Author: Gary McCarthy

Russia’s elite 1^st Guards Tank Army (1GTA)had been tasked with protecting Moscow in case of a NATO attack. Now, it is no more. An army which fought in all of the major Eastern Front battles of WWII, beginning in Stalingrad and ending in Berlin, has been demolished outside Ukraine’s second largest city, Kharkiv. Clearly, the surviving generals of 1GTA should stay away from open Moscow windows in the coming weeks but this particular military debacle did prompt a related thought. Are our civilian ‘generals’ – politicians and monetary authorities – in danger of using out-dated strategies to combat today’s global economic challenges too? Put your helmets on and consider the current thinking in our battles against inflation, energy security and autocratic populism.

In a single day of trading this week a whopping $1.6 trillion was wiped from the value of US stocks. The cause of financial market volatility was, at the headline level, a slightly worse than expected US inflation(CPI) figure. However, in truth, there was nothing new in the CPI report with inflation remaining stubbornly over 8%, but this meant market traders knew the “generals” at the Fed were going to stick to their weapon of demand destruction – more interest rate hikes. Our fear is that the Fed is using the wrong weapon to save its credibility and that supply rather than demand is the bigger challenge. A combination of Covid-19 and war in Ukraine has crippled supply chains and destabilised energy markets but the initial cost shock seems to have receded dramatically in a number of key markets:

• US house sales have been falling for 6 months and are now down 30% year-on-year(July).
• US gasoline prices at the pump are down 25% and have been falling daily for 3 months.
• Global freight rates for container shipping (measured via the Baltic Dry Index) have dropped by 70% in just 4 months.

Arguably, the Fed is doing even more damage overseas. Higher US interest rates have seen the US dollar increase in value dramatically. Readers are probably aware of a loss of euro and Great British peso purchasing power of 14-15% during 2022, but in emerging markets the effect has been even worse, particularly for those countries buying critical commodities priced in US dollars. Diminished purchasing power can dramatically impact global demand for US goods like iPhones and Nike sneakers. Just yesterday, a Twitter commentator was highlighting the price of an iPhone in Turkey (in Lira terms) is the same as that of a new Volkswagen Golf back in… 2015!

So, in our view, the Fed’s idea of monetary Red Cross treatment is the equivalent of going back to the battlefield to shoot the wounded. According to financial data group, Factset, a whopping 240 of the S&P 500 companies made mention of recession on their recent Q2 earnings analyst calls. Now, adjust your helmets. The news on the supply side is looking much better. More specifically, energy prices and newsflow are moving significantly in the right direction. Consider the following developments:

• Germany’s reserves/storage of natural gas have almost reached 90% a full 2 months ahead of schedule and despite Russia cutting off the NordStream 1 pipeline.
• Goldman Sachs reckon Europe has “successfully solved” its gas supply issues for this winter and is forecasting the price of gas to more than halve.
• European political “generals” are beginning to act in unison and reform energy markets urgently. In the existing Europe-wide electricity pricing framework the price of gas was the dominant pricing influence and failed to take into account cheaper renewable options. In Germany alone, renewables account for 40% of energy generation. Political action on pricing frameworks and excess profits/windfall taxes will add to the downward pricing momentum forecast by Goldman’s research team.
• As we pointed out in a previous article, oil(down 25% from highs) and gas are commodities which generally trade in equilibrium and require only marginal changes to supply/demand for pricing to exhibit extreme volatility. Now think about the “marginal” impact of a weakened Vlad the Vulnerable coming to the negotiation table and potential commodity pricing moves. As recently as March 2020, oil futures prices were actually negative ie the producer paid you to take future delivery.

Irrespective of short term energy solutions, there needs to be a European political re-think on nuclear energy if long-term energy security is going to be a realistic goal. Of course, there are negative aspects to nuclear energy but the climate crisis and geopolitics are messaging clearly that the current alternatives are pretty grim. On that note, our political “generals” should also be urgently looking to skewer another alternative solution with false promises – autocratic populism.

