Irregular Roundup, 8th July 2024

We begin today’s Irregular Roundup with inflation.

Inflation at 2%

UK inflation finally hit the BoE’s 2% pa target for the first time in three years, but few people expected it to lead to an interest rate cut from the BoE.

• Indeed, the Bank held at 5.25% pa – a 16-year high – for a seventh meeting in succession.

The price of housing, furniture and household goods all fell. Some food prices also fell (fish, milk, cheese and eggs).

• But services inflation was higher than expected, at 5.7% rather than 5.5%.

Core inflation fell from 3.9% to 3.5%.

Most people expect the first rate cut to happen in the autumn (perhaps August or September).

For AJ Bell, Laura Suter said:

The Bank will want to wait to see the outcome of the election and the final economic plans before making that first cut. With no meeting in July, that means all eyes are now firmly on the August meeting.

For Hargreaves Lansdown, Susannah Streeter said:

Policymakers still have their eye on hot wage inflation, with earnings including bonuses still running at 6% at the last count. Services inflation has only retreated slightly, so although August remains a possibility for a rate cut, September is looking more likely – and the markets are only fully pricing in a rate cut in the autumn.

For Quilters, Lindsay James cautioned that now the energy and food price falls are in the number, inflation could go up again in the next few months.

For Bloomberg, John Stepek warned us not to expect too much in the way of cuts.

• He expects UK rates to settle between 3% and 4%.

Real rates (the interest rate minus inflation) in the UK are usually positive.

In the two major periods that it has been negative, it’s been during decades that have been defined by global economic crisis. Unless you expect another big economic crisis in the near future, then it’s likely that the Bank of England rate will remain in positive territory.

If inflation remains around the target of 2%, that would imply a Bank of England rate of at least 4%.

I agree.

Productivity

Joachim Klement looked at a new study analysing the causes of the recent decline in productivity in the West.

He picks out four major factors:

• The loss of capital investments in productivity-enhancing technologies as well as worker education and training. About half of this decline is due to the lack of access to capital and the lack of investment during and after the financial crisis.
• An ageing population. [particularly] in the UK and Germany.
• Fewer benefits from international trade, in the UK and Germany. This is a result of these countries either having less access to the most productive technologies or being replaced by other countries in global value chains and thus losing the incentive to invest.
• Measurement errors and the inherent difficulties in determining what constitutes productivity growth.

The final factor is “misallocation of resources”, which has three parts:

First, there is the misallocation of human resources. This is the result of some industries paying more than others and people going where they can make the most money with their talents, even if these industries have small productivity growth.

Second, there is the trend toward less competitive markets and large businesses building moats around their products and services and stifling competition. 

And finally, the misallocation of capital results from the persistent decline in bankruptcies and creative destruction. The rate of firm exits and startup creation alike has declined in the US and most developed countries. Where zombie companies are allowed to continue operating, many resources are wasted, and employees remain in jobs with low productivity growth.

The second and third points sound like the easiest ones to fix from a governmental perspective.

Jevons paradox

For the FT, Tim Harford wrote about the Jevons Paradox.

Two San Francisco doctors persuaded [their] busy hospital to replace their clunky and inflexible old pagers with WhatsApp. The pilot was not a success. Messaging became too easy.

To interrupt a busy consultant by paging them to demand a return phone call was a serious step, taken with care. But with WhatsApp, why not snap a photograph and zip it over just to get a spot of advice? Doctors were soon swamped.

Jevons lived in the 19th century and predicted (wrongly) that coal would run out and also (rightly) that energy efficiency was not the fix.

Imagine a more efficient blast furnace, one that would produce more iron for less coal. More iron would be produced, which was a good thing, but the consumption of coal itself would not decline.

Tim uses light, which used to be expensive, as an example.

• In the 1700s, President Washington spent $1K a year on candles, but LED lighting is both much better and cheaper – so we use much more.

Another example is refrigeration/air-con:

The refrigeration technology that was once used to cool a cupboard’s worth of food is now used to cool entire buildings.

Email is yet another example.

Yet the strong version of the paradox – that efficiency leads to greater consumption – no longer seems to hold:

In my lifetime, energy consumption per person in the UK has fallen by one-third, while carbon dioxide emissions per person have fallen by nearly 60 per cent. While some of this fall reflects the offshoring of manufacturing to other countries, most of it does not.

At the same time, Jevons can’t be ignored:

When we regulate to require energy efficiency, consumption will fall less than pure arithmetic suggests.

