Financial Stability It Ain’t

With the appointment of Jeremy Hunt as Chancellor, we have now had four different Chancellors in a matter of a few months. What will overseas investors who dominate the markets make of this?

It will surely not instil confidence in the stability of the UK and its financial management. Liz Truss has not helped by apparently backing tax cuts and then now back-tracking on those commitments. Corporation tax will now rise as originally planned making the UK a less attractive place to invest. The Truss “high growth” strategy is floundering.

The gilt market is gyrating as the Bank of England planned to halt further QE and then changed its mind to stabilise the market while the FCA has allowed pension funds to pursue risky investment strategies which led them into panic selling of property funds and other assets.

Let us hope Mr Hunt can halt this merry-go-round. But what future is there for Ms Truss as Prime Minister? Not a long one in my view. She has not demonstrated confident leadership and her public statements have been quite dire. In a few months I think she will be gone.

I have decided to join the Conservative Party so I might get some say in who will lead the Party in future. I have supported the Party in the past – for example I helped Boris Johnson become Mayor of London although that turned out to be a questionable decision after London became the cycling capital of the world and the road network was severely damaged. But I never joined as a Member.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Woke Inc and the Corruption of Capitalism

I have been reading the book Woke, Inc. by Vivek Ramaswamy. It’s not a very good book in my opinion so I will not do a detailed review but it does highlight how corporate profits are being diverted to social causes, good and bad, in the USA. It enables directors of public companies to espouse their favourite causes and signal their virtues while shareholders pay the cost of this munificence.

This largesse is also spreading to the UK. Recently Shell UK announced that “British Cycling has signed a long-term partnership that will bring wide-ranging support and investment from Shell UK as a new Official Partner. The agreement starts this month and runs to the end of 2030. This new partnership will see a shared commitment to; supporting Great Britain’s cyclists and para-cyclists through the sharing of world-class innovation and expertise; accelerating British Cycling’s path to net zero…..”. David Bunch, Shell UK Country Chair, said:  “The partnership reflects the shared ambitions of Shell UK and British Cycling to get to net zero in the UK as well as encouraging low and zero-carbon forms of transport such as cycling and electric vehicles”.

Some cyclists promptly accused the company of “greenwashing”, i.e. offsetting their oil/gas pollution by pretending that their profits are going to good causes. But as a shareholder in Shell I object to them redirecting their profits which should go to shareholders to other purposes. Particularly when the clear objective seems to be to reduce consumption of the company’s products.

But companies are now also interfering in politics. So Paypal has been closing the accounts of people and organisations that hold dissident political views. They even closed the account of a UK group that campaigns for free speech. They closed the account without warning, and companies such as Facebook and Twitter have been censoring users who espouse unpopular political views.  

The author of the aforementioned book has even launched two ETFs that explicitly aim to pressure companies to drop efforts to diversify their workforces and their focus on climate change according to an article in the FT. That’s contrary to the stance of many institutional investors such as Blackrock. Ramaswamy says: “In reality, companies like Blackrock, and in particular their leaders, are using social causes as a way of assuming their place in a moral pantheon. And in the process, they’re quietly dropping hints to consumers to take the bait and make purchasing decisions on the basis of moral quality rather than product attributes alone…. Woke consumerism is born when woke companies prey on the insecurities and vulnerabilities of their customers…..”.

Ramaswamy argues that capitalism is being corrupted and companies are abusing their public trust.

Businesses have now gone far beyond the promotion of the interests of stakeholders as well as shareholders (reference Section 172 of the Companies Act). Racing cyclists (the main focus of British Cycling) are hardly a stakeholder in Shell.

Yes they are “greenwashing” and they should not be wasting my money on such trivia.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Why Property Companies Are Falling

A couple of articles in the FT today explain why commercial property company share prices have been falling of late, causing some damage to my portfolio.

First there is an article headlined “Goldman Sachs sounds alarm on UK commercial property”. They predict that with a sharp rise in borrowing costs billions of pounds will be wiped off their value. Prices could fall by 15 to 20 per cent by the end of 2024 they say. See https://www.ft.com/content/f4f96cf7-29a2-4416-a1cd-83ea362cfcaa

The article also points out that the “mini” budget which caused a disruption in the gilt market has caused pension funds to sell their property holdings. Several property funds have suspended redemptions so no doubt they are ditching holding in property investment trusts instead which I hold rather than open-ended funds. This means that a company such as Schroder REIT (SREI) has fallen to a 47% discount to NAV which seems excessive.