Janan Ganesh writes an interesting piece in the Financial Times this week, “US soft power grows as the alternatives become clear”. The US bit might surprise but the starker conclusion in the article is that 2022 has proven to be a year of “autocratic incompetence” as Russia flounders in Ukraine and China compounds a property meltdown with zero Covid zealotry. Populist right wing charlatans have been banging the Putin drum that liberal democracies are failed social models. As Ganesh puts it, “This has been illiberalism’s pitch through the ages: not that it is nobler or moral, but that it works. In this telling, democracy is a well-meaning charter for chaos and weakness.” But, autocratic regimes are having a very bad year. And, global leaders should not stop at Russia and China in exposing false promises and failure.

President Biden has outraged many Republicans with his direct accusation that the MAGA cult of ‘Agent Orange’ is a threat to democracy. Arguably, he could have been even more explicit and robust – the United States on January 6^th 2021 came dangerously close to a coup and it is increasingly clear that the former golfing executive in the White House was trading national secrets with foreign powers for financial gain. And why stop at Washington? As the UK mourns the death of a genuinely respected global leader it should not be forgotten that its last Prime Minister left office in disgrace. The incompetence of Brexit and the pathetic Channel dinghy bashing was bad enough but the Johnson administration possibly saved its worst till last. As the NHS and cost of living crises gripped the nation in July and August the entire government went missing-in-action. Populist alternatives don’t work, literally. And there’s another thing that doesn’t work…..yesterday’s generals.

Today’s real leaders should be more vocal about those “generals” promising a return to rose-tinted periods of a country’s history. Take your pick from 1950s ‘Apple Pie’ America, Global Britannia or Iron Curtain hegemony. The future is the opportunity for all, the promise of the past is a lie for the few. A very few. Want to go back in time? Between 1920 and 2020 the average human life span doubled. However, if you were a white male in America wanting to ‘Make America Great Again’ your life expectancy just dropped by 3 years between 2019 and 2021. Bad generals get their own killed too.

“If nothing else works, a total pig-headed unwillingness to look facts in the face will see us through. “

General Melchett – Blackadder Goes Forth

What a grim anniversary. It’s exactly 6 months this week since 100,000 Russian soldiers and their outdated tanks rolled into Ukraine. Also, on the very date of that initial assault, we wrote a piece suggesting investors in ESG and sustainability funds should challenge the stewards of potentially $50 trillion of investment capital to be true to their “do good” promises. These were our very early requests:   

• Any debt or equity instruments directly linked to the Russian state or Putin-related entities should be sold/removed from ESG portfolios. The US has just banned the sale of Russian sovereign debt in Western capital markets.
• Follow the money. Those non-Russian entities facilitating the commercial interests of Russia, Putin and his kleptocracy should also face potential removal from ESG portfolios, or worse. Think about Mastercard and its sponsorship of a St Petersburg UEFA final. Then think about BP and its 20% shareholding in Russian oil player, Rosneft, with its $2 billion annual dividends going to BP profits.
• Weaponise banking. My own personal view is that Russian banks should be refused access to the global bank payments network, SWIFT. The counter-argument is that this punishes ordinary Russians. Perhaps there could be a more focused weapon. Banks could refuse to process transactions which occur outside Russia ie make travel and overseas spend for Russia-connected individuals incredibly difficult.”

Arguably, the international political and investment community has been proactive on those requests. However, these actions have not been enough. Russian forces are still pounding Ukraine with artillery barrages and a civilian death toll well into war crimes territory. The direct human losses are, of course, uppermost in our minds but the shockwaves inflicted on food and energy supplies have spread the pain across the world and contributed to governments toppling in Sri Lanka and Pakistan. A global recession would only add to the misery and the following data does not augur well for this winter:

• Electricity prices are now above €600/MWh in many European countries, including the UK. That has the equivalent impact of oil reaching prices above $1,000 per barrel. Spot oil prices(for today) are currently trading below $100 per barrel. This is 1973 on steroids.
• US new home sales have cratered 50% from their 2020 peak. Inventory for sale numbers(unsold) rocketed by 28% in July to a level not seen since 2008(!)
• German manufacturing, Europe’s engine room, is right on the front lines in the energy war with Russia and it is battling soaring operational costs. The just-published German Producer Price Index which tracks cost inflation for businesses clocked a whopping 37% year-on-year increase for July.

