Halloween or Guy Fawkes Night?
There arrives a point at which our gaze lifts beyond the immediate chaos of politics, beyond the maelstrom, to the line of sight beyond, to calmer waters. We are there now, the US election (on November 5th) no longer matters much to how we trade out the year. The next administration canât start enacting policies until January, the State of the Union speech and the new Congress.
In the UK, we have had a phoney war since July, awaiting a budget, due the day before Halloween. Budgets are (or should be) a process, albeit leaky. Sadly, most of the leaks and badly flown kites, to date, are predictable, telling of a cash strapped government desperate to pay off their supporters, by ever higher taxes. They hope markets wonât notice. Some chance.
Globally inflation is falling based on goods deflation, a fair bit of which is out of China. The ongoing normalisation of energy supply, post Ukraine, also contribute, and is offset by regulatory rises in labour costs, stagnant productivity, and out of control welfare. None of that changes.
Meanwhile investment and necessities are now the areas being squeezed hardest, and business confidence is elusive.
From this OECD update
So where are the dangers for investors?
One has been to ignore gold, a long running afterthought in our in-house momentum portfolios, at a steady one sixth weighting. Some afterthought!
A more dangerous mirage is fixed interest, because it has been priced for a massive set of rate cuts for far too long, and all you get is a speedy convergence back to negative real interest rates.
Indeed, for a lot of investors, service inflation, not goods, is already the pain point, and service inflation and post-tax interest rates have already converged.
Although with the internet, net interest margin for the banks is not as volatile as of old. There are no longer big pots of locked in money in current accounts. So, falling rates are not hurting bank earnings much, indeed the danger is more of elevated rates causing defaults. But is that denting profits? Not really. Banks are getting good at holding their margins.
Another dangerous deceit has been the flow into value and into emerging markets, that trend has lifted prices, has been doing so all year, but again quite slowly, while some sectors and markets, like aerospace and Latin America, have been pretty vile.
Both Value and Emerging Markets have now had an awful lot of false dawns. Those too feel like a mainly 2025 trade now.
Europe â where next?
Europe seems genuinely to be struggling. I notice credit default swaps on French debt remain elevated after Macronâs summer failures. While Germany still relies on China and the motor industry too much. Without peace in Ukraine, it will struggle, although the arrival of lower energy prices and more tariff protection against Chinese dumping, will slowly help.
We are (nearly) all protectionists now.
So? Well, what has worked, likely still works, and while October might (yet again) be seeing a leg higher, it feels hard to get too excited, until after November 5th.
Private Equity
Two other 2025 themes are private equity and competition.
Private equity is just about holding its own. Those big, expected, discount compressions are not yet happening, so conflicting market views persist. The bears who, judged by the discounts, are still winning, see overstretched balance sheets, unaffordable debt, at any likely refinancing rate and a closed IPO exit market. So, a lot of stale assets.
The latter is both a reflection of how thoroughly investors felt ripped off in the last IPO boom and the bypassing of over regulated, backward looking public stock markets. For hot stocks, in particular, capital is still easier to raise off market. You can buy into AI without buying IPOâs.
However some mid-market managers are quite happy to use trade sales instead, and those will pick up, once politics gets out of the way and interest rates get more sensible.
Some smaller tech areas, which never relied on debt, nor expected an IPO exit, are starting to look quite frisky, as recent buys have not been at such high prices and they have ridden the post COVID technology expansion well.
And tech has been moving very fast of late. So, buying debt free, post 2020 investments, as they now start to exit, can be pretty good, and decreasingly offset by the collapse of lockdown casualties.
Competition
On competition both Draghi and then Lagarde are saying loudly that competition policy in Europe, which has been seen as being by national market alone, will continue to weigh on productivity. Instead, the competition view must now be pan-European, and on that metric, for example, we have far too many telcos and banks. We now have a new EU Competition Commissioner, but also a desire for a ânew approach to competition policyâ clearly stated by the EU President in July.
