It will be hard to better this week’s example of the Alice-in-Wonderland world that is today’s fixed interest market. Last Tuesday, the Bank of England bought in £1.18bn of long-dated UK government stock. On Wednesday the Treasury sold £1.25bn of long-dated UK government stock. On Thursday the traders opened the Krug to toast the taxpayer.

You need a heart of stone not to laugh at this ridiculous charade. The BoE pretends that it is boosting the economy through Quantitative Easing, while the Treasury pretends that it is financing the government’s deficit. Those in on the game hope that the technical complexities of the market will prevent the rest of us from spotting that the government is trading with itself, paying a handsome bung to the professionals in the middle.

This is expensive enough for the taxpayer, but in today’s zero-yield world, it is positively ruinous for company pension funds. Trustees have been bullied by their actuaries into believing that shares are nasty, risky things, while government debt is “risk-free”, even if “reward-free” would be a better description at today’s prices. Only investment-grade bonds will do to match the company’s liabilities.

Such bonds are rare and return hardly more than government stocks. Companies could issue many more of them (for the pension funds of other companies to buy) providing low-cost capital for expansion. Few are doing so. We are faced with the paradox that while money has never been so cheap, boards seem unable to find anything constructive to spend it on. They are reduced to purchasing their own company’s shares or buying up other companies to reduce competition.

Both activities provide a short-term boost to profits and fat fees for their advisers. Andrew Smithers, a wise veteran observer of markets, has a rather less cynical answer to this reluctance to borrow. Noting that unquoted companies invest at twice the rate of comparable quoted companies, he blames the bonus culture that has infested British boardrooms.

No self-respecting group of directors would be seen nowadays without their remuneration consultants. If those consultants say the boss is overpaid, they are likely to be replaced by a firm with more imagination.Aided by complexity and a little corporate mumbo-jumbo, the consultants can almost guarantee high rewards, come what may.

Today’s CEO, over-rewarded and over-worked, knows that his time at the top is short, and behaves accordingly. Incentivised to maximise earnings, executives will avoid the short-run hit to profits that longer-term investment inevitably entails. This, Mr Smithers believes, also explains why productivity growth has stalled.

Describing the executive pay problem is easier than solving it. Longer-term incentive plans can even be counter-productive if they encourage the CEO to accept a headhunter’s offer, complete with compensation for leaving his plan early.

Bonuses paid in shares which must be held for, say, a decade would help align the interests of the executives with longer-term shareholders. This might even encourage our CEO to borrow at today’s rate and invest for tomorrow’s profits. It would certainly have more impact than near-meaningless cuts in interest rates, or this pointless round-tripping in the gilts market.

One dam thing after another

The running sore that is the Samarco dam disaster for BHP Billiton was painfully displayed last week. Perhaps fortunately, there were other sores which contributed to a monster $7bn of impairment charges, from slumping metal prices and writedowns of oil assets. These latter are painful, but healing, while the $2.2bn for Samarco looks like a down payment.

Andrew Mackenzie, BHP’s chief executive, learned something from BP’s experience with the Macondo oil blowout, by taking personal control of the aftermath. He should have learned rather more. BP was eventually forced to cut the dividend, long after doing so would have helped the politics of the catastrophe.

Had Mr Mackenzie announced the suspension of payments promptly, it would have been a concrete sign that he did indeed feel the villagers’ pain. Never mind that the dividend looked  unsustainable at the time, the move would have garnered goodwill when it was badly needed. As it is, the previous “progressive” payout plan has since been scrapped, replaced by a (much lower) meaningless mixture of “minimum payment” and “additional amount”. A special prize, then, for anyone who can calculate the forward yield on BHP shares.

This is my FT artcile from Saturday

Do you know anyone who would like to receive this blog?  If so, please forward it. They can then choose to be alerted whenever a future edition is published. Thank you! NC

 

Forecasting is always difficult, especially for the future, as the old saw has it. This difficulty does not seem to put off Mark Carney, who despite his record of failure, is set to try his luck again. The experts at Bond Vigilantes think he may have a “whatever it takes” moment on Thursday, cutting interest rates and ordering the Bank of England to buy more government debt.