We could trot out lots of other gloomy headlines and throw a winter wobbly but let’s focus on one critical aspect of this crisis. It’s gas, and it’s not funny at all. Specifically, Russian gas supplies(or lack of) to Europe are disrupting electricity pricing for industrial and residential consumers. For illustration, the additional cost of energy in UK this year is expected by ex-Chancellor, Rishi Sunak, to cost £100 billion. Now let’s return to our reference to “spot oil prices” in the earlier data development. There’s a real danger the commentariat, governments and the business community are thinking too short term. Spot prices are literally today’s prices. In the commercial world of commodities (food, oil and metals etc) longer term contracts and hedging(insurance)strategies are not struck on a daily basis. Ask Ryanair. So here’s a few other things to consider about commodities on a longer-term basis:

1. Commodity spot prices are incredibly volatile. The reference to spot oil prices was deliberate. Anyone rember spot oil prices being negative – yes, you were paid to take possession – as recently as 2020?
2. It doesn’t take much to dramatically shift the equilibrium in commodity spot prices. Now think about the various long-term substitution strategies being considered by consumers of gas. The shift to renewable energy sources has accelerated exponentially. The Japanese are going back to nuclear power options. Even the hapless Germans are having a strategic re-think on nuclear energy.
3. Commodities fear technology. Think coal. Irrespective of sustainability and ESG goals, technology is changing consumption trends and behaviours. Now think electric vehicles, new battery chemistry, hydrogen power and small modular nuclear reactors.

Now here’s another thought. Should governments take a longer term view on gas prices? To use the UK as an example, government Covid supports cost the Treasury £350 billion. What’s to stop governments entering into long term pricing contracts(say 2 years) with industry and consumers at an agreed/payable level? Then, when spot prices fall (and, oh boy they will) below the agreed contract price, governments will be able to recoup their subsidies. As in the Covid pandemic, it would be preferred that governments act in concert/solidarity to avoid unfair pricing differentials post the crisis period. Bluntly, there needs to be far more creative thinking in government and financial circles to combat Russian financial attack.

Also, a final thought on solidarity and on how marginal moves can have a huge impact on commodity prices. In a spirit of solidarity with Ukraine how hard would it be for most healthy individuals to target a 25% reduction in their heating, energy consumption? Turn the lights off, have a cold shower, wear more layers. It might be inconvenient but you might actually be delivering the “S” in ESG and sustainability. Furthermore, you might be turning yourself into a financial weapon. How might it feel to be part of the first social attempt to turn the financial markets on their head, in a good way? Do good.

Things are about to get real and I’m not talking about Leaving Certs, A-Levels or the Orange Toddler being fitted for a matching jumpsuit. Who knew a Trump legal defence against the criminal possession of US nuclear secrets would be “it’s mine” ? Too surreal for you? Well, Adam Neumann might just say “hold my beer”. The implosion of Adam’s WeWork from a $47 billion IPO wannabe to a zombie office portfolio of just over $3 billion will be no surprise to readers of our articles back in 2019. However, what is truly staggering is that the WeWork founder has just managed to persuade the legendary venture capital player, a16z, to write its largest ever funding cheque ($350 million) for his latest real estate adventure, Flow.

A penny for the thoughts of Softbank’s Masayoshi Son, or possibly $10 billion which is the approximate amount he has already ploughed into WeWork and “Our mission to elevate the world’s consciousness”. Just not investor consciousness. Too late now but one suspects Son wishes he had been conscious that WeWork was losing an astonishing 84 cents for every dollar of sales at the time of its first IPO attempt. This might be a rather extreme illustration of the collision between revenue hopes and investment returns reality but start-up founders should be prepared for increased scrutiny of margin progress(profitability trajectory).

Revenues are, of course, critical but tales from the funding coalface are pointing to a much greater focus on cash burn. And, there is a further complication. We can’t avoid inflation these days but in the world of investment there is a double impact. First, investee companies must deal with potentially higher costs in their operations. The second factor is a financial reality which has been shrinking in impact for forty years. Until now. In a low inflation world of sub-2% we were less conscious of the exact returns being promised in an investment prospect. In an inflationary world that could be an expensive mistake. Allow us to explain.

