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Diary of a Fund Manager - The Drive for Power

Date: 20 September 2021

In this week’s Diary, updates from around the world, but no forecasts about what the 11 central banks reporting in the week ahead may say or do. More about Evergrande’s troubles and the implications outside China, together with thoughts about the small margin of safety built into electricity supply systems.

The drift continued with equites, bonds and gold all ending the week lower. Commodity markets were mixed with the price of a barrel of oil rising by over 3%, the most significant move. The US dollar strengthened. Sometimes any excuse will do when it comes to inaction, but to be generous the calendar for this week is full with central banks meetings, including the US Federal Reserve and the Bank of England, and elections in Canada and Germany.

Recent economic and business news highlights the difficulties of reopening. Chinese growth appears to be stagnating and although the US continues to recover, the pace is slowing. Over on this side of the Atlantic, the UK is suffering from a double dose of higher than expected inflation and a lack of willing workers in the right place with the right skills. EU imports into the UK will remain unchecked for a while longer than planned, whilst goods moving the other way are governed by post Brexit rules and regulations. Turning east, the top three container manufacturers, all Chinese by the way, are reported to be working flat out to narrow the gap between demand and supply. Apparently 5.2 million 20ft boxes are on their way, unfortunately, port capacity problems are not so easy to solve whether on the US west coast or in Europe.

Action not contemplation drives progress, but the agenda for those deciding what action to take whether investors or business managers is full, some might say overwhelming. We remain in the middle of the unique monetary experiment which started in 2008 and still there seems to be no end in sight to plentiful supplies of cheap money. Where this will take us remains a mystery and I doubt that the central banks reporting this week will do much to clarify the situation. The pandemic shock is also work in progress, whilst the carbon neutral revolution is only just getting serious. Finally, the impact of blockchain technology is far more significant and wide ranging than a few crypto currencies. All of this is implicit and explicit in any serious discussion about stock selection. At the risk of repeating myself, the gap between the winners and the losers will be wide with no guarantee that incumbent market leaders will make it to 2030. A smooth transition is possible, but not without a few rough edges.

The Evergrande saga continues to develop. A few numbers to put things in perspective. This huge property developer has been built with debt of $90 billion, but with total liabilities of $300 billion, similar in scale to Portuguese national debt. As Evergrande has struggled to pay interest on its borrowings, let alone contractors and other creditors, the market price of debt issued by other Chinese companies has also fallen. Those who invest in indices might like to know that Chinese property developers account for 36% of the Asian High Yield index. Is this problem contagious in the way that subprime mortgages were in 2008? So far it seems not, either in China or internationally, but trouble in a sector that directly and indirectly accounts for 30% of Chinese GDP can’t be regarded as good news for any of us. Lower growth over there will have a knock on effect over here.

Port capacity problems are not so easy to solve whether on the US west coast or in Europe.

Rising energy prices are in the news with higher inflation to follow. In the short term a combination of not enough wind in Europe, lack of water in China and Brazil reducing hydro-generation capacity has increased demand for natural gas around the world. The France/UK interconnector fire is a more local problem, but does show that building systems with a small margin of safety is an invisible risk until it isn’t. Industries that are heavy users of electricity are closing down production lines at times of day when electricity is expensive, adding to the list of headwinds for economic growth.

The drive for power has fuelled growth ever since industrialisation took over from agriculture; always cheaper and ever more plentiful as we moved from wood to coal and then oil. Now as we make the transition from fossil fuels to renewables, the prospect of free electricity in the future is no longer fanciful, but between now and then the infrastructure that will have to be put in place will be very expensive both in terms of money and resources. If the transition is mishandled, or we ‘retire’ fossil fuels faster than we build renewable capacity or if economic growth exceeds expectations then we might, for the first time, have to face up to more expensive energy and less of it than we think we need. Grandstanding politicians who think that they understand the implications of their words should beware as voters can be contrary beasts.

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