Following the indices is vanity, cash is sanity

One of the oldest rules in the book is that markets have a PhD in focussing on economic releases that support their mood whilst conveniently downplaying the ones that don’t. Thus it was that the December US employment report of Friday had something for everyone. The actual Nonfarm Payroll increased by 223,000, ahead of the 200,000 consensus forecast while at the same time the unemployment rate fell to 3.5%. Oops, the Fed isn’t going to like that, is it? Wrong! Focus fell on the hourly earnings which back in September had been rising by an annualised 5% but which by December had fallen back to 4.6%. Falling wage pressures, on the other hand, will be pleasing the Fed which will be given an extra option when it comes to reducing upward interest rate pressure.

Talk of a party breaking out. The Dow closed the day up 700.53 pts or 2.13%. The S&P put on 86.98 pts or 2.28% and the Nasdaq rallied by 264.05 pts or 2.56%. The Russel 2000, an index which as a new year’s resolution I had vowed to track with equal interest, rose by 2.26%. But despite all the fireworks and marching bands, the real action was in the US Treasury market where the 10 year note closed at a yield of 3.56%. At the beginning of the week, that had been at 3.80%. To people who switch off when the word “bond” is uttered, this means little but to a serious old bond dog, a move of 24 bps in one week is as big as a trip to the moon and back.

There is an irony here. On Friday morning I had been dialled into my regular quarterly investment committee meeting where there was in general still an air of doom and gloom. I did, however, make quite clear that I was not quite as pessimistic about the state of the world as many out there and that I suspected inflation might fall back sooner and faster than consensus would have it. I’d be the last one to push back against the expectation that 2023 will bring recession to the US economy although I do feel tempted to suggest that it will not be the falling off the cliff event some would seem to anticipate and that it might prove to be a fairly flat one. Not a soft landing, just one which is not skull-crackingly hard.

A Volker-style strangling of the inflation beast might be on many lips but I’m not sure how many of the pontificating economists are actually old enough to have been there to experience when between 1979 and 1983 Fed funds at no point ever traded below 7.36% and when they peaked in 1981 at an eye-watering 22.36%.

I have over the years banged on and on to the point of becoming a bore about the way in which the world changed when credit was democratised. Credit, and by that I mean the ability to use borrowed money to one’s own delight rather than simply in the form of single assert related hire purchase, was until the 1980s the privilege of the middle class – some would argue that it was the availability of credit which actually defined the difference between working class and middle class – so there are large swathes of society which went through that high interest rate period without any meaningful debt. Those to whom credit had been available, whether they had drawn it down or not, knew just how painful things could get and have in general shunned buying stuff they don’t need with other people’s money. There is, I believe a collective lack of experience in holding debt in a period when money really cost something. The fear of being indebted is not there but the panic over what to do when a large part of the population is stalks both debtors and central bankers.

Here in the UK we had in the 1980s a similar development in the interest rate structure, albeit without the privilege of fixed rate mortgages enjoyed by our America cousins. If anybody asks me why the standard of living in the US is so much higher than here, I can think of no better argument than that the cousins have a fixed rate mortgage market and that, as rates fall, they can continually refinance to their own advantage. Mortgage interest rates rose in the mid-80s into the high teens and I recall a time when even going to the pub for a pint with the mates had become something of a naughty luxury.

I was born 9 years after the end of WW2, so to some extent I am I suppose in terms of upbringing the tail-end of the war generation as well as being a baby boomer and to me debt is an alien for whom there is no room in the house. When Volker squeezed the living daylights out of inflation, non-mortgage household indebtedness was still comparatively modest. That is no longer the case and the Fed, as well as its peers, are painfully aware of just how much damage a seriously strict high interest rate regime could do.

A term which had been current during the Greenspan years was “verbal tightening”. Just the mention of possibly tighter monetary policy by Greenie would do to have bond and money markets react. His real power was in his ambiguity and in his legendary sphynx-like demeanour. Transparency was for the glass industry. Not only is Chairman Powell expected to be unequivocal, he is also faced with a debt laden society with little to no tolerance for rock hard monetary policy. The Fed might be able to talk tough but realistically it lacks the freedom to be able to act it too. Thus markets will take any ever so tiny signal that the tightening cycle might be slowed and start popping the champagne. That’s Friday in a nutshell.

After the swathes of lay-offs in the tech sector – remember that most of the companies had huge valuations but comparatively modest staffing levels – the dole fairy is now in the process of spreading redundancy dust over Wall Street. Goldman Sachs is in the limelight with the announcement that it is preparing to fire 3,200 of its 49,000 staff.  No doubt there will be some who would wish the number to be 3,201 and to include CEO David Solomon. Under him the grand old firm has been slaloming in and out of a variety of strategies and, business environment apart, such a massive retrenchment points to the top floor having been asleep on the job and not having anticipated what lay ahead.