So whatever nativist German noises there are, if Commerzbank has an Italian suitor, that deal is still possibly good for Europe. If Vodafone wants a merger in the UK (or any other) mobile market, that should be fine too. Indeed, clear evidence exists globally that low prices cripple investment in the telecom sector, and to keep investing, keep advancing, sensible returns are now needed.
Of course, that goes quite contrary to the idea of competition authorities (and regulators) as agents of social change and protectionism, but it is being said very loudly now by the ECB. This comes with clear warnings about the need for spending cuts, to get Euro budgets under control, aimed notably at France, presumably as Italy is deaf and Spain is behaving.
Yes, we have heard it before, but the clash between cheap services (but no investment, no stability) and a sensible return (with investment, and stability) is getting far clearer.
Lower inflation will at last allow the rates of basic services to rise, to give a sensible return, to create a real market.
The name of the game
What is the point of investing? How has that changed over time.? Do we still need so many choices? Are single stocks relevant? And we salute the prime palindrome.
We were taught that investing is an economic process for allocating capital to allow competition to seek out the best opportunities and fund the best businesses for the benefit of all. Countries with good markets have good capital allocation, grow faster as enterprises with the best return on capital, and then attract more of it.
Really? Not what it looks like now. Things change. The old gateways got knocked down, so anyone can access any investment anywhere. The paternalistic City was never sure about that, but in reality, markets followed communications, which went global.
The FCA (and to a degree the SEC) has a muscle memory of these protected times, and constantly wants to suppress innovation, keep new issues and ideas away from investors. Slow it all down, so they donât just regulate markets, but control them. But excess capital flows are changing all that. It is instructive how the SEC, by trying to stop Bitcoin, has simply made it respectable and transacting in it safe.
And looking skyward and not understanding how this excess liquidity is created by quantitative easing is sadly no longer viable for investors; entire economies are built on it, like Japan. Nor is it transitory, it is embedded in the US and EU as much as anywhere.
Governments hoped to take control, using QE they forced the cost, to them, of debt down to zero, on the way creating such a shortage of bonds, that prices rocketed. Paradoxically as did equities, for they could keep offering a yield and had no âlower boundâ, so their prices could rise for ever.
Then equity investors got back in control, they realised they could move the price, on the thin sliver of equities that are actually traded, pretty much as they wished. In particular they could signal or co-ordinate, so that everyone was on board with the price direction. Which is both the meme stock phenomenon, but also at the heart of momentum investment.
And liquid, global, interconnected exchanges were designed to let all those price signals out in an instant. Of course, co-ordinating them takes only a few seconds more.
THE POINT IS
Which brings us back to what the point of investing is. I am only interested in capital allocation, if by understanding it and dissecting the choices, I can get better returns.
I can have an altruistic angle of course, I just like old style engineering and banking outfits, I sponsored the IPO of an art gallery once. I have a soft spot for Kenya and Bulgaria. I want to avoid âdefenceâ industries, I dislike tobacco and polluters, and not sold on slave labour either. How nice, and in the investing world, how utterly useless. Never, ever, fall in love with a stock they said: quite right, sadly.
Indeed, what you and I call capital allocation is what others call hot money, and it moves faster and faster. As for those bad actors, well money always attracts crime, the faster it moves the more options for criminals exist, quite a few of whom wear suits.
But then who needs stocks and analysis when you can now buy a market cheaply? Everything says invest in multiple geographies, but really? The process I have outlined above favours one or two markets, they win, so they give a good capital return, so they win again, almost regardless of what the underlying business does.
Indeed, Bitcoin shows, it can indeed be regardless of the underlying asset. Coordination and belief matter, not reality.
So, what of all the rest, the unfashionable markets, unfashionable stocks, they just keep underperforming, keep being sold, with very little scope to recover. With rates low it was possible to pay a competitive dividend, but when money market funds are expected to offer you twice the rate of inflation, even those dividends are unattractive, and they get taxed hard.