Such moves, if we see them, would reflect the blue funk that has overtaken the Remainders since the referendum, rather than a logical reaction to events. There is no useful data about the impact of the vote on the behaviour of companies or individuals; people still want to buy Taylor Wimpey’s houses, while GlaxoSmithKline has decided that Britain is not a basket case after all. There was a conspicuous absence of teeth-gnashing or garment-rending in this week’s avalanche of corporate results.

Cutting Bank Rate from 0.5 per cent would be a futile gesture. The big banks have already inserted clauses warning commercial customers that they might be charged for holding their cash, provoking understandable fury. In the real world, halving the rate would make no difference to confidence or the plans of borrowers. As for more Quantitative Easing, the BoE already owns a third of the national debt. Buying more would drive down yields still further, intensifying the pain in the pension funds, and forcing companies to compete with the BoE to buy more “risk-free” bonds instead of investing in productive assets.

This is the economics of the madhouse. Our new prime minister and her chancellor have sensibly abandoned the misguided, impossible goal of balancing the state’s books by 2020. When her government can borrow at 1.5 per cent for 34 years, there is a golden opportunity to finance the thousands of capital schemes which produce a sufficient return to make the country richer over time. Nearly all of them are relatively small – road improvements, council housing, schools and clinics.

We do not need vanity projects. It is still not (quite) too late to avoid the financial disaster that is the Hinkley Point nuclear power station, and the new government can easily scrap HS2 in favour of upgrades to make the existing railways work better. None of this requires gesture rate-cutting or more QE. When the future is so obscure, masterly inactivity is often the best policy. This week we may see if Mr Carney can manage it.

Force the shareholders to decide

It is hand-wringing time again on executive pay. The latest waffle is served on behalf of the Investment Association. This trade body, there to protect the vested interests and privileges of highly-paid investment professionals, finds that boards should “explain why they have chosen their company’s pay level with consideration of relativities.”

That’s telling ’em. The explanation promises to be as complex as the package, and nobody – possibly not even the executives themselves – will understand either. Exhortation of restraint has had the opposite effect, as if talent at the top was as rare as world-class footballers.

Here’s a suggestion: no contract for a director should be binding on the company until shareholders have approved it in general meeting. The voting should also be transparent, to expose the block votes of the investment professionals. A few good men might choose not to serve, but the measure might at least slow down this runaway train.

Please don’t shout

Finally, a curiosity: a company is coming to the Aim market which is not a speculation in gas, oil or minerals, nor is it in financial services or some obscure corner of the technology market that normal mortals cannot hope to understand. Autins Group actually makes things – to reduce noise in expensive cars – and there’s not a trace of private equity.

Sales were £20m last year, profits £910,000 and with £14m of new money, the market is expected to value it at around £40m. Noise is one of the curses of the age, and products to reduce it have a fine future. Autin could be an attractive stock – provided its debut doesn’t make so much noise that the price runs away.

This is my FT article from Saturday

Suppose you have money that you do not need for several years (just imagine). You could lend it to the British government, and after a decade, £1000 will have turned into, well, £1000 or thereabouts. If you want to be sure of getting your capital back in 2026, then your grand will make about £9 a year.

This is the so-called “risk-free” option, the corral into which the actuaries have driven the herds of pension funds. As a result, long-dated government stocks return a magnificent 1.5 per cent. This yield is anything but risk-free. Any possible upside depends on an even greater flight to perceived safe havens, while a return of inflation in the next decade would bring massive capital destruction. Stock prices and the purchasing power of the proceeds would both fall.

At the other end of the risk scale stand the leading shares whose prices have been poleaxed by Brexit. These are, the experts tell you, totally unsuitable for the innocent investor. Here are a (nearly random) dirty half dozen: Aviva, Persimmon, Lloyds Banking, British Land, BP, Marks & Spencer. Our actuary might call them the height of madness for a future pensioner. Just look at how the prices have fallen! Aren’t you glad you didn’t own them last month?

