By their works . . .
Well, the works this week: a pensive Jerome Powell does nothing, a reckless Andrew Bailey does nothing, Canada joins Biden in picking fights, and the bulk of most equity markets are stuck, going nowhere.
NO MORE US RISES
So, the apparently knowledgeable financial press said that Powell predicts rate rises? He said nothing of the sort of course. True the other members of the FOMC dot plots were in aggregate higher than the current rate, but by a fraction, it is like the average family being 2.4 children, meaning everyone, in the absence of King Solomon, has three children. No, it does not, it means on average there are no more rate rises.
So, Powell has stopped the runaway train, by lighting red flares in front of it and throwing railway sleepers across the track. Job done. Inflation is way below base rates. Bailey has asked nicely and tried to lasso the inflation express from half a mile down the track - wonât work. Inflation above base rates is misery, inflation below base rates is time to loosen.
Powell did start rambling, describing parts of the economy with âby their works ye shall know themâ but decided that was all a bit erudite, before he had even finished the thought. He then reverted to the old saw, âforecasters are a humble lot, (with much to be humble about)â. Presumably that is unlike Central Bankers? I still think that judging them by their works makes sense.
But Powell is happy: the Q&A session threw him a litany of gloom, government shut down, students having to repay debt, auto plant shut downs, but no, all is fine.
The core US consumer and therefore the US economy, is in a good place was his verdict.
BAILEY DITHERS
Bailey seems to like to crash the pound every October, which is not good for inflation, just as picking fights globally is not good for oil prices. And it is also bad for inflation.
And either the UK government will cave in to public sector strikes or productivity will keep falling due to said strikes. Neither are much good for the economy. Nor is it good for the markets: in performance terms, the UK remains the sick man of Europe, amongst major markets.
THE MAGNIFICENT SEVEN RIDE ON
I was at the annual Quality Growth conference in London again, a stock pickerâs feast as usual. It seems that if enough stock pickers can agree on the menu, as the dominant prevailing theory of investments, they will drive the prices of their favoured stocks ever higher. Which they do, it seems. This is helped by the âover the long run valuations donât matterâ line, pushed hard by Baillie Gifford (amongst others). You might recall my article on Scottish Mortgage a while back.
And of course, as we know from both index and momentum investing, once something starts to move in a flat market, it keeps moving.
But that leaves the vast bulk of quoted stocks flat or down on the year, which makes some sense. When rates rise, bonds are substituted for stocks. The last two quarters in particular have been flat to soft, and while some of these stocks may have hit a bottom, it is still very hard to tell.
The only good news for UK investors is that Andrew Bailey has ensured their overseas (especially US) stocks have a nice currency tailwind.
MADE IN JAPAN
Meanwhile from Comgest thereâs a radically different view of Japan. The equity rally there has been fantastic, but it is not the typical exporter boom of a weak yen, in their view, but more about bank stocks soaring on the expectation of the end of Central Bank rate control. This allows their vast balance sheets to earn a real return, at last. This is quite a departure from the general explanations about âthis is Japanâs timeâ. That one has caught me out far too often, but explains the horror show from respected funds like Baillie Gifford Shin Nippon - small and illiquid is just nasty everywhere.
So, although the global rally looks to be strong, it is terribly narrow, and built on different foundations in different places. Or more positively, a broad advance awaits the first rate cuts, either from triumph (US) having controlled inflation or disaster (Europe) having created a recession and left inflation out of control. Either route to rate cuts wins, it seems.
GLASSHOUSES AND THROWING STONES
Oddly, I feel the Canadian spat with India is really quite serious, the tendency of rich Northern countries to preach, in this case standing very carefully behind the only global superpowerâs shoulder, really annoys the global South. It has been going on for centuries and is at heart simply the old colonial mindset.
Indiaâs continuing reaction may well portray the accuracy (or otherwise) of the allegations, as on the face of it this is deeply insulting to the worldâs largest country, and one that has tiptoed down the line between offending the West and creating starvation and destitution for millions in the South.
I donât believe it - murdering virtuous plumbers in Canada over the Punjab, which has long ceased to be a primary source of domestic concern, is plain weird.
All things are possible, and India cares far more about Kashmiri terrorism (for instance), but if it is false, expect a sizable slap to Canadian interests, and more accommodation for Putin.
After all, if you are treated as if you are behaving like Putin, why would you ostracize him?
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).