NO COMPETITION IN COMPETITION
While the Government has also destroyed the competitive market for companies, by largely sidelining hostile takeover bids. In any event issuing poorly rated paper for poorly rated paper never sounds great. But that closes out profitable exits; sure you get insiders sweeping the Aim floor for cheap deals, but by definition those are not competitive, you canât have two sides both inside.
The government knows that almost any deal has a loser, or someone not as well protected for life, as they had hoped. Which means media noise and MPâs getting lobbied, so far better to âlong grassâ it, via a competition investigation. Isnât it odd that the competitive market in asset allocation created by an active takeover market, is the one market the competition authorities simply wonât investigate. But without that cheap stocks just stay cheap, it is why buy backs are so prevalent: the companies are right, the price is wrong.
Of course, index investing has issues, you buy the bomb maker, cigarette seller and dodgy legal firm all in one bundle, but thatâs the game. If it is big enough, it goes in the index, and you buy the package.
And hot stocks are likely to favour low commission markets, and low transaction costs. It may be an accident, that UK commission and tax is based on total deal value, but US commission is based on share count (and there is no stamp tax). But it does mean that you buy a share in Berkshire Hathaway for the same dealing cost as one in Game Stop, or if you prefer Nvidia and Trump Media.
Assuming sanity, you trade in the US, or in stamp free index ETFâs, not UK stocks. Although the FCA are fighting a rearguard action against both ideas, with the discrimination against holding ETFs seeming particularly bone headed and indeed against consumer interests.
But few stocks, fewer markets, more hot stock volatility, it is just the way we have set it up, donât be surprised that is how capital is now allocated, growth funded, prosperity achieved and destroyed.
TIME FOR A BREAK
As for this market, it had to break, we have said it for a while.
Levels have dropped sharply, and money is rotating back into bonds, or at least not flowing out of bonds.
Waiting to see through the summer, when that first rate cut arrives and who wins the US Presidential election, is all impacting the hot flows and making staying in cash feel easier.
While a more sinister undertow is coming from the narrative that the terminal interest rate settles out higher.
Our core assumption is still that real interest rates are now in a steady decline, but the equity bonanza of negative real rates is not coming back anytime soon. While for now, only one Central Bank and one market is going to keep on winning the hot money race. No prizes for second anymore.
The Winner Takes It All.
Jerome K Wiley?
We do think Powell is running off a cliff, just not the one the market assumes. As we endured the wettest February since (at least) 1836, when William Lamb was prime minister, and the wettest Tory government since records began, is there any chance of dryer times?
But first the tiresome tango of rate rises, the market swept to and fro, nation by nation, until the firm stamp of a well-heeled bond whips the whole mass back round again.
Bailey of the BoE, and Powell of the Fed
So, this week it is to be Bailey first out the gate, FTSE up, bond yields down, next week who knows? That rates will fall this year is the only certainty and the big US markets have built a near vertical climb out of that snippet. But you will note, not in rate sensitive stocks, the Russell (small cap) is still pretty flat, weighed down by the regional banks that dominate it.
And Powell, heâs guessing or as he calls it is âdata dependentâ, but for all that he is pretty happy projecting those guesses forward. So, he has moved from three rate cuts this year, to a new position of ? Well - three rate cuts this year. Not much data dependency there.
Before long he will run out of âthis yearâ, because the inflation numbers are not behaving, nor critically is the oil price. Â Like Bailey in the UK, he is desperate to cut and under heavy political pressure to do so, both have said 2% inflation is not now needed, just moves in the right direction.
I feel the only thing that can get us there is a sudden (and indeed overdue) drop in the energy price, which we do expect in the summer, but who knows? It has held up rather well so far.
So, at the moment, Powell is perhaps  running on thin air. Protectionism and vote buying fiscal measures mean he canât get there without some other help.