Yet this is rather the point. Our struggling six are now discounting years of misery ahead. Last week Aviva’s CEO pledged a “sustainable and growing dividend”. Aviva’s capacity to disappoint is legendary, but at 360p the yield is nudging 6 per cent on last year’s payout.

Shares in housebuilders Persimmon cost £13.60. On Tuesday last week the company reported that people still wanted to buy houses and re-iterated its commitment to pay out a total of £7.90 a share by 2021.

Lloyds Bank may be constrained from raising its payout by the governor of the Bank of England, but at 50p the shares yield 4.7 per cent, even excluding a repeat of the 0.5p special dividend.

Property fund investors have rushed to the exits from open funds, only to find them closed. As a closed-end company, British Land shares have suffered less from the fallout than the bargain-hunters might have hoped. However, its cheesegrater building burnishes the City’s skyline -whereas Land Securities’ neighbouring walkie-talkie horror just burnishes passing cars. At 570p British Land shares are just off a three-year low, where the yield is 5.1 per cent.

BP has actually risen since Brexit, but oil majors are the new tobacco companies in the eyes of some investors, who are selling out of them. (Tobacco companies have been fine long-term investments.) BP shares yield over 6 per cent at 455p. How much over depends on sterling, since the company declares its dividends in dollars.

M&S is another triumph of hope over experience. It looks more like a high-risk annuity than a dynamic, forward-facing retailer, and demonstrated again this week how resistant it is to management attempts to make it competitive. However, much of that pessimism is in the price, 291p is a seven-year low, and there’s a decent food retailer buried among the frocks and socks. The yield on last year’s payout is 6.5 per cent, or 8 per cent if you believe there will be further special dividends.

These shares could fairly be described as unsafe havens. Some may be forced to cut their dividends, and one or two may not even survive the next decade in their current form. However, as investors stampede into absurdly overpriced government securities, this balance between risk and reward is too extreme to make any long-term sense.

 

Old Mut to the rescue

Is there no end to the Brexit misery? Even the dog is suffering post-referendum remorse, according to Liberum. As things get worse, Fido’s owner is expected to downgrade his treats from the upmarket Pets at Home to some budget on-line chow provider. Coming after what the broker describes as “a poor flea season” – though perhaps not from the dog’s point of view – this is enough to warrant an earnings downgrade. Since coming to market at 245p two years ago, Pets shares have jumped up and then – down Fido – to today’s 225p. Still, it has one faithful holder in Old Mutual. The fund manager has just raised its holding above 14 per cent. Good boy!

This is my FT column from last Saturday. The share prices were correct when I sent the copy on Thursday night.

Oh no! House prices may go down! We’re all doomed! The emerging consensus among those paid to guess is that our Brave New World will chop between 2 and 5 per cent off next year. This has translated into a wipeout of shares in housebuilders. Taylor Wimpey, the biggest volume builder, lost a third in the week since the big day.

This reflects the triumph of panic over potential. BB (Before Brexit) the sector did look overvalued, but not by 50 per cent. Redrow, among the best-run builders, was even moved to issue a reverse profit warning, to report how the buyers were queuing up outside its show homes.

The queues may be shorter this weekend, but if the buyers disappear, the builders know what to do. It is only eight years since Taylor Wimpey’s near-death experience after the banking crisis, and in the event of a post-Brexit apocalypse, they will stop buying land, build fewer houses and run the businesses for cash

This protects the dividend, but does nothing to tackle the UK’s housing shortage, because  this is something the companies are not really designed to do. Smaller builders, ruined in the last recession, lack the capacity to cope with today’s complexities of planning and compliance. This suits the leaders, who can control their rates of construction to ensure the continuing shortage of supply. It’s another urgent problem for the new government. Shelving vanity projects like HS2 and Hinkley Point would be a start.

So the big housebuilders will ensure they can keep paying dividends, albeit in the rather idiosyncratic manner they seem to prefer. Taylor Wimpey has paid out 7.4 per cent of its current market value in the last year, but only a small fraction as a “maintenance dividend”, while Persimmon prefers “capital repayments”.

