What the man said
by Doug Brodie
In this blog:
A key part of inflation has gone negative
Here comes the bill
‘The weirdest time in 40 years’
/1. A key part of inflation has gone negative
You probably don’t know (much) of Russell Investments, however this US firm runs £230 billion under management, supervises a further £824 billion and trades around £1.8 trillion. In all, it’s around the second largest external chief investment officer for company pension schemes. They know their mustard on such matters and this chart has just been published by them:
As you (should) know, inflation is a ratchet rather than a speed like MPH, so as long as inflation is above 0% then prices are going up. For prices to come down we need to see dis-inflation (deflation) and an overall fall in prices, which is a very rare bird indeed.
The reason you need to understand these figures is to ensure you have a realistic understanding, and expectation, of how your income in retirement will pan out over your coming years.
CPI is the inflation basket of 743 items excluding housing costs such as mortgage payments. Core CPI also excludes food and energy costs.
PPI input is Producer Price Index input costs, that is, the measure of the prices of materials and fuels bought by UK manufacturers for pressing – the wholesale, manufacturers costs.
If PPI input costs are falling (deflation) then in a few months those new lower costs will be the basis of Core CPI, so we ‘know’ that inflation is falling down steadily. (Cue the politicians at the year end claiming credit for the lower inflation).
Andrew Bailey, as governor of the Bank of England, indicated just 26 days ago that the interest rates may have to stay high for longer due to ‘stubbornly high inflation’.
Really?
Unfortunately for the voting majority, the BoE’s sole tool for dealing with inflation is raising interest rates – that has various effects including ‘removing’ money from our pockets, so we have to cut back on spending.
The BoE explains the strategy as:
How do higher interest rates help to bring down inflation?
Higher interest rates make it more expensive for people to borrow money and encourage people to save. Overall, that means people will tend to spend less.
If people spend less on goods and services overall, the prices of those things tend to rise more slowly. Slower price rises mean a lower rate of inflation.
The action we take to keep inflation low and stable is called monetary policy. (Bank of England/explainers)
/2. Here comes the bill
Hot off the press, the FT reports that the UK is currently incurring the highest interest bill on government debt in the developed world. This year the Treasury will spend £110 billion on debt interest (that’s £301 million every day, which is the annual salary of 9,000 nurses spent each day).
You might be intrigued about why our interest rate bill is higher than others and the answer lies in inflation – around 25% of UK government borrowings is via index-linked debt, which is around 2.5 times the amount of linkers issued by other developed countries.
Why is that? And who are the intended buyers of index-linked gilts? The only buyers we can think of are final salary pension schemes, the largest of which include the universities scheme, BT, RBS, Railways, Greater Manchester, Strathclyde, Barclays etc.
Politically contentious it may be, however we think it is time to unwind these schemes and roll out the Collective Defined Contribution model currently being trialled by Royal Mail. The price and value of ‘guarantee’ no longer make sense.
/3. ‘The weirdest time in 40 years’
A key part of our work in investment research is listening to others; perhaps we could be accused of suffering from confirmation bias, however we long ago made our bed in the camp of value investing as that fits with our remit of income investing for clients, plus we think that valuing investments according to cashflow is logical.
I’ve never heard of Seth Klarman, nor the Baupost Group; in my ignorance I assumed this was a firm from deepest Bavaria, however Seth is a Boston local who follows the same value assessments as Benjamin Graham, he thinks the same way as Mr Buffett.
He’s recently recorded a podcast outlining simple thoughts about the investment markets in 2023. This from a man who bought one share of Johnson & Johnson when he was 10 because he had used a lot of band-aids. Later, he ended up with $1.48 bn of eBay, having passed through Harvard Business School alongside Jamie Dimon of JP Morgan.
"When the market is more expensive than historic averages, you can lose a lot to simple mean reversion."
“This is one of the weirdest environments in the 40 years I’ve been in the investment business."
"Just because an asset is in illiquid form doesn't mean it's purely illiquid. Buildings get sold all the time. Companies get sold all the time. Whereas 9.9% of the shares of a 400 million company might be a very illiquid block. Liquidity may not be what everybody seems to think."
"Bill Ackman once said to me that value investing is like watching paint dry, but I bring a hair blower. That's a good definition of activism."
"We go miles wide to look for opportunity. When we think we found it, then we drill miles deep."
"Sometimes there’s chaos in the markets and moving quickly is necessary, so a large enough discount may offset a lack of the deepest possible knowledge."
"The hardest thing about value investing without a catalyst is that you can own something that's out of favor for an incredibly long time. Over a 5- or 10-year period, being early and being wrong look exactly the same."
"An investor must think about cyclical change like Graham and Dodd did, but now secular change as well. The combination of that has made finding mispricing harder and requires digging deeper."
"Science progresses secularly, but finance progresses cyclically. Most ideas have been around before, and we repeat the same mistakes. There's a lot to learn from studying past periods."
"There are two constraints on every investor: capital and time. Both are important."