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Diary of a fund manager - Cyclical Rationality - 19.08.2019

David Miller, Investment Director, Quilter Cheviot

In this week’s Diary, why August is never without its challenges, the thought that rationality is cyclical rather than structural, and a couple of examples of long term change.

It was another indifferent week for equity investors with share prices down across the board. Bonds and gold moved higher, whilst after a strong run the dollar fell back with sterling slightly better for choice. When a ‘technical problem’ on Friday delayed the opening of the London Stock Exchange for a couple of hours, an eerie calm descended.

Joint first as the biggest story of the week was a tweet by President Trump, delaying tariff increases on China until 15th December to make sure that Americans have a good Christmas. I think that he blinked, albeit temporarily. An unexpected primary election result in Argentina caused a 50% fall in the stock market which says more about fragile confidence and consensus thinking than the likely policies of a new government if elected. The 100 year bond issued a couple of years ago and bought by investors with no sense of history is now 40% down. The contraction of the German economy, which started in the motor sector is spreading out, but has yet to reach services directly linked to the consumer. In the UK the economy is contracting for the first time since 2012, but wage growth is the highest since mid-2008. The democratic process in the UK remains completely opaque to those looking in from abroad, even though it does, of course, make perfect sense to the locals. A headline to savour; ‘Tories favour Corbyn premiership.’ Events in Hong Kong continue to cause concern.

As an aside in last week’s Diary I mentioned that the Autumn IPO schedule was filling up. Undeterred by the August lull, pre-marketing of the WeWork issue is in full swing. Having hired almost all of the leading investment banks, critical comments which are numerous are coming mostly from journalists; loss making with no plan to be profitable, along with corporate governance failings top the list of concerns.

Central banks continue to be supportive, with the ECB taking the lead in recent days. The great and the good will be gathering at the annual Economic Policy Symposium in Jackson Hole over the next few days, but no particular surprises are anticipated. It seems likely that US interest rates will end the year lower which is what investors really care about. Fine words from the ECB are welcome, but enthusiasm is tempered by the memory that it took seven years after the credit crunch for full QE to be implemented. Given all that is going on at the moment, expectations that the Bank of China will do anything to help the global economy are minimal. China First is the natural reaction to America First.

The thirst for explanations is intense at the moment which probably explains why I was invited to contribute to discussions on both CNBC and Jazz FM last week. The worry list is long and when the other big story of the week, the rather technical issue of yield curve inversion, caused a sharp selloff, this became the focus of attention. In the past an inverted curve, where the yield of shorter dated bonds is higher than those maturing decades from now, has been a good indicator that a recession is on the way. Will it be different this time? As ever, there is no clear answer, although give me twenty more pages or a couple of hours and I would be able to add a lot of detail to the uncertainty if not the clarity. It was only on Friday that I realised that what matters is the balance between rational and irrational behaviour. Is rationality cyclical or structural? All of the known problems have a solution, or at least a range of solutions. The economic slowdown being seen at the moment has been caused by several factors and there is a strong case to be made in favour of a recovery before recession takes hold. Sometimes, however, rational solutions are ignored for too long and policy mistakes become much harder to reverse. The differences of opinion between optimists and the pessimists centre on this which, as they say ‘is what makes a market’. The most likely outcome is that collectively we and our governments will behave sensibly, but it’s hard to be more than hopeful just at the moment. As the remaining months of 2019 roll through there are important investment judgements to be made.

Images of the demolition of the Didcot power station cooling towers were spectacular if, for me, rather sad. My late father was part of the team that commissioned the four state of the art at the time generating sets. In the mid-1970s the Central Electricity Generating Board was already past its prime, but still regarded the supply of electricity as a national duty. Over-capacity and, therefore, financial inefficiency, was built into the system in order to ensure that we never went short. I have written about this before, but power cuts a few days ago show that much has changed in the intervening years. Coal has been replaced by less dirty sources of energy which is a good thing, but the margin of excess capacity has been cut to the bone.

Overheard on the Underground, another example of change courtesy of two young American tourists. ‘Can’t wait to get home. I really miss plastic straws’.              

Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

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