Markets are supercharged â is it sustainable though?
And if rate cuts are what has supercharged markets in the US, I donât see that as sustainable right through the year. It might instead be the possibility of a more market friendly, fiscally prudent, Trump, which would be more logical, in some ways; but that still feels implausible.
Nor do I see, as yet, many other markets joining in. Partly, why own anything else but the NASDAQ? Some markets have moved (Germany, Japan) but you could also argue that was after being oversold for too long. While the Swiss have cut rates, it is in part (as ever) to restrain their currency, I am less sure others will want to move ahead of the US.
They may be forced to, but there again their scope before European and UK elections looks limited. And some parts of the market, like UK smaller companies and many REITs (and some renewables) are not signalling anything but yet more damage and destruction, from suspect refinancing at high rates and over optimism on revenue.
Air Cushions
It was notable too how keen Powell is to slow the tightening imposed by reducing the Federal Reserve bond holdings, which has to date been done at a fairly brisk pace. He now talks of stabilising holdings, (in other words resuming bond buying, stopping the runoff of expired holdings) at what seems a high level, for fear of taking too much liquidity out of the system.
From this explanatory article on the process by the Richmond Fed.
For a while rates and reserve sales were working as one against inflation, but not for much longer it seems. Which should be good for bitcoin and other liquidity consuming monsters, if nothing else.
Who is Next in the UK?
The interesting Tory battle is between the Official wing, now entrenched in power, and showing no sign of intelligent life, beyond wanting to âmake a good fist of itâ in the inevitable electoral defeat. Then there is the Rebel wing, keen to cause trouble, break things, get popular support, or be nasty, if it gets them attention. Although the Official wing regards this as disloyal, it follows an old pattern. It is not just about this particular bunch: see this paper.
Faced with a like quandary under Blair, the Tory party swung left, towards the centre and power, just as Gordon Brown started the decade long Labour march to irrelevance. The Official assumption is that will work again, although the alternative scenario is that Starmer settles down in the centre for the long haul, and the Rebel wing, kept securely away from power, withers for lack of a structure.
But all ruling parties were, by definition, rebels once.
Back in 1836, William Lamb was an unsuccessful politician, wrapped around by Peel, sent to the House of Lords, then brought back as a centrist Prime Minister, and being generally useless, was turfed out again, after naming an Australian city, en route. One must hope for no repeats from history.
William Lamb, Lord Melbourne â from this site
It does not feel time for compromise candidates, nor will a âsafe pair of handsâ do. Rishi is in a fight.
Meanwhile the fields here feel like salt marshes, dark water lurking in deep cracks, the lips of which slide into clay and suck at the soles of your feet. We certainly could do with some heat.
I do expect this run in markets to go on, but the upside in the big US indices looks more limited and broader participation elsewhere will await those rate cuts. Both their size and speed have a capacity to disappoint, especially when they are so hotly anticipated.
The politics, a long time coming, may become more influential. It could get choppy.
We will take an Easter break, after what feels like a long spring.
And return with the sun (we hope) on 14th April.
Reserve in Reverse
Fallen Emperor?
With almost two thirds of global equity markets represented by the US, the fall in the dollar so far this year is quite dramatic, and for many investments, more important than the underlying asset.
UK retail investors are especially exposed to this, as although Jeremy Hunt (UK Chancellor) may not notice it, the US is where most UK investors went, when his partyâs policies ensured the twenty-year stagnation in UK equity prices.
While Sunak continues to pump up wage inflation, which he claims, âwonât cause inflation, raise taxes or increase borrowingsâ Has he ever sounded more transparently daft? Sterling, knowing bare faced lies well enough, then simply drifts higher. Markets know such folly in wage negotiation can only lead to inflation and higher interest rates.
We noted back in the spring, in our reference to âdollar dangerâ that this trade (sell dollar, buy sterling) had started to matter, and we began looking for those hedged options, and to reduce dollar exposure. To a degree this turned out to be the right call, but in reality, the rate of climb of the NASDAQ, far exceeded the rate of the fall in the dollar.
