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.Ā 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 ā 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 OPECās ability to stem the energy glut. As a final blow to value stocks, āhigher for longerā, 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 ātech moatsā 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 āall clearā.
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.
Wood for the trees
We have all been obsessed with rates and inflation, but we seem to be in danger of missing what looks like a widespread bull market running broadly from last October. This is widely applicable outside the main US markets, including in gold. There is a similar and at times masking trend of dollar weakness.
What are the implications of this?
We also look at the unending tragedy of the various remnants of the Tory party.
Still Rising?
With markets still fixated on the next crash, we can sometimes overlook the long momentum swings. Although the US banking crisis matters, it is of little relevance to the far more concentrated and tightly controlled Basel III banks in Europe. Many would say to excess, but they are clearly tighter rules. The few assets not marked to market are a footnote in Europe; in the Wild West of US regionals, they can be the whole story.
On a one-year basis, the France CAC 40 is up 14%, the German DAX by 12%, with both the UK large cap and Japanās Nikkei also positive, so equity markets have been strong, almost regardless of rate rises. The US is the main home of negative twelve month returns, but the gap between the S&P and the NASDAQ declines over that period, is now quite small, after the spring bounce back in the latter.
What does that mean?
For all the media love of the disaffected trashing their own communes, doing the right thing on pensions (they were very out of step) apparently helps France.
While the splitting of power in the US Congress and the meanderings of a senile President, has perhaps hurt the US, with everything from banking regulation to the debt ceiling made into a political game.
Brazil is down too, but India and Russia are up.
Well perhaps I go too far, but maybe there is a pattern? Markets like stability.
Relative values
While comparisons are complex where accounting systems diverge, the UK still looks like the lowest rated with the highest yield, and conversely the NASDAQ still has (by some way) the highest rating and lowest yield. US earnings are it seems still much more valuable.
The savagely anti-business stance of the UK, including a brutal rise in corporation tax maybe part of it, it will create a fall in earnings (and likely dividends) next year.
While the less visible, but still onerous onslaught in the US, including Ā a minimum tax take, wonāt be good.
So, does inflation matter?
The UK perhaps is also seen as the one major European market that looks to have dithered too long on controlling inflation (which could explain sterling strength). However, I see no real appetite for more austerity in the UK, so I find that assumption slightly puzzling. Having the FX market convinced UK rates are going a lot higher (because of policy failures) is hardly comfortable, but feels a little like re-living last year now.
Oddly too, controlling inflation the US way, has hurt equity markets more, it seems, than letting it burn out in the European style. Heresy to many of us, but thatās what the numbers imply.
All the theory, all the historic data says we now must get a sharp recession, but then grandpa, pray where is your beloved recession? Still looking, since mid February. It seems we must appease the inverted yield curve and believe base rates matter, but a bit more evidence would certainly help.
And rate cuts will be a powerful tonic, when they come. The bears are now reliant on widespread recessions, and soon.
Perhaps the best of this little bull market has gone, but there is a lot of liquidity still about and being out of the market with high inflation, is not great.
A multitude of sins ā local elections coming up
And what of the UK Tory āPartyā, if such a mess can be called that. The assumption for a while has been that the imminent local elections will be bad for them. However, they are a curious mix of voting locations this time, not London, not all of the Home Counties, none of the Celtic fringe, but a good chunk (but again not all) of the Red Wall seats. See map below.
Map from Wikipedia page on 2023 local elections
But really it is heavily biased to the Tory heartland, vast swathes of Labour free wards, where they are not even bothering with candidates, so it will not tell us that much. The Lib Dems will do well, but significant conquests in many areas will now require quite substantial swings.
The assumption is also that Dominic Raab was cut down by Sunak, who has yet to learn that throwing competent colleagues under the bus may feel good, but it thins the ranks of effective ministers, and builds up the malcontents. He has handled these badly, and forgets the real target is not his ministers, but his own position.
Tory strategy
Seemingly the Tory party has run just one electoral strategy for years, based on old victories; just trash the opponent. In a two-party state, voters must then decide who they dislike least. And both Labour (and the SNP) have reliably offered something so vile, that a simple victory follows.
But no longer, Labour (despite their recent rather crude posters) still seem innocuous.
The Lib Dems are sticking to their amateur politics, which can also look strangely alluring, if the other two parties look mysterious or inept. The Tories (like the SNP) are now in danger of being judged by results, not by fear or hatred of the alternative.
The score card on that basis looks pretty bad, and Sunakās pledges are so far, going the wrong way.