JP’s Journal: A Tale of Two Quotes

“The past is a foreign country; they do things differently there.”


It is not just the past that this can be applied to. Despite some common heritage it looks like Europe and the US are developing different societal priorities.


There were two news stories I noticed last week that brought this home. The first was the rise in the number of US air travellers that forgot that they could not take guns in their hand luggage; last year nearly 6,000 guns were caught in this way. The attitude to guns says a lot about different priorities. Observing from afar I see a fragmenting US society – in parts very liberal but in parts very libertarian. Is this contradictory? I don’t think so – what we are seeing is a polarisation based upon the perception of the role of government and the rights of the individual. From a European perspective the reverence placed upon a constitutional document drawn up to reflect society of the late eighteenth century seems strange. To Americans it reflects their escape from the tyranny of overbearing or unaccountable government.


The second story is about investment strategies. In America, environmental, social and governance (ESG) is becoming a political issue with Republicans portraying ESG as a risk to US companies. So, it appears that Texas is mandating that state pension funds disinvest from asset management companies that have reduced oil and gas exposures based upon ESG considerations. In Europe it seems to be the opposite, with strategies that do not consider ESG factors, in relation to climate change, out of favour. I appreciate that Texas is not the same as the USA but it is a trend that is evident in a lot of Republican States. 


Does this matter? Well, I think it is important on two levels. First, the strong relationship between Europe and the US has been based on shared ideals and a weakening of these mutual values will weaken ties. Second, from a climate perspective it will make things more difficult if one of the largest polluters is not wholly on board.


However, we should be careful in Europe of perceiving a definitive moral advantage in relation to ESG. Whilst the current energy crisis is overwhelmingly due to Russia, we should acknowledge that the move towards net zero and wide ESG considerations has immediate implications: higher cost of capital and lower investment (e.g., oil refining capacity) in some sectors that are vital to the current functioning of the global economy. And the immediate consequences are felt disproportionately by the poorest. Another example of how having your cake and eating it does not work in real life and why the implications of choices made need to be carefully planned and then spelt out.

Inflation still in the headlines

“Having a little inflation is like being a little pregnant” has not been a fashionable quote in recent years as central banks like the European Central Bank (ECB)  and Bank of Japan have struggled to generate any inflation. But now the adage could be making a comeback. Citibank hit the headlines last week with an estimate that Consumer price index (CPI) inflation in the UK could exceed 18% in early 2023, with Retail price index (RPI) above 20%. It already looks that the Bank of England’s 13% CPI peak has passed its sell-by date (already three weeks on the shelf). A 50bps move up in UK bank rate now looks on the cards for next month, taking the rate from 1.75% to 2.25%. The bad news is that expectations have leapt ahead with the yield curve now pricing interest rates of 4% or more by May 2023. From a UK household perspective this is a triple whammy: rising energy and food bills coupled with higher mortgage rates. Two-year fixed mortgages are now above 4% and may head above 5% in coming months. There are some mitigants: households have built up savings and there are a lot of homeowners who have repaid their loans. But for households with mortgage debt and high energy usage the outlook is unpleasant. And that is assuming that we don’t face energy rationing during the winter.


Jackson Hole got the headlines last week. I think it is somewhere in Wyoming and it sounds like a one-horse town from a 1950s Western. But it gripped attention last week as the Chairman of the US Federal Reserve re-iterated a commitment to get inflation under control. This sent bond yields shooting up, with 10-year US treasuries ending the week at 3.1%. UK yields were also markedly higher, reflecting inflation concerns and doubts about the economic policies of the likely new Prime Minister. There was a bit of catch up, due to the Bank Holiday, but we are now seeing 10-year gilt yields at 2.7%, the highest yields in almost a decade and two-year yields at 3%, back to levels last seen in 2008.


What are we doing against this background? Well, I am buying more high quality bonds. I believe we are heading for recession and on this basis, the implied forward interest rates look attractive from my perspective. This is based upon inflation coming down – and I think it will as businesses start to retrench. I have not been this pessimistic about the global economy for a long time. Equities remain resilient but I prefer bonds at the moment. 

Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.

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