JENSEITS VON GUT UND BOSE
We ponder the point of the UK markets, ignore clashing BRICs, set up for the slow fall in interest rates in 2024, yes, long lags are long.
There are two investor markets, one akin to gambling and speculation, one allocating capital efficiently to invest capital or fund governments. But like weeds in a nutrient rich field, spare liquidity attracts the rankest growth of useless vegetation. Thereâs no clear way of knowing which is which. Money famously does not smell, and clients donât really care much about how they earn a return, whatever they may say.
From: The FT Adviser Website
Fads and fashions in investing fuel some success at first - then they can no longer conquer new lands, and deflate, dragging down asset values as they go.
ARE INDIVIDUAL UK STOCKS WORTHWHILE?
I look back, as all investors should from time to time, at my successes and failures. Luckily out and out failures are pretty rare, and in some measure, so are successes, as I quickly milk the wins (usually from takeover bids), so they disappear from the record.
This leaves me a pretty solid mass of fairly dull UK equity holdings, I slightly favour value over growth. So, I know a simple snapshot wonât reveal the steady benefit of, at times, decades of good dividends.
But at the end of it all, for a UK investor, what remains is a mass of general mediocrity. Resource stocks have been good to me, still are, but the mass of industrials? Not really.
Or property companies?
Well big dividends from REITS, but again not really. Of financials? Again, long years of high dividends, but capital values stay scarred by the GFC. Chemicals, retailers, distributors, tech, utilities: well, all fascinating, with some good runs, often good yields. But in the end?
I could ignore such perennial plodders when their yields were far above base rate, but they are now surpassed, by a simple savings account.
So, I do wonder at times like this, why I hold them. Doubtless we will get rallies, but the tone feels a tad discouraging just now. And I sense the politicians of all hues, who seem to be eager to relieve me of anything that looks like a nominal gain, or enforce their often extreme views on my assets.
PERHAPS OTHERS DO IT BETTER
My long-term winners by and large stack up in investment companies, with specialist fund managers, and almost entirely overseas, or at the very least global. Not that is much of a surprise, we have mentioned before how the FTSE100 has not moved much in twenty, going on twenty-five years. Yet again it has flattered to deceive this year, yet again it has that slumping dinosaur feel to the graph.
The UK is not alone in that. Most of Western Europe shares that fate, and Eastern European investing has been a good way to create losses. Somehow Europeâs governments have done just enough to keep investing alive - and somehow the stock markets have had just enough liquidity to avoid collapse.
It is partly why so many investors love small companies, but they are savagely cyclical, as we are seeing just now.
I could blame management, and their apparently limitless greed, but while many quoted boards maybe have rogues or knaves, but nigh on all of them? No, I wonât accept that.
Globalization has freed capital to move easily and fast. Far faster than any real business can adjust, and in this world the ability to attract capital is vital. True many attract it, to waste it, like a meme stock, or Peloton, but it would be wrong to see that as a line of tricksters repeatedly finding ways to con the market (although many have) more about the power of liquidity to inflate prices, attract buyers, inflate prices once more, in an unending climb. That is until the last buyer has paid up, and the tipping point is reached.
Taken from this website
Then the whole thing unwinds downwards, down to a true value, or less.
WHERE NOW?
On the one hand, as interest rates fall, and they will do soon, even if that one last hike is much discussed and may well happen, the path looking forward is downwards.
FED rates in the last 5 years
This should benefit value stocks, as more and more dividends emerge once more above the high-water line of cash deposits. Rates wonât go all the way back to zero, that is gone, but should start on the way down.
On the other hand, the liquidity trade is here to stay, money attracts money until the thermal tops out and the vultures glide along to the next spiral, or indeed back to the last one.
And looking over decades, as fund managers must, that is all that happens in most markets globally, one or two have true secular growth that also gets returned to investors (a key caveat), most seem not to. Investors become either hobbyists in love with a stock or short-term traders. It is notable how many of the new breed of big company directors spurn the shares of their own companies, bar a token few thousand.
Markets seem to have progressively been made easier for momentum, versus âtrueâ investors, allocating capital to create real jobs. The capital allocation bit is worthy but dull, and arguably governments and regulators seem to have strangled it into stasis.
The endless, joyful, mindless dance of momentum, is simpler, prettier, easier to tax, cheaper to trade; quite wonderful really. But is it much else besides that, or is it substance without meaning?
It is odd how governments moan about the lack of growth and yet cripple capital allocation. In a market system, the best capital allocator wins. It is really quite simple.
Once the tightening stops, there should be more currency stability (of sorts) as all the Central Banks realign their rate patterns again. In (to us) an unresolved month, the dollarâs strength has been notable, when not a lot else was.
