One down, one to go

“I eat Green Berets for breakfast. And right now, I'm very hungry!” (Arnie/John Matrix, Commando)

This has been another of those weeks where it has been very helpful to be able to call upon the legions of experts and specialists happily at our disposal. From the Budget in the UK to the continuing deluge of quarterly corporate earnings and a mass of important economic data, there is simply no way to reliably sift signal from noise without quite a bit of help.

As usual, strident views on any of the above should be an automatic signal to switch off and focus elsewhere. There remains plenty for the optimists to get their teeth into, even if it requires a bit of effort in the world mangled by social and other media for our apparent benefit.

Budget

Perhaps predictably, the bark of the long-awaited Autumn Budget ended up worse than its bite. Since former Prime Minister Truss and former Chancellor Kwarteng, the word ‘Budget’ has acquired an extra frisson. This version was certainly never prefixed by ‘mini’ in the carefully orchestrated run up either.

The Chancellor announced a meaty rise in front loaded spending, funded by a mix of tax rises (providing just over half the lift) and debt increase. The market reaction has so far been relatively benign. This is in spite of some surprises on the issuance side, and a set of Office of Budget Responsibility (OBR) forecasts that took a necessarily cautious view on some of the questions posed by this attempt to reinvigorate investment.

The sharp further increase in taxes as a percentage of GDP projected under the OBR forecasts certainly warrants watching. By 2028/29, the expectation is that taxation will punch through to the highest levels seen since the aftermath of World War 2. Much will ultimately depend on how much you see the decade or so past as prologue for the UK economy.

This shock strewn period was dominated by the recovery (or lack of it) from the Great Financial Crisis and an absence of productivity growth around much of the world. It is certainly possible that wars, financial crises, pandemics, and a continuing absence of productivity growth feature in the decade ahead. However, a brighter path is also possible. The year so far in the UK (and in particular the US) could conceivably presage a welcome return to faster productivity growth, driven for the moment by everything but generative AI.

The profile of debt to GDP in the coming decades, whether incorporating financial assets or not, is minutely sensitive to tiny changes in the trend in GDP growth (Figure 1). It is simply not worth treating necessarily dismal long-term forecasts from the OBR and others as fact. Breath could be much better spent on exploring what can be done to make the most of this incoming industrial revolution beginning to show most clearly in the US data.

Figure 1: UK public sector net debt in historical context is currently not exceptionally high

Source: Bank of England, Office of Budget Responsibility, Barclays

Top Dogs

A few years ago, a well-known investor uncovered an interesting conundrum within markets, known as the ‘top dog’ problem. He found that investing in the largest company within the US stock market on a rolling basis yielded terrible returns. Others have since verified this, creating an index investing in only the top stock on a rolling one-year basis and comparing its total return to the wider S&P 500. The index starts at 100 in 1949 and closes on 4 at the end of 2023!

The interesting thing for our purposes is that what worked for six or so decades after 1950 was suddenly spectacularly wrong in this last 10 years. This is a period where concentration at the top (the share of the overall US stock market market capitalisation commanded by the top 10 companies) doubled. Corporate titans to rival the previous peak in concentration in the late 1960s have trounced all contenders via a range of means. As usual there are many potential explanations, most only obvious after the fact.

The point for investors in amongst a still impressive batch of earnings results from these behemoths this week is diversification. The degree of concentration in the US stock market is rare, as are the valuations and levels of profitability. There is something in here about the unique power (and potentially vulnerability) conferred by huge intangible asset accumulation, certainly an artifact of the moment we are in.

As usual, the sensible investor will diversify their portfolio beyond the recent batch of winners, being sure to keep a foot in the more unfashionable corners of the world’s capital markets. There valuations, profitability and expectations are much less of an impediment to prospective returns. It is easily possible that it will be some of these more unloved sectors where the gains from the continuing rapid advances in the technological frontier will show up most vividly.

US election and optimism

The world’s most important election still lies between us and the annual mince pie orgy. At the time of writing, it remains on a knife edge. Whichever way the various races go, this has already been an election for the history books. The reminder from us again surrounds the appropriate context and perspective for this jarring, frequently shocking build up.

For the overwhelming majority of humanity’s time on this planet, there was no visible progress in living standards. The same short, brutal and frequently terrifying life was the lot of generation after generation. The fact that no progress was observed made it impossible to imagine how one conceivably pursues such a thing. No good could come of novelty or change for our forebears, a fact reinforced by early religions and the frequently spiteful gods conjured up.

However, starting in Italy and spreading across the European continent, the renaissance and subsequent scientific revolution and enlightenment managed to change all that. The industrial revolution that followed is part of the recipe that has ensured that progress is now an assumption.

There are, as Karl Popper, David Deutsch and others have observed, no limitations other than the laws of nature, to continue humanity’s astonishing progress to date by creating new knowledge. As the latter noted “If we are failing at something, it is either because succeeding would violate universal laws, or because we have not yet created the requisite knowledge. There is no third possibility.¹”

This is important in the current context. Further progress will require open minds, a tolerance for the unfamiliar. This can be scary and frankly exhausting. However, it is the basis on which all past progress is founded. The same goes for investors. The US economy’s current momentum is centred around its incredible dynamism and the way that its entrepreneurs are experimenting and adopting the evolving technologies of the last few decades. Much of this exists outside of the influence of whichever President occupies the Oval Office, even if the focus of the media will likely be understandably different.