Liberum Capital reckons a 3 per cent fall in house prices would take 18 per cent off earnings, or rather less than the post-Brexit slump in share prices. A 3 per cent fall would be welcomed by many, following the 5.1 per cent increase in the last 12 months. Meanwhile, Goldman Sachs is bearish on the builders, and we all know what a fine contra-indicator the bank’s published views are. At today’s prices, their shares look a better bet than their products.

Oh dear, another failing LSE merger

Today the shareholders in the London Stock Exchange must vote to decide whether, despite a history of failed attempts, they should merge with someone else. As usual with the LSE, the commitment of the management may not be enough. Despite protestations all round, the Brexit vote destroys the dynamics of the “merger” with Deutsche Borse.

Like the previous failed deals, this one was already far from satisfactory for the LSE shareholders, who know there is no such thing as a merger. The CEO of the LSE is already running for the exit, on rather better terms than those being offered to the shareholders. In return for power, his newish counterpart at Deutsche, an ambitious former Goldman Sachs executive (them again) allowed the company to be based in London.

The German authorities are revolted by the thought of their market being run from a country outside the EU, rather as trading in the euro in London infuriates its members. Like Britain’s relationship with the 27 remainders, this deal should be best shelved, at least until everyone has calmed down.

On Borrowed time

Simon Borrows took the helm at 3i in 2012 when it was just out of intensive care. The previous management had been forced into that rare humiliation for the board of an investment trust – a rescue rights issue. Shares in what should have been a relatively low-risk investment had fallen into the 90 per cent club.

It has been a long haul back, but this week the shares jumped to 543p, close to their eight year high, after 3i revealed enthusiastic buyers for its stake in Action, a Dutch retailer. The subsequent revaluation has added 11 per cent to net asset value, to 538p on Cazenove’s calculation. It is rare for an investment company to stand at a premium, but as long as Mr Borrows stays in charge, it is hardly surprising that Cazenove reckon they are cheap.

This is my FT column from Saturday

It is not quite true to say that the stock market is relying on the Royal Dutch Shell dividend, but since the oil company accounts for over a tenth of the total dividends paid by UK companies, a cut would be quite a shock. The shock would be terminal for Ben van Beurden, since the Shell CEO would have broken the promise made during the takeover of BG Group.

This is why Shell will find the $8bn needed to pay out on the capital enlarged by what Nick Butler of Kings College London describes as “an act of corporate obstinacy that is still destroying shareholder value”. However, “find” is not quite the same as “afford”, as Shell shares are signalling with a yield of 7 per cent, more than twice the market average, for a company that has not cut its dividend in over half a century.

The price is, in effect, anticipating the end of the oil age; that if Shell shells out $8bn every year, it will have to keep selling assets and eventually stop exploring, turning the shares into a high-risk annuity. This case assumes that for oil, $50 is the new $100, that alternative energy sources will displace it from more and more uses, and that pressure from environmentalists will do for oil what they have done for coal.

Well, maybe the oil price is in long-term decline. Fracking activity in America is now rising again, as the costs fall and drillers adjust to their newfound role as swing supplier. Yet if “peak oil” does turn out to be peak oil demand, rather than supply, as had been generally assumed, there is no sign of it.

OECD countries have been using less, but global oil consumption rose by 12 per cent in the 10 years to 2015, despite costing over $100 towards the end of the decade. Today’s lower price is having the entirely predictable effect on consumption in the west, with Americans driving like never before. The glut looks temporary.

All the oil majors became fat and inefficient in the boom years. As BP demonstrated after the Macondo disaster, they have valuable assets that they hardly know they possess. They are also learning to make money from selling their products rather than finding more crude. We are nearly all shareholders in Shell, some of us more directly than others, but that dividend looks sustainable, and not just because Mr van Beurden wants to keep his job.