Skipping along
Skipping is the weekâs theme, following the inadvertent use of the term by the Fed Chairman, along with the rather weird behaviour of Jeremy Hunt.
Although any skipping seems unlikely soon, on this side of the Atlantic.
The dear old ârecessionâ still lingers, unseen but feared, like an ex Prime Minister. We are convinced it will arrive, but as a âtechnicalâ recession only. It should be hard for anyone to be surprised. Labour markets are much stickier and far more fragmented. Supply is short, so any systemic shock feels unlikely. While as old hands keep noting, single figure mortgage rates, well below inflation rates, are hardly restrictive.
Chair Powell (almost) mentions âskippingâ.
Jerome Powell was bowling along contentedly, when he suddenly described the Reserve Boardâs June inactivity as âskippingâ. Although it actually was just a âskipâ, before he realised the error and with a guilty look speedily reverted to the far more passive âpausingâ. Â But we knew how he was thinking. He was going to keep his foot on the neck of borrowers for a bit longer â interestingly, he refers to real rates of interest, as somehow unjust and injurious. Odd that when asked anything about fiscal policy he instantly plays the neutral, technical banker, no good and evil there.
Moves in the real economy.
So, what has really happened?
Not a lot, energy prices have climbed all the way up, and now slid all the way down. Aggressive fiscal stimulus continues, any chance Biden has to bribe the electorate with their own money, he still takes. Employment remains strong, although there is some tightening in hours worked, but it is still pretty hard to see how the Fed gets down to 2% inflation for a year or two.
And yet, markets by a mix of that unseen recession and faith in so called base effects, do think inflation by the autumn, will justify a real pause. No skipping.
UK Chancellorâs odd statements
Here in the UK Jeremy Hunt is in quite a different place. Inflation still looks high and embedded, but he has carefully outlined how he would keep going with substantial hand outs to offset inflation (aka fiscal stimulus).
However, inflation control was all for the Bank to sort out.
This is nonsense, of course. The UK Government is yet again stoking inflation while taking no responsibility for stopping it. He then gave a tortuous explanation as to why his policies have now produced exactly the same interest rates as the Truss typhoon, created by his reckless predecessor, but somehow, not at all the same.
Rate rises â a global feature.
Funny that, as we noted at the time, there was little odd about the October rate spike, and much that the Bank could have done (but refused to) by a prompt rate rise (matching the US) to stabilise the currency and inflation.
Rate rises are a global feature, with not a lot one small country could do about it.
2021 chart produced by the UK Institute of Chartered Accountants
So quite where the virtue of the Truss toppling quarter point rise is now, is rather unclear.
As sterling shows, the prize for that autumnal sloth will be higher rates (and inflation) than elsewhere for longer. The thing about fire fighting is the sooner you start the less you have to do.
So how did Monogramâs methodology work?
Our in-house model switched into Japan in December 2022 and Europe in March 2023. As we only ever deal in half a dozen big global index Exchange Traded Funds, this is not a tickle, but 25% of the total equity position in (or out) at once.
Brutal and scary, but effective.
We look at the signal, kick the tyres, thump the bonnet, turn it off and on again, look for reasons to ignore it, and then six months later look back in wonder and say, âoh yes, that was rightâ. These signals are delicate enough to very seldom feel right at the time, but after almost a decade of running the model, we have learnt to obey.
So, our Momentum performance discussion, yet again, is about how much we made, not about in which direction the money went. While the GBP version, seeing similar signals, has also never come out of the S&P 500, which for a good while also felt wrong, but it seems was right, taking a long view. The USD model was more skittish but is back in both (S&P and NASDAQ) US indices now.
So, we do know where momentum has been, and it is quite strong.
Markets in the political timeline
The rational thinkers say the market is (still) too expensive, but the trend followers donât agree, who is right?
We tend to feel just as Central Bankers were very slow to spot inflation, they are possibly being too slow to see it has now been contained, and the US skip may be a pause and then a snooze. Which would be very convenient for the Fed during the US Primaries, allowing for cuts into the US election?
Related to that, we watch with amusement a dialogue about the attractiveness of stock exchanges, in particular in London, couched entirely in terms of what potential listing companies say they want. Not a mention of what investors want, as if they just donât matter. Quite absurd, as what all listings need is a deep market, good liquidity, stable tax regimes, and an attractive base currency.
Is London aiming to provide these? We seem to favour founders â so, tweaks to voting rights, smaller free floats, fewer shareholder rights. But then oops! No buyers.
