people) complaining at dollar fragility. Others may not attack it yet, but it increasingly looks like US policy.
Much of that perhaps matters little to Wall Street immediately; inflation makes you own real assets, bonds are now utter rubbish and so far, very little of US individual wealth is invested abroad. So, Wall Street almost inevitably drives itself up and thatâs a hard tiger to dismount.
But it maybe matters more to us Europeans, who need to both believe that US overvaluations will persist and critically that the dollar will not weaken further.
So, in the end politics do matter, not now, not today, but how these contrasting styles evolve over the rest of the year, will be very important to how currencies and markets respond.
Getting it right for the second half involves a big call, this year, as it did last.
Flat markets are not always still markets.
Charles Gillams
Monogram Capital Management Ltd
06.06.21
YELLOW BRICK ROAD
The recent elections in the UK probably result in a mildly stronger position for Boris in his Merkel persona, his Christian Democrat (CDU) disguise, so the fiscally left wing, culturally right-wing hybrid, that seems popular; but other than disasters averted, the poll achieves little more. For all the noise about the Hartlepool by-election, we are talking very small numbers, with a 40% turnout in a seat already slightly subscale due to depopulation and industrial decline. It has no resulting impact on the governing majority. Indeed, but for the Brexit Party, it would have been Tory already, so it really says nothing about the right-wing vote. The Tory Party is still miles from representing a majority view, but as long as the left is divided and the right united, that will persist.
Nor do I see much of interest in the council elections: a good result for the Tories in building on an already strong performance last time, which shifts the middle third of councils around in the quagmires of NOC or No Overall Control. This morass, like the bilges on a boat, washes left or right depending on the political tide. But with staff (and councillors) aware that only a few seats can shift them in or out of the NOC swamp, its impact is not great, particularly where they have elections three years out of four. These permanently transient councils tend to be run more for themselves than anything tedious like ideology or providing decent local services.
Neither Mayors nor Police Commissioners have any major power. Sadiq Khan, freshly back in office, faces a central government happy to call in his local plan (on housing) and impose central government representatives on his transport authority, thereby strapping one hand behind his back, in both his areas of real influence. Meanwhile London policing remains ultimately under Home Office control, so like the other areas is just for political grandstanding, not real service delivery. Policing in London also seems an enduring disaster: where it is needed, it is not wanted, where it is wanted, it is not needed.
Reading the Party Runes
So, what of Kier Starmer? Well, it also tells us little about his Cameron-lite policy of avoiding controversy, avoiding spending on fights he can neither win nor cares about, and ensuring he controls everything in the party. That policy is seemingly intact. The Corbyn wing will continue to spout for the microphones on demand, but matter little. The key issue is whether the big funders will want to have a go at winning the 2024 election. I think they will, but should they decide it too is lost, Starmer has a problem. If the partyâs money bags decide he canât win, he wonât.
For Boris it is at the least an endorsement of his recent COVID strategy, and that higher taxation to pay for the incredible spending splurge, has yet to impinge on votersâ minds. So, it permits him to carry on, but perhaps recover more of a strategic view, after the recent wallpaper storms? Does it make exiting COVID lockdowns any easier? Well, it should, but hard to tell if it will. Does it validate the extreme turn green? Not really, the Greens still did better in terms of new seats won, than either the Labour or Lib Dems, and are still advancing (from a very low base).
I am not sure if the Lib Dems expected much, they have Keirâs problem of irrelevance tied to being pro-European, when the EU is behaving more oddly than ever. So roughly holding their ground was fine. Indeed, they polled way ahead (17%) of national election ratings (which are more like 7%), but not over the magic 20% required to hit much power. Â Â Â
Those Strange US Job Numbers
Which brings us to the real shock from last week, the weird US jobs numbers on Friday. We have long said that how and if labour markets clear after the great lockdown experiment, is the vital economic issue. The problem never was the banks (so last crisis) nor the ability to borrow to sling money down the giant hole dug by the virus. Both are easy. But once you have smashed the economic system, does it regrow, like a lizardâs tail or simply start to rot and decay?
Many of us would have avoided the deep wound in the first place, but now the experiment has been started it must conclude. So, what did happen to slash monthly US job creation from expectations of a million to just a quarter of that? The instant reaction that it meant inflation has gone and so bonds were fine, was as instant reactions often are, garbage.
The bull or âBidenâ case is that as they have the right medicine, it just needs a bigger dose, or to take it for longer. Seems credible; labour force stats are notoriously volatile, some of the job losses came from manufacturing, where supply shortages are biting, but thatâs transient. Some seem to indicate a mismatch of jobs to vacancies, hopefully also transitory.
Encouragingly, a spike in wage inflation and hourly rates indicated plenty of demand for workers.
Yet, slamming the brakes on, shutting the economy down and paying millions of people not to work, might have brutally destroyed the delicate economic system. Thousands of small firms, where the bulk of employment is created, have just gone. The complex prior system of sales, working capital, scheduling, delivering, inventory, payment has been eliminated. Sure, the people still exist, so do the premises, but the invisible mass, the self-directing hive, is lost: no map, no honey, no queen.
Bigger firms are also planning to work differently, perhaps needing less labour.
Once you stop working and get paid to be idle, and indeed have limited ways to spend your money, it feels easier to stay in bed, study Python, redecorate the house, or whatever, but not get back on the treadmill. Indeed, in a lot of cases, once you step off, stepping back on is hard and also downright counter intuitive. Sure, your old boss wants you back, but do you want the old boss back? Worth a look round at least? As the title song puts it, âthereâs plenty like me to be foundâ.
Well, we still go with the bull case.
However, the bear one is not trivial. If you canât get labour markets to clear, welfare will be embedded, as will high unemployment, deficits and unrest. It remains the most critical feature, worldwide of the recovery, and several questions about it remain as well, including the need to keep new bank lending elevated, cheap, available. Expanding needs cash, contracting creates it.
The oddity to us then remains, that if the liquidity barrage really does work, why should it work better in the US than elsewhere?
And if it works the same for all, donât US markets then look rather expensive?
Charles Gillams
Monogram Capital Management Ltd