Dear Apple: don’t abandon jack

Hutber’s Law, named after a distinguished City editor of the Sunday Telegraph, states that improvement means deterioration. If the scuttlebutt is to be believed, Apple may be about to demonstrate the law’s truth, by launching an iphone without a headphone jack.

You can see why purists dislike wires, which tangle however carefully they are put away, and pull out of your ears whenever you move. How much more modern to have a wireless connection, even if the earpiece is lumpier – oh, and you need two of them.

The headphone jack is an all-too-rare example of the industry managing to agree on a standard across all brands, even extending it to in-flight entertainment. The headphones themselves cost pennies, so it hardly matters when they break. An expensive little wireless headset will inevitably get lost when you need it. Unlike a physical wire, the radio connection is vulnerable to interference, or even hacking. Memo to Apple: don’t be silly.

Now we’ll never know

Rodney Leach was that rarity among the City’s elite, a man who enjoyed talking to journalists. His views, delivered with a dreadful clarity, were delivered with a twinkle in his eye, as if the most serious subject was also slightly ridiculous. Even when disagreeing it was impossible not to like him. He was cruelly struck down in April and died last weekend. Yet even now, here is something he would have enjoyed – the arch-sceptic on the European Union had not said which way he would vote in the referendum. The mixture of logic and pragmatism that made him such a powerful figure were pulling him in opposite directions, and now we will never know which side would have won.

This is my FT column from Saturday

 

What is a stock exchange for? For the exchange of stock, obviously, matching buyers and sellers in a reasonably transparent way. Well, up to a point. For the London Stock Exchange, this workaday activity sometimes seems almost secondary to charging for the use of its benchmark indices on the one hand, and finding ways to cash in on the burgeoning derivatives market on the other.

The LSE’s portfolio of FTSE indices has become a nice little earner since it started alongside the Financial Times in 1984. It bought out the FT in 2012. Market participants provide the raw material in the form of share prices, which is put through the sausage machine and sold back to them as indices.  Every transaction on the exchange is called a “bargain”, but the participants feel that this bargain is decidedly one-sided.

Now one of the LSE’s competitors, Bats Europe, is having a crack at the index business by launching its own lookalike benchmarks. Competition is all very laudable, but it looks a long haul to reach the retail customers who are used to the FTSE indices to measure their managers’ performance.

A far longer haul is in prospect for the promoters of a different kind of stock exchange. Suitably named, the Long Term Stock Exchange is the idea of Eric Ries, a silicon valley entrepreneur whose previous advice to companies thinking of going public was to lie down until the feeling went away. Today’s exchanges, he argues, reward short-termism and punish companies which take the long view. His exchange, if it ever happens, promises votes for loyalty and much longer horizons for executive rewards.

We can all support the idea of innovation and risk-taking to generate future wealth, but if all the shareholders are long term, there’s no exchange at all. Besides, it is a paradox of our zero-interest age that companies are under pressure to pay dividends almost come what may. As for the LSE, the long-term plan of its departing CEO is to push the business much further into short-term derivatives by selling out to Deutsche Borse, while trying to bat Bats out of the benchmarks park.

It’s not alright Ma

It was a bad moment when Jack Ma, the founder of internet leviathan Alibaba, claimed that fakes were often better than the brands they were faking. Made in the same factories, and from the same materials, quality knock-offs strike at the heart of what brands are all about. Fakes are not a new problem, but identical fakes easily bought on-line are something else.

You may say that the Hermes Togo Leather Birkin Tote is to die for, or at least to pay £15,000 for, but if the same product is available at a fraction of the price, it may betray that you are merely buying it to flash the label. Mind you, men never understand handbags and shoes, which might explain why Jimmy Choo caught the market on the hop (sorry) with results  after analysts had braced themselves for bad news.

The company sees China as the future for Choo shoes, as does every other major luxury brand,  but Alibaba is the gateway. These brands seek to reconcile growth and exclusivity, trying to maintain margins while hoping that nobody will notice that the emperor has no clothes – nor, indeed, shoes. By pointing it out, Mr Ma has not helped them.