A carbon tax would work better to discourage behaviour of which we no longer approve.

Momentum vs value

For Bloomberg, John Authers wrote that there has never been a better time for momentum investors.

• Inflation blocking rate cists should cause problems for the stock market, but AI and ChatGPT have kept the momentum going.

If this is a typical Goldilocks scenario where growth and inflation cool but the economy avoids a recession, it should benefit quality stocks — generally defined as having debt low enough that they don’t rely on inflation and nominal growth to service it. But instead,momentum is extending its gains.

Relative to the S&P 500, momentum is now higher than during the dot com bubble.

ChatGPT was the spark, but things have exploded in recent weeks.

AI was also the catalyst for the increase in the PE of the momentum index – this rally is driven by valuations, not earnings (even though there have been some big earnings upgrades).

John notes that it’s rare for a momentum rally to last as long is this, and that when momentum stalls, it often suffers a serious crash.

The biggest momentum reversal this decade came onthe day in November 2020 when the results of Covid-19 vaccine tests convinced investorsthat the worst of the pandemic could be over much earlier than thought.

That was a reshuffle away from pandemic stocks to their opposites.

For now, volatility remains subdued.

The S&P 500’s biggest peak-to-trough fall this year has been -5.5%, which contrasts with -33.8% in 2020 and -25.4% in 2022. Even in 2013, a year when the S&P 500 enjoyed a great return, there was still a 10.3% reverse.

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So is this a bubble?

The question is whether the AI hype can become a genuinelytransformational technology that adds to companies’ productivity and profits — or whetherit will merely make huge money for a handful of companies.

History suggests that the latter rarely comes to pass.

John also notes the pain of value investors, who despite earning close to 10% pa over the last decade, have been swept away by growth investors.

Hargreaves Lansdown

The board of Hargreaves Lansdown has backed a £5.4 bn takeover offer from private equity firms led by CVC Capital Partners.

• It would mean another delisting from the beleaguered London Stock Market, but would it have any impact on investors?

In the 1980s and 1980s HL was an innovator, consolidating funds from many investment managers into a “supermarket” that made managing your portfolio simpler.

But like many market leaders, they have failed to move with the times.

• They still charge £13 a trade, when most of their competitors charge half of that or less.
• They promote expensive mutual funds over cheap ETFs.
• They have uncomfortably close relationships with leading fund managers (most notably Lindsall Train at present, but previously with Neil Woodford.

Could owners from private equity (despised by many UK private investors) be the straw that finally gets people to jump ship?

Berkeley

For the FT, Joshua Oliver reported that housebuilder Berkeley Group plans to become a landlord.

• Berkeley specialises in city developments and builds 10% of new London homes.

The move – initially for 4,000 homes over the next decade –  is in response to high rents and low demand for new houses and flats (because of high interest rates and large deposit requirements).

CEO Rob Perrin said:

Rents have gone up so much and house prices haven’t moved in the same vein.

The UK private rental sector is dominated by small landlords, but the institutions are moving in.

Blackstone has struck two deals in the past year to buy properties from housebuilder Vistry, worth £1.4bn and covering more than 4,500 homes. Berkeley has already sold around 1,000 homes to institutional investors over the past three years.

Labour watch

For the Spectator, Kate Andrews looked at the impact of the party manifestos on the overall UK tax burden (currently sitting at 36.5% of GDP).

• The plans of all three major parties will see this number increase.

• With the Tories’ tax cut announcements, worth £17 billion the tax burden will increase at a slower rate.
• Labour would increase the tax burden to its highest level on record. It announced £8.6 billion worth of additional tax, taking tax as a share of GDP to 37.4 per cent.
• The Liberal Democrats would see the burden rise to 38 per cent.

Here’s the long-term version of the tax burden chart for context:

Kate also notes that Labour is playing a game:

Apart from the taxes Labour has already ruled out hiking – income tax, NI, VAT and corporation tax – there was no mention of specific taxes at all. Only a few tax hikes have been ruled out, and all the others are being left on the table for Labour to consider when the party wins the election.

Since they have now won the election, I guess we are about to find out.

Quick Links

I have three for you this week:

1. Paul Kedrosky looked at Monetizing Loss Aversion for Fun and Profit
2. UK Dividend Stocks provided their UK Top 40 Quality Dividend Stocks for Summer 2024
3. And Alpha Architect found that Polluters Provide Higher Returns than Non-Polluters

Until next time.