While sadly the other way round, a lot of resource and energy positions fell because of weaker demand and the extra supply and stockpile drawdowns, which high prices will always produce. But that decline was then amplified by the falling dollar, as most commodities are priced in dollars. So, a lot of âsafeâ havens (with high yields) turn out to have been unsafe again.
The impact of currency on inflation
Currency also has inflation impacts. Traditionally if the pound strengthens by 20%, then UK input prices fall 20%. The latest twelve-month range is from USD1.03 to USD1.31 now, a 28% rise in sterling.
In a lot of the inflation data, this is amplified by a similar 30% fall in energy, from $116 to $74 a barrel for crude over a year. In short, a massive reversal in the double price shock of last year. In fairness this is what Sunak had been banking on, and why the âgreedflationâ meme is able to spread. But while that effect is indeed there, other policy errors clearly override and mask it.
A Barrier to the Fed.
In the US we expect the converse, rising inflation from the falling currency, maybe that is creeping through, but not identified as such, just yet, as price falls from supply chains clearing lead the way, but it is in there.
Finally, of course, this time, the dire performance of the FTSE is probably related to the same FX effect on overseas earnings assumptions. Plus, the odd mix of forecast data and historic numbers that we see increasingly and idiosyncratically used just in the UK. If the banks forecast a recession, regardless of that recessionâs absence, they will raise loan loss reserves, and cut profits, even if the reserves never get used.
Meanwhile, UK property companies are now doing the same, valuing collapsing asset values on the basis of the expected recession, and not on actual trades. So, if you have an index with heavy exposures to stocks, that half look back, half reflect forward fears, it will usually be cheaper than the one based on reality.
Why so Insipid?
OK, so why is the dollar weak? Well, if we knew that, we would be FX traders. But funk and the Fedâs âfront footâ posture are the best answers we have, and both seem likely to be transient too.
If the world is saying donât buy dollars, either from fear of the pandemic or Russian tank attacks or bank failures, thatâs the funk. As confidence resumes and US equity valuations look more grotesque, the sheep venture further up the hill and out to sea. To buy in Europe or Japan, they must sell dollars.
The VIX, in case you were not watching, has Smaug like, resumed its long-tailed slumber, amidst a pile of lucre.
From Yahoo Finance CBOE Volatility Index
So as the four horsemen head back to the stables, the dollar suffers a loss.
The Fed was also into inflation fighting early; it revived the moribund bond markets, enticed European savers with positive nominal rates, (a pretty low-down trick, to grab market share) and announced the end of collective regal garment denial policies. But having started and then had muscular policies, it must end sooner, and perhaps at a lower level. So that too leads to a sell off in the dollar.
Where do we go instead?
So where do investors go instead?
In general, it is either to corporate debt, or other sovereigns. Japan is not playing, the Euro maybe fun, but not so much if Germany is getting back to normal sanity and balancing the books again. So, the cluster of highly indebted Western European issuers are next.
Sterling now ticks those boxes, plenty of debt, liquid market, no fear of rate cuts for a while, irresponsible borrowing, what is not to like?
For How Long
When does that end? Well, the funk has ended. You can see how the SVB failure caused a dip in the spring, but now the curve looks upward again. Although fear can come back at any time, as could some good news for the UK on inflation. However even the sharp drop the energy/exchange rate effects will cause soon, leave UK base rates well south of UK inflation rates.
So, every bit of good news for the Fed, is bad news if you hold US stocks here.
How high and how fast does sterling go?
Well, it has a bit of a tailwind, moves like any other market in fits and starts, but could well go a bit more in our view. Oddly the FTSE would be a hedge (of sorts).
Pain delayed, pleasure denied
We look at the startling emergence of another US based tech bubble, the failure of value investing and offer some reflections on the UK market.