I was a bond salesman, as was Solomon, and I think I’d be one of the first to suggest that that investment banks should not be run by salespeople. I don’t work at Goldman and never have done although I did spend enough time hanging around in the City and on Wall Street to know that the best not always make it to the top. Any number of them fall victim along the way to concerted sniping and back-stabbing. Not that I’d wish to cast aspersions in the general direction of the Goldman CEO, a keen amateur disc jockey who appears at raves as DJSol, but is there something of a pattern of the last man standing or, as I’ve also seen, a case of “rising without trace”? I have heard, however, and this is of course unconfirmed and uncorroborated, that Mr Solomon was an unrelentingly political animal in his own right and that much of the blood on the carpet in the executive suite is of his making. Last year – that’s for 2021 with the bonus declared in early 2022 –  Solomon got paid US$ 35,000,000 which works out as US$ 95,900 per day, weekends and holidays included. A year later he has to fire 6 ½% of his staff. Could it be that his view of the future was blocked by the banknotes piled up in front of him?

I have no fear for the 3,200. Having Goldman on one’s CV knocks the spots off even the best old school tie. Desk heads across the industry will be lining up to have someone who is “ex-Goldman” in their team without, I suppose ever asking the critical question which is why they are “ex”? The presupposition – and I’ve been on the receiving end – is that Goldman’s worst are still better than everyone else’s best. To that I can add that most of them, albeit not all, look entirely ordinary when no longer equipped with the buff-coloured Goldman Sachs business card. Without it, their swagger can look somewhat inappropriate. I have enough stories to tell on that subject to fill a complete after dinner speech.

Today, and after having been closed for a full two years, the border between Hong Kong and mainland China reopens as President Xi and his merry men continue to knock over the zero-Covid policy as though it had either never existed or at least as though this dialling back had always been part of the master plan. The world is running scared.

At our quarterly investment committee meeting on Friday – due to the railway strikes it was held remotely, a well-oiled process thanks to Covid – our chief economist reminded all that I had apparently said at the January meeting in 2022 that I thought the little wee virus’s goose to be cooked. The current mutation – at the time it was Omicron Mk 1 – was in my assessment getting more virulent but less dangerous. That appears to have been how it has played out and I would suspect that whatever the Chinese might spread now will be yet weaker. Our resistance to illness, dreadfully depleted by lockdown and isolation, is regenerating so what applies to the Chinese people in terms of susceptibility as they begin to step out again need not be extrapolated to the rest of us. By all accounts the seasonal flu which is doing the rounds here in the UK is substantially more debilitating that the residual Covid strains.

My point? Don’t get too hung up on the effects which a rapid spread of Covid during the Chinese New Year will have on its and on the global economy. New Year’s day and the beginning of the year of the Black Rabbit falls on January 21st. There are all kinds of scary predictions doing the rounds as to how many tens of millions of Chinese are going to contract Covid when the nation is on the road and of how many hundreds of thousands are going to mortally succumb to it. I would have thought that we would have learnt that excess deaths today, especially amongst the elderly, lead to less fearsome stats a few months hence. The positive influence on the cost of social and palliative care and the early shifting of accumulated wealth from the elderly to their heirs might not be mentioned any more than the name of Voldemort is in Harry Potter’s wizarding world but it is not to be underestimated.

I have just done a quick re-read of what I have so far written and I have to be led to conclude that the best way for us to go about our business is to try not to overthink. AI – artificial intelligence – works on a basis of analysing and re-analysing past patterns of behaviour, based upon which It  putatively predicts future behaviour. If, as many believe, the monetary policy and hence asset valuation paradigm of the past decade and a half has run its course, then the AI models which both drove it and were driven by it should be out of date.

Wherever I go and whoever I speak to, the consensus is that the stock picker and the active manager, for too long decried as withering dinosaurs, are back in vogue. The human brain, so I’m told and I wholeheartedly agree, is still worth a bit more than the electronic one.

So off we trot into a new week. The S&P might be up 1.45% year to date – that’s all of four days of trading – but it is still down by over 17% year over year. The Nasdaq’s losses year over year are, despite the big rally on Friday, just a smidgen under 30%. Have we seen the worst and is it plain sailing from here? The history of past pre-recession sell-offs would suggest it is and that full risk-on is the way to go. I am cautiously optimistic and last week put switched around a few positions. That said, I still have enough cash to keep afloat, should this year (and next) prove to be more tricky that expected. Whatever you do, if you’re a money manager, never forget that beating an index has never paid a client’s gas bills. Index is vanity, cash is sanity.

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