Goldman Sachs were happy to report that the companies in the major US stock index, the S&P 500, grew their earnings/profits by an average of 9% in Q2 this year compared to the same period a year ago. Whoop whoop. But what was the REAL profit growth? In the financial world you will occasionally read metrics such as “real GDP growth”, “real yield”, “real returns” etc. This differentiates these numbers from their “nominal” siblings which take the headline number and make no adjustment for inflation. No biggie in a low inflation world, but now we should be paying attention. Back to the S&P 500, profit growth and the current US inflation rate are each trucking along at a similar 9% rate. REAL profit growth calculated by subtracting the inflation rate would suggest actual progress is closer to zero. The same applies to reported headline rates of revenue growth.

Companies in the UK’s blue chip index, the FTSE 100, might post revenue growth of 10% but if inflation is running at over 10%(as recorded this week) then this metric in real terms looks far less heroic, possibly more Tory. Another way of looking at this is to expect most companies to be growing their revenues at least as much as prices are rising in the wider economy. This inflation phenomenon is adding an extra hurdle to operational performance and perhaps hiding some real world problems. Arguably, there are other significant financial documents requiring more scrutiny…

1. Investment reports will document historic returns/losses and give guidance to future returns. So, in 2022 in REAL terms, if your stock portfolio is down 10% that involves a real negative return closer to 20% ie your purchasing power has decreased by more than just the nominal value of the share prices.
2. Fundraising documents will feature revenue growth and returns projections. A 15% revenue growth rate might look respectable in nominal terms but if inflation is 10% then a 5% real growth rate is less exciting. Clearly, this will impact returns expectations(and valuations!) for investors too.
3. Pension plans will typically have an average returns target to be achieved over time albeit not necessarily the same percentage gain each year. Many plans for those closer to retirement might be conservatively managed and have annual returns targets of say 5%. If inflation persists at 4% for a few years after 2022, and one factors in management fees of 1%, then it is entirely possible that your pension plan is making no progress in purchasing power terms for your retirement.

The above examples should not lead to instant panic. Inflation may have already peaked so the longer term story might not change too much. However, be wary of promoters or financial advisors hiding behind inflationary tailwinds. Bluntly speaking, 10% growth in revenues or returns in 2022 could be in real terms closer to zero progress. However, let us end on a more positive note and again it involves some mathematical reality which the financial commentariat is in danger of missing amid the cost of living horror headlines.

In our “Ten Little Rays of Macro Sunshine” we mentioned month-on-month US inflation peaking in June and possibly going negative in August. Before everyone questions the reality or sanity of that statement predicated on a recent supermarket visit we need to understand a key inflationary truth. Prices do NOT need to decline for inflation rates to fall. The mathematics are very clear. If prices in aggregate were to stay at these elevated levels for the next 2 years the inflation rate would NOT be the current 9-10%, or 5%, or even the ECB or Fed targets of 2%. The inflation rate would be ZERO percent. The numbers do count but don’t ask Adam. Ask Masayoshi Son – Softbank just lost $23.4 billion in Q2. Forget return on your capital, how about return of your capital!

Perhaps it’s the heat melting my brain but I’m feeling better about things. I’d normally avoid twisting the thoughtful logic and words of William Shakespeare by claiming now is the summer of our discontent but please indulge me. Yes, the home of The Bard is, like many countries, enduring crippling inflation, a decline in real wages and growing labour force unrest. And…the shocking headlines about a winter of rocketing electricity/gas bills and geopolitical tensions in the Taiwan Strait don’t help either. However, what if the bad stuff has actually peaked before winter has even arrived? What if, winter will really be summer? Crikey, I’m suddenly finding my inner Rees-Mogg! However, unlike Rishi or Liz, we might have reality-based supporting data to illustrate potential winter relief. Here are ten developments which have caught our eye….