The Bones of World Financial Markets.
This has been a baffling half year in which, with few exceptions, we have ended up going sideways for most of it. The exceptions were in descending order, within equities, the NASDAQ (by a mile), Japan, Germany, the S&P and France. Although all, especially Japan, offset by a weakening local currency for UK investors. A quite unusual, largely unrelated, mix of old and new.
Overall, cyclicals in general, and energy in particular, as well as bonds, and China have been painful and financials at best so-so. It feels like a year to not hold what worked last year and vice versa. Nor is it as simple as growth versus value; neither have worked consistently, except in the case of a small (but rotating) group of tech stocks.
Our view thus far, has been that until global growth starts to move, we stay out of the way. This has been wrong, because the overvalued US mega stocks, were almost the only game in town. Yet jumping in now, of course, also feels very dangerous.
However, a few of our growth markers have, even if flat on the year, started to shift, not the highly speculative micro stuff, which is still falling away, but the solid middle ground. The hot India tech sector, far more connected to Silicon Valley than we realise, has suddenly jumped.
Macro Skeleton
What about the underlying macro story? Well, the pain of the invisible recession, and the pleasure of resulting rate cuts, have been delayed and denied respectively.
From the UK office of National Statistics â see this chart more clearly on this page.
Well, there it is, poorly controlled inflation persists, a longer rate squeeze may still be needed. The vanishing China post-lockdown boom means that there was no sudden stimulus to offset that. Our published data (from Andrew Hunt) was saying Chinese ports were remarkably empty three months ago, from soft export demand, a good lead indicator.
All of that was hidden by strong services demand, and in closed economies (as the UK is oddly becoming) there is no relief valve, and hence it suffers embedded high inflation. But clearly consumption is dropping in the US, recent retailer numbers are all over the place, confirming those China export stats.
While on commodities, the failure of sanctions to impact energy is ever more clear, and I doubt OPECâs ability to stem the energy glut. As a final blow to value stocks, âhigher for longerâ, on interest rates, which we have been predicting for two years, hurts indebted companies, who increasingly have to refinance at high rates. It also makes their dividend yields less attractive.
When rate cuts do come, growth having survived the storm, may well soar; as we have noted before, the prevailing fashion in investing heavily favours so called âtech moatsâ and dislikes debt. That markets keep seeking out new moats, real or imagined, is all part of that.
The speed at which digital currency and virtual reality have become old jokes, but generative AI will save us all, is remarkable.
Bond Dilemmas
In bonds we have seen no point in our lending to governments at rates that are below inflation; in most of the world as inflation falls, bonds still remain unattractive, as yields then start to drop too. So, the bond trade has been messy to say the least.
With greater certainty about a consumption recession, the fear of defaults also rises, and the longer rates are high, the more that refinance risk looms. Jumping a spike is possible, vaulting a table, without spilling your drinks, rather less so.
There is also still a ton of money parked up in fixed interest, just waiting for the equity âall clearâ.
Lost London?
The UK market (yet again) simply flattered to deceive; I struggle to see much hope for it. While we can hope the likely change of government will be an enhancement, it really will just entrench welfare dependency and producer capture of state services, albeit in a rather more disciplined way.
The risk of Brexit always was that we would use our new freedom to rebuild old prisons. Can a new flag on an old workhouse change much? As for where our stunningly high inflation comes from, again, it must be our own creation, the Ukraine energy peak is now a dip, so it is not imported.
While no one wants to say it, tax rises, especially of such magnitude of corporation tax, in particular, are inflationary, but so is the cheap theft of frozen income tax thresholds. Trade unions employ good economists too, they negotiate for higher take home pay. Rate rises also cause extra inflation, especially with our persistent high national and consumer debt levels.
Sterling strength (it is now moving up against the Euro too) is a sign of markets seeing the UK as the best bet for avoiding rate cuts (and for getting more rate rises). That is not a good sign domestically.