Fragmentation

The world’s political landscape is splintering, with nations turning inward. Germany's recent border controls, a move to curb migration, underscore this shift. It's a bold step from a nation central to the EU's free-movement ethos, reflecting the pressure from the far-right AfD's rising influence. This challenges Mario Draghi’s call for EU unity to tackle productivity woes. As the Financial Times quips, Brussels is “where good reports come to die”— if they can even cross the border. As the world fragments, so too may allocations.

And as country specific risks increase, I expect more country specific funds/ETFs to emerge. For if you want exposure to the opportunities found in the UK, Japan, Saudi or Brazil you won’t find them in the ACWI.

The same sort of thing?

I’m reaching here, but could the recent criticism aimed at the BBC for adding too much US content symbolise a similar, more insular trend here in the UK? If it does, I wish some of that sentiment extended to the guardians of our nation’s savings and the new Chancellor of the Exchequer, who’s become decidedly frosty of late. It’s as if she’s realised her inheritance has been halved (like it has for the rest of the country).

Cheer up Rachel

Rachel Reeves paints a bleak picture of Britain’s immediate economic future, with talk of fiscal black holes and tax hikes. Yet, the UK market remains resilient. Could this be a strategic lowballing, a massive dummy-pass? Wishful thinking perhaps, but I’m not yet prepared to sell the rumour and move to Milan. Albeit tempting. There are things she could do to raise cash without impacting markets. For example, as Meryn Somerset Webb suggests, instead of dumping the British ISA she should ‘dump the rest’. Do away with Cash ISAs (where non-coupon gilts provide similar tax-free returns), merge all into a single stock ISA and say everything in it should be UK listed. If she wants to go full Donald (or Olaf) she could shift stamp tax from UK to foreign shares, increase the tax take (as bigger % of total turnover), catalyse repatriation and ignite a home bias at a time UK retail participation is near record lows (v US allocations at a record high). Finally, could she tax gambling? Maybe start with CFDs and spread-betting (which are bets on share prices), but with no ownership (hence no tax). Indeed many GenZ’s believe gambling is investing, so why not treat it as such for tax purposes? It may help with other things, like addictions and bankruptcies.

So Rachel, tax sin, not shares and help put a smile back on our faces.

More new narratives

Equity markets often pay a premium for scarcity. For example, as bond-yields fall, cash returns become a little scarcer, helping to explain renewed interest in rate-sensitive and dividend-paying sectors like REITS, Construction, Utilities etc. Less obvious, but still driven by falling discount rates, is ‘Quality’ – defined as companies that consistently generate high-cash returns on capital, where those returns are likely to endure. As discussed, our old EU QCC basket made a record this week, and is up 13.5% YTD. Not a US stock in sight, just great companies expressing the scarcity of yield, growth and consistency. (Note that similar vehicles including US Tech like NTUQLVTR and NTUQDDFT have done even better). This provides some support for our sobriety thesis of a fortnight ago.

The market narrative is clearly changing, for if there was one sector that should be making highs on lower rates and a San-Fran shrimp fest, it’s TECH. And given this sector’s hold over the Index, it’s probably time to think about a move into new assets, new factors and new regions.

Crowding out

Every asset has a lifecycle and I’ve made no secret of my belief that we may be late in the cycle for Private Equity (PE). As distributions/NAVs decline, new funding channels increase via greater retail participation, more innovative use of debt finance and with larger PE firms morphing into even larger PC firms (Apollo’s credit fund is now 4x its buy-out division). Retail participation brings greater regulatory scrutiny and we are seeing demand for more frequent marks, which in turn will – mathematically - increase volatility and lower (risk-adjusted) returns. Perhaps the biggest late-cycle sign is that Blackrock-Preqin is exploring indexation, which has a tendency to crowd out alpha, flip competitive focus onto cost and favour those with size and scale (see US public tech for clues). It’s not over, of course. Some managers will thrive in this environment, especially those focused on operational improvement – but manager selection is key. That said, lower asset class returns are likely for a time.

So, for my money, I prefer assets not reliant on leverage or information asymmetry to generate returns. Assets that display early cycle behaviour, historically low institutional and retail participation, are good value relative to history and comparable assets, have genuine inflation links, and pay you to play. Dividend compounders.

More to go

And yes, investors still seem to like gold, and note that the next catalyst being discussed is not aggressive Fed rate cuts, falling real yields or geopolitics (which are in the front window already) but the BRICs conference in late October, where there is growing speculation that joint plans will be announced to create a currency/payment unit backed by gold, not dissimilar to that other bastion of fiscal preserve, Zimbabwe (ahem). Needless to say, this remains a fertile context for gold prices. Remembering most central banks hold only a fraction of the gold reserves they held during periods like that of the 70/80s.

The other trade that macro traders are focused on is the Yen, where the increasing home bias of Japanese capital may provide a tailwind to domestic revenues, and by extension Japanese small cap stocks.

Renewed narratives on climate?

We haven’t heard much about sustainable or climate related investments lately. They’ve suffered as the public pushed back on transition costs during the cost of living crisis and while investors pushed back on regulatory confusion and higher interest rates depressed the implied value of long-term cashflows. Since then ESG has almost become a swearword. 

But, the structural challenges remain: 2024 is likely to set another heat record (unless you live in the UK!), San Sebastian and Chamonix were again jammed with folks escaping the summer heat of Madrid and Nice and we still need approximately six units of green energy to displace one unit of fossil fuel. And now inflation is falling. So too are interest rates. And could talk of fund closures be a contrarian signal?

Might renewables now renew? 

Well, there are signs of life in Australia. Wall Street’s ESG backlash does little to dent Australia’s enthusiasm, says the Australian Financial Review. That’s interesting given that it’s an extraction-based economy. Might it suggest the Aussies have solved the debate over exclusion v engagement in favour of the latter? As Border to Coast Pensions Partnership (a UK pension investor) recently showed, ‘the academic evidence is much more supportive of the impact of engagement than divestment on corporate action, and majority academic opinion would support “voice” over “exit”. Might oil companies be invited back into ESG frameworks? Advocates would argue that from the climate’s perspective, a tech company producing 10,000 tonnes of carbon going to net zero is less beneficial than a polluting company producing 1,000,000 tonnes but with a 10% per year reduction plan.

Or contrast Google, where emissions have increased ~50% in five years, with US oil companies, which are down -22% over the same. Engaging with these companies, keeping their feet to the fire, encouraging them to invest more in renewable technologies (like carbon capture) and carbon credits, could eventually provide greater benefits for the ecosystem over time than divestment.

As could a new digital platform to facilitate the development of the voluntary carbon market.

A digital carbon ecosystem

I raise this because Northern Trust has built a digital assets platform: Northern Trust Matrix Zenith™ that supports key digital asset lifecycle events from creation to trading, pricing, custody and reporting. And its first application is a fully digital carbon ecosystem for the lifecycle management of digital voluntary carbon credits. It’s a significant industry development with the potential to enable the VCM to operate at scale.

And one that, I believe, comes at the right time of the cycle (see above).

Outrageous

Says The Guardian: ‘some 28% of young people today say they haven’t had a drink in the past year, up from 18% in 2011’. Yet rates of depression are climbing? Could these be linked? The good news is I now know what to buy my nieces/nephews for Christmas.

A corkscrew.

Just 27% of 18- to 24-year-olds own one, compared to 81% of over-65s.

You’re welcome.