Green negotiators for Brexit

Those who had never seen Philip Green negotiating had a treat last Wednesday. Ducking, interrupting, with nothing ever quite settled, Sir Philip demonstrated how he has beaten so many adversaries into submission. However, should we vote leave his talent could present him with an opportunity to repay his debt to society.

He is just the man for the divorce talks with our European partners. Come to think of it, the bunch of political second-raters (with rare exceptions) who could find themselves empowered next week should pick a team of negotiators from private equity and tell them to get on with it. Starring roles beckon for Donald Mackenzie (CVC) Sir Damon Buffini (Permira), Simon Borrows (3i) etc. The other side would hardly know what hit them.

You probably don’t think much of your bank. Mailshots of services you have happily lived without; “your call is important to us” as you wait and wait to speak to a human being; fat booklets of terms and conditions that life is too short to read; punishment charges for going overdrawn.

They are all the same – or not, according to Michael Lafferty and Jane Fuller, both formerly of this parish. Their Bank Quality Ratings, culled from those other unread tomes, the annual reports, prove that there is gold buried in the hundreds of pages of low-grade ore. They pan for sustainability in the small print, and award stars.

The answers are not a great surprise: no big UK bank gets more than three stars out of five, while Barclays gets only two – and even that is an improvement on its one-star rating the last time Lafferty looked.

When it comes to assessing sustainable models in banking, it seems that big is bad. Cleverer people are noticing. Now that ignorantia non excusat for those at the top, even persuading the best people to step up to run the big beasts is hard. Of Europe’s top 100 banks, only four can boast a CEO with a proper banking qualification.

The international monsters may never escape the sins of the past. Morgan Stanley’s  worst-case estimate of costs and fines against Royal Bank of Scotland is almost £30bn, or half as much again as its market value. That estimate includes just £500m for RBS’s treatment of distressed businesses in the crisis. A report from the Financial Conduct Authority is due shortly. If it is as damaging as the rumours suggest, Lafferty’s two-star score will look generous.

Only nine banks warrant four stars, including Aldermore and Close Brothers in the UK. They are all small enough to be comprehensible to the human mind. Those running the big banks may wish to be smaller and simpler, but it is not easy. Lloyds spent as much disentangling TSB as it raised in the sale – and TSB was promptly bought by Santander. There is clearly a very long way to go.

Elliott, the long-term shareholder

There is one clear loser from the decision of Lord Rothschild’s RIT Capital Partners to abandon its pursuit of Alliance Trust. Alliance’s biggest shareholder, Elliott Advisors, had agitated for a deal to allow a profitable exit from its 16 per cent holding, but RIT, bounced into a statement when the story broke in the FT, lost the initiative and then lost interest.

Elliott has achieved much from hounding Alliance. The complacent old board has gone, and radical action is now all but certain. This is likely to mean dismantling the current structure, to turn the company into a conventional investment trust with outsourced fund management, shorn of the administration business.

However, Alliance is too entwined in Scottish politics to apply the slash-and-burn approach so familiar to Elliott. The Dundee employees must be treated carefully, which will take time. Until the end of the process, Elliott looks as though it is locked in to a holding which may prove hard to sell at anything other than a big discount to its underlying value. Be careful what you wish for.

Definitely not your usual suspect

Want to know how the markets will greet a controversial appointment? Leak to The Sunday Times. If there are signs of revolt, deny the story and blame the press. Or, nowadays, go to premier scoopist Mark Kleinman at Sky News. So it was that John Kingman, freshly into the Treasury’s out tray, was fingered as the next chairman of Legal & General.

It’s an unusual appointment, all right. He is miles away from the list of usual suspects. Not only is Mr Kingman 13 years younger than his CEO, but his extensive experience excludes anything remotely like chairing a large, complex corporation. However, there are no signs of revolt, so he looks like a shoe-in. Rather than the quasi-political appointee he appears to be, he may turn out to be an inspired choice, but it is another sign that L&G is not going to be your run-of-the-mill life office.

Follow

Get every new post delivered to your Inbox.

Join 106 other followers