But gilts have rallied today which might relieve the pressure on pension funds. Another FT article said this: “Investors had previously been unnerved by confirmation from [Andrew] Bailey on Tuesday that the BoE’s bond-buying programme would not be extended beyond Friday, with the Bank warning troubled pension schemes that they had just three days left to sell whatever assets they needed to in order to restore their cash buffers. However, after the central bank purchased £4.4bn of bonds on Wednesday — easily the biggest daily volume so far in the BoE’s programme — markets were reassured by signs that pension funds were taking advantage of the facility to offload gilts and raise cash”.

Comment: I am getting really annoyed by these gyrations. When commercial property should be one of the less volatile of shares they are being driven into bouncing around by speculation on what the chancellor and governor of the Bank of England will do.

Even the negative prognostications on borrowing rates from Goldman are misconceived. Property companies rarely need to refinance their loans in the short-term and their loan to book values are generally not high (28% in the case of SREI in March this year for example). If loans need to refinanced in a few years time, what will be the loan interest rates achievable then? They are likely to be somewhat higher as the rates have been unrealistically low for many years but nobody really knows.

In summary these gyrations might soon be making property trusts more attractive but the general malaise in the stock market is not going to encourage anyone to buy unless the outlook seems brighter and the gilt market stablises.  

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Preparing for Power Cuts

The Government seems to think we will be able to muddle through in the same old British fashion but I am getting prepared by thinking ahead. It’s not going to be as easy as it was 50 years ago when miners were striking in the 1970s as so much now depends on electricity.

National Grid have warned that power cuts may have to be imposed this winter for periods of hours because of a shortage of gas which is the largest source of electricity generation. If there is a very cold spell, supplies of gas are cut off from Russia which is already happening, and a combination of other negative factors occurs then we will be facing a bleak mid-winter.

You might have gas central heating but your boiler won’t operate without an electricity supply. Are you working from home? Forget it because your PC or laptop will shut down along with your wifi router. Even your 4G phone signal may fail as phone masts only have a few hours back-up battery supply.

I have checked out our two old oil lamps (photo of one above which I have polished) to see if they still worked and they do, with some oil remaining in them. Can be lit with a few matches.

We also have a gas fire in our living room that can be lit manually with a match which will suffice – it’s rare for a domestic gas supply to be cut off because, so far as I recall, to do so creates problems when the supply is reconnected requiring a visit to every household in case a pilot light needs lighting. Industrial users would no doubt be cut off first.

But I probably should not have thrown out a paraffin room heater a few years ago – however they are still available and cheap.

As regards electronic communication, my broadband supplier (BT) provides auto switchover to a 4G connection if the broadband goes down but I don’t think that will help if the router loses power. I had a quick look at UPS systems but these are mainly of help in providing a gentle power-down. They typically only provide a few minutes battery time unless you spend a large amount of money. If you want hours of back-up you need a diesel generator. I doubt the expense of that is worthwhile.

A mobile phone like my iPhone 13PRO will operate for two days without a recharge so that should cope with lengthy power cuts. But if your phone has a shorter life then you need a “powerbank” which can give you many hours of power. They are readily available and not expensive. It could also support notepads as well as phones but laptops and PCs are another matter.

In extremis I could power my laptop in my car because I have a converter that plugs into the car auxiliary socket and supplies a 230-volt normal 3 pin socket. I can then probably tether my laptop to a 4G signal via my phone.

This might enable me to continue trading my stock market portfolio one way or another but will the stockbroking platforms and the LSE continue to function? I have no idea. I hope they are thinking ahead at the moment on how they can operate if power cuts are widespread.

A diesel or petrol car can supply many days of power but those folks who have bought plug-in electric vehicles might have difficulties if there are lengthy power cuts.

The above covers my personal “resilience” on power supply but nationally we seem to be in a really dangerous position. The Nord Stream gas pipeline was apparently easily damaged by some malicious act – probably Russian, but electricity interconnectors which we rely on for power from the continent are vulnerable. Similarly internet/phone cables could be easily damaged (as happened in January to a link from Norway to Svalbard).  In the modern world we are extremely open to all kinds of malicious acts from foreign powers and Russia now seems intent on using its capabilities to cause mischief on a global scale. All off-shore installations are vulnerable in essence so we need to crack-on with fracking.