1. Inflation: Hot off the presses but US inflation(CPI) has just printed at an annual rate of 8.5%. Not great, but better than the commentariat expectations of 8.7%. Remember, inflation is all about future expectations. So, what if monthly rates of inflation roll over? Well, ex-Conlethian, David Kelly, is Chief Global Strategist at JP Morgan and he thinks August could see monthly rates go negative after peaking at 1.3% in June. Falling gasoline prices and mortgage rates(long-term interest rates) are the big driver here which is also causing some amusing reverse-ferret action from various Biden-bashing US media channels. More of that later.
2. Jobs: Yes, the jobs market is a lagging indicator so it would be one of the last areas to signal recession. However, there is something strange going on. A quick tour of Connemara in recent days confirmed staff shortages are still a big issue. Ireland flying along at 6.3% GDP growth may not be reflective of global conditions but if we return to the US a potential ‘goldilocks’ scenario is emerging. Lots of companies have frozen hiring plans but recent data shows July job openings falling by more than 600,000 compared to job creation of 528,000 new roles. Currently, the ratio of openings to available candidates is  2:1 but the Fed would rather see that at 1:1. So, expect some job market cooling but possibly not as many job losses as in previous downturns.
3. Interest Rates: We never stop saying the cost of money drives everything. The reason US mortgage rates have dipped back below 5% is that global long-term debt markets are seeing rates/costs/yields fall as investors factor in an economic slowdown, and lower inflation.
4. Business Cycle: There are many analysts out there who believe these lower interest rates will be accompanied not just by a slowdown but by a wintery recession. We’re not so sure. Two things fly in the face of that cycle swoon. First, if recession looms then investors wouldn’t be buying stocks in the at-risk Consumer Discretionary sector. In fact, they’d be buying safety in the defensive Consumer Staples sector. Hmmm. Why then did July see Consumer Staples have their worst month relative to Consumer Discretionary in more than 20 years? Secondly, another hyper-cyclical sector, media, should not really be seeing M&A activity at juicy buy-out valuation multiples. Well then, explain news publisher Axios being bought by Cox Media for $525m or more than 5x its annual revenues, or Dive being swallowed up by the UK’s Informa PLC on similar 5x multiples.
5. M&A Activity: It won’t just be Elon Musk forced to do big deals(Twitter) – yes, selling $7 billion of Tesla stock was the tell. We noted in last week’s article “Islands Of Investor Love” that the likes of Amazon, TD and Estee Lauder were doing deals. Currently global M&A activity is holding up at 80% of the record-breaking levels achieved last year but remember our mantra about the cost of money/capital driving everything? In particular, healthy debt markets(lower interest rates) drive deals for a very very important player…..
6. Private Equity: Private equity(PE), by its very nature, uses debt/leverage to ‘juice” the equity returns for its investors and partners. So, when we see US long-run interest rates drop below 3% we smell the PE “Barbarians” coming to the buy-out gates soon. And, boy do they have some weaponry. Just the $3.6 trillion of “dry powder” in PE parlance is sitting earning miniscule returns with institutional investors becoming impatient. Expect increasing pressure on PE giants to do deals as interest rates stabilise or keep falling.
7. Confidence: Technology is our future. A struggling tech sector and painful share price collapses do not help confidence. So, after a difficult first half of 2022, check out one of the best months ever(July) for tech stocks: Apple up 19%, Airbnb up 22%, Amazon up 24%, Paypal up 24% and Tesla up 31%. Wow, that happened quietly. Clearly, the media preferred the bad news and spin; but for the most important country in the world, confidence is absolutely critical right now.
8. US Healing: I could be guilty of wishful thinking here. Anyway, here goes. The US Supreme Court over-turning of female healthcare rights protections in Roe v Wade was a very dark day and the Google searches for “US civil war” have spiked significantly. However, recent news flow hints at a United States whose institutions are beginning to re-assert themselves. First, the Biden White House is finally getting some wins. Falling gasoline(under $4) and mortgage costs(under 5%) certainly help but the Democrat administration is also chalking up some big legislative results on climate protection, drug pricing, veterans healthcare, semi-conductor(CHIPS) investment, infrastructure spend, Ukraine support and gun control. The majority of Americans see these as good for the country. But, espionage is most definitely not. Of course, the FBI search warrant served on the Donald’s Mar-a-Lago residence triggered MAGA/GOP hysteria and accusations of political “harassment” but…..there is a much bigger accusation hanging in the Florida air. The division of the DOJ/FBI who searched Trumpolini’s mob base are tasked with countering espionage and sabotage by foreign powers. Me thinks the Trump-appointed Director of the FBI, Chris Wray, and judges who permissioned the search would not have risked political chaos to secure the return of the minutes of an Oval Office briefing. Something far more damaging to US interests was probably “for sale”. Hence, the political risk taken. We shall see (Trump whined but didn’t show the warrant) and probably be shocked, again. It won’t move the MAGA fanatics but mainstream GOP types won’t fancy wearing ‘Make Saudi Great Again’ hats….unless they’re pro golfers.
9. China: Taiwan tensions won’t go away but Beijing will have noted a bi-partisan US determination to support their ally. Instead, hopefully it will allow China to focus on domestic challenges and stimulate consumer demand. It is encouraging to see a lead indicator, “the China credit impulse” which tracks the injection of credit/liquidity into the economy, pick up in recent days per Bloomberg data. China is the biggest shopper on the planet so that “credit impulse” is rather important to the global economy.
10. Supply Chains: The Financial Times is citing S&P Global data which indicates delivery times/supply chain pressures are easing around the world. It is important to note, and contrary to current central bank orthodoxy, that the inflation pressures in the world have been supply driven(blockages, wars, Covid etc) rather than demand (consumer, wages) driven. Arguably, inflation which caught central banks napping on the way up might surprise our monetary overlords and the commentariat on the way down.

