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Diary of a Fund Manager - Boosterism

Date: 11 October 2021

In this week’s Diary, a review of surprises; black swans or just a bit grey? Also, an update on the energy problem and finally tenuous links between the present, James Callaghan and Cicero.

It was a better week for investors. Equities and the pound ended higher, gold drifted and bonds fell back. Some of the headwinds of the last month became less intense with the US debt ceiling argument reaching a temporary truce and Russia indicating that it might pump more gas into the depleted energy system. Early days, but we live in hope.

Ever since Nassim Taleb injected black swans into our collective consciousness, his theory has been used as a shorthand by those looking for disasters to come. A black swan event describes something that comes as a surprise, has a major effect, and is then rationalised with the benefit of hindsight. Recent events may have shaken investor confidence, grey swans perhaps, but not black. Reporting to a client I was asked what had most surprised me about this year? Fortunately, he provided a good answer whilst I was thinking; ‘’supply chain disruptions weren’t in anyone’s January forecasts’’, a good point. Rallying, I added the sustained move by the Chinese government away from market forces to command control policies that have changed our view of the future both in China and internationally.

Central bank policy changes are hardly a surprise and so don’t qualify as either black or grey. Monetary policy had to come out of the emergency ward eventually and now seems as good a time as any. Those taking excessive risk or just overly complacent may find trouble, but for the rest of us slightly higher interest rates are manageable. Last week New Zealand and Poland joined the higher rates club, the latter after nine years at 0.1%. Setting a base rate of 0.5% whilst inflation is 5.8% is a decidedly tame move. Gentle tapers seem to be the order of the day for central banks everywhere.

Stagflation is being used to describe the twin challenge of lower growth and higher inflation that we are facing at the moment. During a wide ranging interview with CNBC mid-week I was asked whether we were on our way back to the 1970s when stagflation was a fact of life. Although there are similarities, including higher energy prices, the link between then and now seems weak. Looking back we have experienced similar moderate doses of low growth and higher prices in 2002/03, 2006/08, 2010/11 and 2015/18. All ended without a stagflation crisis, just other problems. Examining in closer detail the two surprises of this year, supply chain disruptions and China, there are connections, but neither with the benefit of hindsight are likely to be remembered as black swans. Having said that, I did read a report from an imaginative strategist linking Evergrande to the end of civilisation as we know it in ten easy steps. All things are possible, which is why conspiracy theories litter the internet, but I am pleased to say his conclusion was, very unlikely.

Stagflation is being used to describe the twin challenge of lower growth and higher inflation that we are facing at the moment.

Market forces may be getting bad press at the moment, but are working on imbalances between supply and demand. Time will solve most of the current problems, although not by Christmas. The latest shortage is silicon which is the second most abundant element on Earth. Apparently, Chinese manufacturers are responsible for two thirds of global production, but are struggling because of a shortage of coal which is part of the high temperature process that turns quartz into pure silicon for chips.

All of which brings me to energy where supply and demand is a complicated mix of business and politics with an overlay of climate change. Chinese demand for natural gas is increasing in order to reduce dependence on coal. This particular policy switch was flicked at the start of the year, when Australia was excommunicated, and is having global consequences. European gas storage units are 70% full as we prepare for winter compared to an average in recent years of over 90%. Elsewhere, coal stocks in India are low and countries dependent on hydro power are worrying about a lack of upstream water. When the wind doesn’t blow in the UK, 50% of electricity is generated using gas. A barrel of oil costs just over $80 at the moment, whilst the energy equivalent of natural gas following the recent price rise is equivalent to a $200 barrel of oil. Governments worry about energy costs and have policy options; rationing, price controls or simply allowing higher prices to reduce demand. In addition, will climate targets be quietly shelved to keep the lights on and bolster short term economic growth? As I said, energy is complicated.

I am often asked whether the UK is particularly susceptible to low growth and inflation? Potentially, but not if you are persuaded by the Prime Minister’s boosterism conference speech. Whingeing businesses just needs to get their act together and all will be fine. On reflection, perhaps there is a link to the 1970s. Returning to ‘Winter of Discontent’ Britain from a Commonwealth conference somewhere warm, Prime Minister Jim Callaghan was reported to have greeted journalists at the airport with the now infamous phrase, ‘crisis, what crisis?’. The fact that he didn’t quite say this was beside the point when it came to the next election. Let’s see what the present occupant of No.10 has to say when he gets back from Marbella. I am sure that with his classical education he knows that rhetoric is a powerful tool, but only up to a point. Cicero’s rhetorical skills may have taken him to the pinnacle of power, but he still met a grisly end.

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