It’s a far cry from when my father ran a coal-fired power station in the 2nd world war – he never ran out of coal. The Government has clearly got to take a good look at energy security in the UK. Even if the hot war in Ukraine cools down we might have an energy cold war for some years. It’s going to be long time before anyone trusts Russia again and certainly not while Putin is in power.

I have also been adapting my stock market portfolio to the new world of energy insecurity in the last few weeks by buying shares in oil//gas companies such as BP, Shell, Serica Energy and Woodside Energy. The dividend yields on such companies are now sufficient to offset the capital risks. I am normally prejudiced against commodity stocks but when times change I decided it was time to reconsider. But I still will not be looking at small exploration oil companies.

I have also been buying alternative energy suppliers such as Gore St Energy Storage, Greencoat UK Wind, Gresham House Energy Storage, Octopus Renewables Infrastructure and The Renewables Infrastructure Group although even those have dipped recently after a good run up since the start of the year. Whether this is due to the general stock market malaise or doubts about the new regulatory regime for electricity is not clear. As in any bear market, there is nowhere to hide as everything falls.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )You can “follow” this blog by entering your email address below. You will then receive an email alerting you to new posts as they are added

City of London Investment Trust Review

On a quiet day for stock market announcements I took the opportunity to read the Annual Report of City of London Investment Trust (CTY). This is a share I have held since 2011 and is one holding in my portfolio that is quite boring and defensive in nature. It is an income and growth trust focussed on UK listed equities and is actively managed.

Since 2011 I have achieved 11.2% per annum average total return on this share in my portfolio. Job Curtis has been the fund manager for even longer than that and has a good performance record although the trust went through a bad patch in 2020. But last year (to end of June) it did remarkably well – a NAV Total Return of 7.5% versus its FTSE All-Share Benchmark of 1.6%.

How did Mr Curtis achieve that? Not by active trading because he is very much a buy and hold investor and with such a large trust it is not easy to move the portfolio rapidly. But the performance benefited from holding the traditional large FTSE-100 stocks.  The top ten holdings in descending size making up 32% of the portfolio were British American Tobacco, Shell, Diageo, BAE Systems, RELX, AstraZeneca, HSBC, GlaxoSmithKline, Imperial Brands and BP.

Note the big focus on tobacco stocks and oil/gas companies! Just to emphasise the lack of attention to ESG prejudices two other big holdings were an alcohol producer and a defence company.

The focus on larger companies paying high dividends and away from highly valued growth stocks and medium/small companies helped and the war in Ukraine resulted in BAE being the biggest contributor to performance. Energy shortages which resulted helped the oil/gas companies also no doubt.

It’s clear that some of these holdings have pricing power which must help in inflationary times. People won’t give up smoking and drinking in a recession and strong branding also helps.

A combination of macro-economic factors and past judicious stock picking while ignoring the public prejudices against some sectors seems to have been the cause of the good performance of the trust last year.

I will continue to hold.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

Pension Fund Hedging and the Bond Market

The Bank of England had to step into purchase gilts yesterday after the bond market looked like collapsing totally. Some £65 billion was spent to do it. This has created panic and uncertainty in the financial community and even affected equity markets.

I will give my comments on these events although I certainly do not claim to have any knowledge of pension scheme management and bond markets. So please correct me if I get it wrong.

Defined benefit pension schemes buy gilts (Government issued bonds) so as to match future liabilities to pay pensions. In recent years they have not only been increasing the amount invested in gilts as opposed to equities but have also been using liability driven investment strategies (LDIs) by using derivatives.

In essence they have been hedging their positions and using derivatives to maximise returns so far as I understand it.

What happened apparently was that the Chancellors announcements last week caused government bonds to fall in price and that resulted in margin calls on the pension funds. That caused bond prices to fall further as funds sold holdings to meet the margin calls. A vicious down trend resulted.

Derivatives are always dangerous. Warren Buffett called them “financial weapons of mass destruction”. The FT reports that Lord Wolfson warned the Bank of England that LDI strategies “always looked like a time bomb waiting to go off”. Pension funds using LDI strategies have risen to £1.5 trillion to give you some idea of the massive size of these operations.

What was the Financial Conduct Authority (FCA) doing to ensure that pension funds were not following risky strategies? Nothing at all it seems. So this looks like yet another failure by the FCA in their regulatory role. There is also The Pensions Regulator (TPR) which has a role in regulating workplace pension schemes who seem more interested in ensuring diversity in pension scheme trust boards and climate change reporting rules than ensuring financial risks are not excessive if you look at their web site.