This is worse than nonsense, it damages what little is left of Londonâs reputation. In this market you start with the buyers. The price performance of many a recent IPO spells out the problem, the sellers are finding it too easy to deceive people â a call is needed for greater transparency, longer lock-ins, and less pandering to insiders and their advisers (not more).
A RIGHT OLD TONKIN
About Influence â American and Russian, mediated by the Chinese
So, to start with what does worry us: That is the slide to a hot war with the powerful Eastern autocracies, fueled by the EU with Napoleonic tendencies, an old man in the White House and a curious sense of âcrusadesâ with no consequences.
For those with long memories of American imperialism, the latest drama even fits neatly as a modern Gulf of Tonkin, a key moment in the slide to war. In that case (south of Hanoi) the clash was naval not aerial but was still notable as one directly between the warring parties and not just their local proxies.
While elsewhere the pieces move, China can not let Russia fail, nor descend into chaos, their long-shared border must stay intact and secure. They no more want the US there than the Russians do. The first step after his confirmation as ruler for life, by Xi, was indeed to go to Moscow.
And the bitter battles in the Middle East of Persian against Arab, Sunni against Shia have cooled abruptly, under Chinese influence. The world once more understands that the US is the threat to peace and stability, not just their fractious neighbours.
For Biden it is an easy fight, the Pentagon so far has played a blinder, what can go wrong? While, for now, France is Europe, no other large state has anything like their stability, Italy is led by the unspeakable, Germany has free market liberals in a bizarre ruling alliance with Greens, Spain is wrapped in its own forthcoming general election, the UK both distinctly detached and under a caretaker government.
The UK budget said nothing, incidentally.
Main influences in France.
While the left in France, as the above photograph shows, are very alive to Macronâs ambitions, to add more territory to the EU, arrange more protectionism for French goods and to suck the labour force out of adjacent states to serve the Inner Empire. Just like Bonaparte tried (and failed) to do, with dire consequences for the French nation.
For all that, the domestic fracas in France (which makes our own strikes look rather tame) was inevitable. Raising (by not a lot) the pension age from 62 to 64, against our own 67 looks small, but it was a clear campaign pledge.
The absence of any minor party wishing to self-destruct, by supporting it in the French legislature, is no great surprise either. So, he has implemented it by decree and Macron has dared the opposition to now either remove his prime ministerial nominee, or shut up.
Banking On Nothing
So, what of markets? Well, the end of SVB is no great loss, it had several policies that had to implode if rates rose, especially on the lending side. It was painfully âwokeâ; I can tell you more about the Board Members sexual orientation, gender and ethnicity than their banking experience, the former just creeps into the end of their latest Annual Report, the latter was invisible to me.
SVBâs long list of ESG triumphs and poses (and it is long) at no point included not going bust. It did commit an extra $5billion to climate change lending, which I guess has all gone up in smoke now. Still apart from all being fired, the bank insolvent, the remnants rescued by the hated Washington mob, under investigation by the DoJ, all the rest of their âGâ was superb, and so, so, cool.
I donât see Credit Suisse as a danger, although it may be in danger. It has had an appalling run of misfortunes, with musical chairs at the top, but it remains a cornerstone of Swiss identity. To let it fold would be highly damaging and cause shockwaves in derivatives markets.
Influence on the markets
So, I do understand the Friday sell off (who wants to be weekend long with regulators on the loose). And we do understand markets needed to go down, after the big October bounce, indeed it was a key reason for our building up over 33% cash or near cash at the previous month end. We knew the winter rally was fake.
But I donât see this as much more. Retest of the S&P 500 October low? It should not be. I take a lot of heart from bitcoin soaring (63% YTD); if liquidity was short, that would not have happened.
But for all that, I donât like March in financial markets, too much is uncertain. So, this is more a time for cautious adding, rather than hard buying, but if we get to Easter (and hoping to be wrong on the Tonkin analogy) it does seem a better prospect.
Nor do I see how the various central banks can justify a pause in rate rises, at this point, but nor will they go in hard, that would be folly.
This Fed has made enough mistakes already.
The Art of the Possible
Image from Wikemedia - by Neide José Paixão
Looking at Absolute Return â Can it be Done?
A wise old hand once told me that all investors want is protection from inflation; do that, earn your fees and your jobâs done. Read more
FEEDING FIDO
International interest rates - what a dogâs dinner! But perhaps also a wake-up call: this is real life - governing for your social media feed does not work. We take a glance, too at the property market.
MARKET EVENT OR MACRO?
