Diary of a Fund Manager - Cascading Cash - 22.02.21

In this week’s Diary, the impact of free money on corporate behaviour, consumers, investors and governments. Also, how companies in sectors ranging from jet engines to construction are dealing with the demand for increasingly complicated products at the right price.
It was a mixed week for markets. US equities ended down, whilst many others continued to move ahead, the pound outperformed both the US dollar and the euro. Gold and oil fell. The clearest signal came from uniformly weak bond markets. Economic growth statistics continue to strengthen with the US in the lead and that’s before the latest stimulus package is agreed; estimated to be in the range $1.7-1.9 trillion. US consumers seem to have started spending even before the money reaches their bank accounts. Re-purposing a quote from The Big Short; ‘if you offer us free money, we are going to take it.’ Then again financial markets have been doing this ever since the credit crunch, although there has been a significant acceleration since Covid-19 appeared on the scene. From Price Value Partners, the observation that 35% of all dollars ever issued have been printed in the last 10 months.
The idea that these are liquidity driven markets is hardly new and certainly of little use when it comes to making investment decisions, but nevertheless important to know. Momentum does push prices higher – the trend is your friend is a well-known market adage. From a Chicago-based contact, and I suppose I should be grateful, a 107-page academic paper full of long sentences and mathematical formulae, investigating this assertion. What particularly caught my attention was the estimate that $1 invested in equities adds $5 to the overall market value. Buying something because it is going up seems to work, that is until it doesn’t. Elsewhere, bitcoin continues to attract attention as the institutions that provide the market’s plumbing put in place the structures necessary for secure trading. That $10 billion of institutional demand in the last few months has translated into a $700 billion rise in the total value of bitcoins in issue looks like a variation on the same theme.
Still on the subject of market plumbing. Last week’s Diary contained the comment that, as a fund manager, all I care about is access to liquid, functioning markets. Location isn’t important. I should have made it clear that ‘functioning’ included well-regulated and fair. Thank you to the reader who pointed this out.
Enough of markets for now, although before moving on I can assure you that they remain based in the reality of the world around us and not just the equivalent of an intellectually stimulating ‘Glass Bead Game’. Products in the broadest sense are becoming increasingly complex and consumers increasingly demanding; quality and innovation come at a price that we seldom want to pay. Companies know this, and by association so do investors. The jet engines attached to the planes that we aren’t using at the moment are extraordinary creations. Reliable, energy efficient, made of new materials as a matter of course, are very expensive to develop and then make. Rather than sell them for cost plus to make a profit, the manufacturers instead rely on long-term maintenance contracts and spare parts for pay back.
This tension between manufacturers and buyers is not restricted just to high specification wonders of engineering but is everywhere. For example, mass production cars have changed out of all recognition in the last 20 years but remain affordable. The sophistication of the production line based on just in time deliveries is a joy to behold, but when one component out of thousands is missing, the whole process has to stop. At the moment a shortage of computer chips is causing trouble, but it could be anything. A few years ago, I visited a client whose company supplied the Mini production line with the knobs that go on top of gear shifts. Simple I thought, just a plastic ball with some numbers stamped on the top. Not a bit of it, apparently there were over 70 separate actions required to deliver the finished product at the right time and in the right quantities.
Construction companies are facing just as many challenges and the rate of change is accelerating. Far from simply pouring concrete and laying a few bricks, the buildings that we now expect are increasingly high-tech. New materials, energy efficiency, integration of the ‘internet of things’ all go into the mix. Add in changing needs as we react to long term demographic change and, in the shorter term this virus, the complications multiply. Quality at the right price is forcing a re-engineering of the way in which buildings are constructed from prefabrication to 3D printing and much more. The good news for the sector is that change is also driving demand. As old technology buildings are demolished, the new ones that replace them are the high-tech wonders that we expect. We should all marvel at the sophistication of the world around us and, when not obsessing about short-term trends, investors do understand that innovation is at the heart of all good companies. The challenge for these companies is to also make a profit and that requires skilful management. Differentiating between those that can and those that can’t is the art and the science of investment.

Written by

David Miller
Investment Director

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Winner, Outstanding Achievement – City of London Wealth Management Awards 2016