It would seem that derivatives have been sold to pension schemes by clever City whizz kids with disastrous results and we are all paying for it now.

FT Articles worth reading on this subject:  https://www.ft.com/content/5802c53b-3130-462c-8fb3-e3e6203f10a7 and https://www.ft.com/content/e2dfb060-a578-45a1-865f-e2e05d86990a

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Currency Impact on the Stock Market

I have been wondering why certain stock market sectors have been falling for no very obvious reason of late. For example UK property companies and alternative energy funds. I suspect one reason is that the majority of UK listed shares are now held overseas – 56.3% at the last reported figures in May 2020 which was a record high.

The pound against the US Dollar has fallen by 14% in the last 3 months. So if you are an investor sitting in the US you will have seen your UK shares fall in price in your local currency by that amount. When shares are falling for no obvious reason, people tend to sell them – at least I know I do. So it’s quite likely that the UK market is being affected by US shareholders dumping their holdings as a defensive reaction to falling prices.

Some people have suggested that UK companies are being affected by the high inflation rate, by labour shortages, by higher interest rates, by logistic issues or a looming recession but in reality the reported results have been OK of late.  Yes some companies might be directly affected by a falling pound – exporters positively and importers negatively. But there is no simple correlation with a company’s share price.

In reaction to the falling pound the Bank of England is buying UK bonds to calm the market. But they surely need to raise interest rates further and soon.

The rising proportion of UK listed companies held by overseas investors is exacerbating the bear market. Exchange rates can be very volatile and this makes for a very unhealthy stock market.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Abrdn UK Smaller Companies Trust and Property Companies

red apples on tree
Photo by Tom Swinnen on Pexels.com

I took the time to read the Annual Report of Abrdn UK Smaller Companies Trust (AUSC) today. It makes for interesting reading for those of us who invest in small companies. The performance last year (to the end of June 2022) was dire. NAV Total Return down 27% and the share price even worse. This wiped out all the gains in the previous year.

This is the main explanation given by the Manager: “The period was a challenging one for performance for the Company, particularly during the second half of the financial year, with our style being out of favour in the market as “top down” global macro factors have taken the lead over “bottom up” stock picking. Smaller companies markets have been difficult, seeing dramatic falls during 2022 after having been relatively stable in the second half of 2021”.

Their best performing holdings were Telecom Plus (TEP), Safestore (SAFE) and Alpha Financial Markets (AFM) and I hold the first two directly also. But they have both fallen back sharply recently.

This is what they say about those two which is a good exposition of their merits:

“ · Telecom Plus 118bps* (shares +72%): supportive end market conditions given the exit of low-priced competitors from the industry, and the strong position the nPower contract has in Utility Warehouse’s pricing offering. Sales force fully engaged again post Covid-19. Strong cash generation and dividends. An investment case study for Telecom Plus is included on page 42.

· Safestore 90bps* (+12%): solid demand in the selfstorage industry with the constant of the 3Ds (divorce, death, dislocation). Rate increases and strong utilisation have ensured consistent earnings and dividend growth”.

One of the biggest fallers in the year was GB Group – down 52% which has been the subject of a takeover bid subsequent to the year end. They exited a number of holdings and it’s worth reading the Annual Report for details of the portfolio changes.

The company has no plans to change its investment style and processes and I agree with that although the company is surely going to come under pressure if underperformance continues (the discount to NAV is currently 15.6%).

Safestore is of course a property company although it does not just rent out space so should ideally be valued in a somewhat different way. But it has participated in the rout of property company prices which continued today. Safestore is also held in some property trusts which has compounded the problem.

There is an interesting article in this weeks Investor’s Chronicle headline “The Sorry State of the London Office Market”. It explains how landlords are concealing a surplus of space and declining rents by offering rent-free periods and other incentives. However average lease lengths have been falling and are now less than 7 years which is far cry from when I was looking for office space 20 years ago. The additional flexibility is surely to be welcomed.

This perceived poor market for offices in London seems to be affecting all property companies when they frequently have a very different customer bases. It’s a typical bear market in essence – the good is sold off with the bad.

But the market seems to be reaching a point in my view when it will be worth picking up the big fallers in property and small cap companies soon. Those sectors are irrationally out of favour. For example some small cap companies have a large proportion of US$ earnings so will benefit from the falling pound in due course.