Our view has long been that we need rates at 5% to make a dent in labour inflation, both in the UK and US. It looks like the Fed (to our surprise) finally agreed. But with that comes a risk of overshoot, driven by the timing of the US mid-term elections. Powell, perhaps rather more attuned to politics than his banker colleagues, was keen to drop the bombshell early, rather than on 2nd November, right on top of the mid-term elections. So, I think the Fedâs now done with giant rises. Future rises may be less and spaced out, and quite possibly not that many.
One of the most chilling sections in Powellâs press conference was when asked about the global implications: yes, he assured us, he quite often takes tea with international colleagues. That was it. This time round the US is happy to crash through the global economy without a care in the world.
Encouraging short sellers
It seems Bailey of the Bank failed to get the memo, because oblivious to the soaring dollar, he stuck to plodding domestic rate rises, as if Leviathan was not bursting forth from the deep. Lifting rates by 0.5% when the dollar lifted 0.75% the day before felt like a joke. And if Bailey could not see that, the markets could: UK two-year gilts abruptly repriced to US rates.
But sterling is still hobbled by UK rates at 2.25% - too low. By trying to be clever on the rate rise, Bailey has simply let the short sellers in. As the chart below shows, having already hit the renminbi and the yen, it was obvious who was next. Sterling is a small but liquid currency block, with no allies â so it typically pays more to borrow. The markets just needed the signal.
From : this siteâs fine moving graphs
I doubt all that volatility really makes much difference to the real economy. Indeed, the Bank has now braced sterling nicely. As for the pension schemes, the FCA (Baileyâs last top job) created the foible of pensions being forced to hold loads of so called ârisk freeâ assets to prop up UK government borrowing. A most amusing idea, always going to blow up one day.
Not that sure even 4.5% rates will slow wage inflation up. But we will know soon enough, after all the destination was to us never in doubt, just the arrival time. I still see the strain of rates rising to (say) 8% as too much for the electorate in either the US (the leader) or the UK (who follow).
Recession fears?
Nor do I consider either the US or UK end rates to be high enough to cause a severe recession, although clearly, they will have an impact on asset prices, and in the end, labour markets.
So, I conclude this is more a market event than an economic one. And surprisingly it is all in bonds (and therefore currencies).
Investors will hang back until they see those settle down and that could take the rest of the year. So, although everything is perhaps cheap, the VIX will keep many on the side-lines.
The UK at least feels at bargain levels, but buying dollar stocks still feels somewhat pricey.
BRICKS AND MORTAR
So, to property. Well, we got this one wrong. Partly we failed to see Ukraine becoming a big war, but one with no quick winner. This triggered European (in particular) energy inflation. Partly we therefore saw interest rate rises staying in single figures, which is not what some REIT prices imply.
Not that we have changed our longer term â4&4â view on interest rates and inflation, (so higher for longer) but other investors and markets clearly have. You canât fight the tape.
In general, outside the warehouse sector, real estate companies (unlike say Private Equity) had already taken the hit to values, their balance sheets showed the new world, backed by real deals. So, adding a second discount does seem odd.
Gearing levels are not high, and debt maturities well extended, and interest (still) well covered. Maybe private markets are worse, but it is not clear why that contagion spreads into quoted ones. If there is a blow up, it is not obviously in public markets or mainstream lending.
But if quoted markets are right, what of residential markets?
Well logically as they are still going up, do residential prices now have a big drop built in, which is yet to happen? The price of mortgage banks, home builders and buildersâ merchants all say âyesâ. But how will it happen? It is not a big sector in UK public markets, but the odd couple that do exist (Mountview, Grainger) have also taken a hammering. They have some debt and are rental specialists (of various types).
So, markets say yes, house prices will also collapse.
Do I believe that? Anymore than talk of imminent dollar sterling parity and 8% base rates? Frankly no. Stagnate, chop around, go sideways, blow the froth off. Sure. Collapse; is wishful thinking.
After Armageddon I fully expect to see a plucky estate agent emerge from the ruins, justifying an offer above the asking price for the debris, with potential (but may need planning consents).
So, if true, that means despite a hair-raising ride, those mortgage banks and residential owners will in time emerge resilient.
Sadly, for many, that also suggests, without forced sellers from the buy to let market (where there will be a few), the stock of housing units wonât change and therefore nor will rents. Housing stock is very lagged and current moves will only close the pipeline two years out. Only mass unemployment hits rents, and if this is a market event, not an economic one, it wonât change, because structural unemployment is not the issue. Indeed, we are at record low unemployment levels.
In summary
A market tremor created in Washington, was transmitted to the UK, and is now rippling round the world; either currencies hold their interest rate differential with the dollar, or get crushed.
Old news; it is odd isnât it, how so many clever people failed to read the memo?