There is a small gallery on the Wirral that houses one of my favourite pictures. Painted in the mid nineteenth century by William Holman Hunt, a leading Pre-Raphaelite artist, it depicts ‘The Scapegoat’, an animal that carries away human sins.
It is a striking image. The gallery is named after the Lady Lever, the wife of the founder of Lever Brothers, and is situated in Port Sunlight. Actually, both the gallery and model village are worth a visit and are a good reminder of the philanthropy undertaken by leading Victorian entrepreneurs.
As someone who grew up on a Cheshire farm owned by Imperial Chemical Industries (ICI) I have always been interested in companies with roots in the area. The dismantling of ICI in the 1990s came with a sense of regret – one of the few giant manufacturing companies that could compete globally. But before I get too nostalgic it is worth remembering that, as at the end of June 2023, both the UK’s largest quoted company and the largest private company have roots in ICI.
Another company with Cheshire roots is Unilever, the result of a merger between Dutch margarine and English soap in the 1920s. I would guess William Lever, back in the 1890s, had an eye on keeping his workforce productive – Port Sunlight may not have been all altruism. Whatever the motivation, however, the village stands as testament to long-term thinking.
Management time horizons
Unilever was in the news last week. Results beat expectations and the share price moved up 4% on the day, adding nearly £5bn to its market capitalisation. What is striking has been their ability to increase margin over time. Is this ‘greedflation’? Well, Unilever’s operating margin is higher than those of the UK supermarkets. But I come back to ‘The Scapegoat’. It is not Unilever’s job to protect the public from inflation. So don’t castigate the company for higher Magnum prices; it is, after all, the board’s responsibility to oversee the business in the best interest of shareholders. But what about the long term? I think William Lever had a generational focus, but it has to be acknowledged that the nature and tenure of corporate leadership has changed a lot since then.
Ownership and management have become more divorced, and incentives focus on the short term – not surprising when the average term of a UK CEO is about five years. Governments have a part to play in tackling inflation – not through price caps but ensuring that competition is robust and that new challengers are not strangled at birth by over-regulation. Big companies see regulation as a handy ‘barrier to entry’ to ward off bothersome competitors. And consumers, like me, have a part to play by switching to cheaper or own brand products. Time I cut back on Magnums anyway.
Central banks drive bond yields
Back to markets. As expected last week saw the US Federal Reserve (Fed) and European Central Bank (ECB) both hike rates by 25bps. In the US, the increase took the Fed Funds target range to 5.25% – 5.5%. Whilst the Fed left the door open to another rate hike, markets are positioning for a peak around current levels. Bond bulls liked Chairman Powell’s comments that real rates as are now positive and are expected to put downward pressure on inflation and activity. Less helpful was the message that inflation is not expected to be back at 2% until 2025. A soft US landing scenario seems to be the consensus. At the close, 10-year yields were nudging 4%, 12bps higher on the week.
The ECB took its deposit rate to 3.75%. Overall, the messaging was dovish and markets sense a change. We still expect a further hike but the ECB’s emphasis on expected inflation declines and reference to tighter financial conditions implies a row back from its previous hawkish stance. This left 10-year German yields just below 2.5%, a marginal increase over the week. In the UK, investors are still awaiting the Bank of England’s rate decision and 10-year yields settled above 4.3%, up 4bps.
However, the biggest potential impact on debt markets came from a central bank that kept rates on hold. The Bank of Japan adjusted its Yield Curve Control (YCC) policy – in effect letting 10-year government bond yields rise above 0.5%, with a new cap at 1%. We see scope for further weakness in 10-year Japanese government bonds, and this will have ramifications for other markets – as Japanese bond yields become more attractive. The latest data shows that Japanese investors hold $1tr in US treasuries and account for 15% of foreign holdings.
Credit spreads continued to grind tighter. Sentiment was helped by further rehabilitation of subordinated financial debt – a recurring recent theme. Last week saw about €4bn of AT1 securities being called – from Barclays, BBVA and Caixabank. In the case of Barclays, the decision to call was based on its strong capital position with its AT1 capital well above the minimum regulatory requirement. Banks have to weigh the impact on future financing costs and the decision on whether to call is based on a range of factors – sometimes sacrificing immediate benefit for future gains. There may be a lesson there.
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