A falling pound should stop the lunacy of importing apples from New Zealand which Sainsburys just delivered to our house in the peak of the English apple season. Making imports more expensive does have some benefits!

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Dividend Tax Rate Cuts and VCT/EIS Schemes

Two little noticed changes in today’s Chancellor’s announcements are reductions in dividend tax rates and support for enterprise schemes. I quote from the announcements:

“In addition, the government will reverse the 1.25 percentage point increase in dividend tax rates from April 2023. This will benefit 2.6 million dividend taxpayers with an average saving of £345 in 2023-24 and additional rate taxpayers will further benefit from the abolition of the additional rate of dividend tax. This will support entrepreneurs and investors across the UK to drive economic growth”; and:

“The government is supporting companies to raise money and attract talent by increasing the generosity and availability of the Seed Enterprise Investment Scheme (SEIS) and Company Share Option Plan (CSOP). The government remains supportive of the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) and sees the value of extending them in the future”.

Does this mean that the “sunset” clause for dividend tax relief on VCTs will be removed after 2025? It is not clear.

See https://www.gov.uk/government/publications/the-growth-plan-2022-documents for details of the Chancellor’s Announcements.

There have been some adverse comments on the removal of the additional income tax rate of 45% but simplifying tax rates and structures has clearly been a priority so that is welcomed. The net cost to the Treasury of that change in 2023-24 is only £625 million. Not that I will personally benefit it is worth stating as I have very little “earned” income.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Interest Rate Sanity and Chancellor’s Announcements

The Bank of England’s announcement of an increase in base rate to 2.25% was just one step in a return to sanity. With inflation nearing 10% why would any idiot lend money at 5% or less as many mortgage providers have been doing. In reality the last few years have seen lower interest rates than have been available for the last 5,000 years.

This has been possible because of Quantitative Easing (QE) to keep the economy afloat. A misguided policy that has resulted in horrendous side effects. It has resulted in property price bubbles and stock market bubbles. When you can borrow money at 2% and use it to buy houses which have been rising in price at 8% or more (as they have done in 2022), people will buy houses as an investment – and the bigger the better. This is one key reason why house prices have been rising to levels that make them unaffordable to those not yet on the bandwagon.

Yes it will mean the cost of mortgages will rise thus making some people poorer for a while. But it is a necessary step to return the UK economy to a rational position.

It is still some distance from enabling savings rates to return to a situation where savers can obtain a real return. This has encouraged speculation in alternative investments that might promise a higher return. This was one reason why small cap AIM shares have been popular in the last few years. But that bubble is now bursting – the AIM index is down 31% so far this year.

In summary, I welcome the rise in bank rate and it should preferably go further to match inflation rates or more.

Chancellor’s Announcements

Kwasi Kwarteng has today announced a number of things including tax cuts.

The 45% top rate of income tax is scrapped and base rate reduced by 1% earlier than planned. The planned increase in National Insurance is scrapped and stamp duty reduced, while the planned increase in Corporation Tax is also cancelled.

The chancellor confirmed that the scheme to protect households and businesses from rising energy prices is expected to cost £60bn for the first six months. With the aforementioned tax cuts, the resulting likely increase in Government debt has caused a sharp drop in the price of gilts (and rise in their yield).  

It has also meant a falling pound which will not help the cost of living but will help exporting companies and those with revenues in dollars. By making imports more expensive it should stimulate UK production – for example of food and make us less reliant on imports.

A surprise announcement is the winding down of the Office of Tax Simplification (OTS) and revision of the IR35 rules. These are sensible moves as the OTS has been totally ineffective in simplifying the tax system which is horribly complex while IR35 rules have been incomprehensible and impractical to apply in the real world without adding massively to bureaucracy.

More reforms to planning laws are promised to stimulate infrastructure building and aid the Government’s growth agenda but we have heard that before. Unfortunately planners just love complex regulations as they generate work for planners and there will be resistance from nimbies so I expect this will see major objections and delays.

There will be new anti-strike laws for essential services and there will be encouragement for 120,000 people on universal credit benefits to “take active steps to take more active work or face having their benefits reduced” (the number of inactive people in the workforce has been rising while jobs go unfilled).

In summary, my personal opinion is that that these are positive moves on the whole. In the short-term, we might all be poorer but some of these reforms were well overdue.  

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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