Clearly, we can’t forecast the future but the data above does, at least, indicate “change” in the trajectory of many of the challenges of 2022. Alas, for Ukraine there is not much in the way of encouraging data, but perhaps history. Exactly eighty years on, let’s hope the winter of 2022 crushes the empire ambitions of a tyrant. Now, that would be truly Shakespearean.

Love Island might be over but there are lots of other crowds voting right now. Despite the gloomy media headlines there’s always somebody or something to love. Check out technology stocks. Unloved, and in a vicious bear market, right? Ehh…. Wrong. The tech index, Nasdaq 100, has just entered a new bull market phase after a quiet 20% bounce from its 2022 lows. Will it last? No idea. However, the bigger point is that just because it’s ‘quiet’ August, and everyone is saying financial markets and start-up funding rounds are difficult, do NOT presume there is nothing going on out there. In fact, there are some intriguing pockets, or islands, of activity which require closer inspection….

IPO Activity: It is a fact of financial life that market volatility makes it very difficult for later-stage companies to list their shares on public markets via the IPO process. Consultants, EY, have published a review on H1 IPO activity which clocked up 630 new listings globally. That listing number was 1,171 at the same stage last year and shows a 46% decline, driven by a particularly sharp 73% fall in US activity. It could be worse, it could be Truss, or at least a country which allows just 0.3% of the population to choose its next prime minister. This writer can recall London, as recently as 2006, commanding an 18% share of global IPO activity. Now, it’s not even 1%.

That looks like a structural decline for UK capital markets but the global IPO market is a classic cyclical beast and if you were looking for signs of an uptick in confidence then watch out for AMDT Digital. Who? This Hong Kong based financial services firm listed its shares on the New York Stock Exchange on July 15^th. In just 3 weeks the share price has rocketed over 14,000% (not a typo) to a value of more than $450 billion (ahead of Goldman Sachs, Disney and Facebook/Meta !!) and inside the top 40 most valuable companies on the planet. Yes, this is a Reddit/meme love stock but a return of confidence and animal spirits is still crucial to financial markets. The casino might be open again!

Venture Capital(VC): The IPO market typically provides new funding/investors for later stage companies but this comes at a public price. Literally. Share prices in public markets trade on a daily basis which boosts visibility, but in sell-off conditions also reveals valuations which have been crushed. In practical terms, the audience and investors can tend to be more short-term focused. All good if you’re in AMDT but the ride could be way more painful if you’ve jumped on Peloton. Let’s just say short-term volatility can be stressful for even the biggest VC investors. So, what are they doing? Well, CB Insights published some interesting data on two global giants of the venture funding world, Tiger Global and a16z. The data clearly shows a shift in focus away from late stage companies towards younger companies seeking seed or Series A rounds of funding. In Tiger’s case, 50% of its deals in Q2 2022 were in seed/Series A companies. The percentage in the same period a year ago was 8%. For a16z more than two thirds of its deal flow went to early stage companies in Q2. And, for those thinking Web3 and crypto is dead, the majority of a16z’s deals were in blockchain companies. 

Web3/Blockchain: One could be forgiven for describing Web3/blockchain companies as super-early stage companies. Or just too early. The daily drumbeat of confidence-shattering news flow on frauds, hacks and cryptocurrency evaporation might suggest a nuclear winter for the crypto world. However, the votes and monies are defying the headlines. The latest market report from CoinShares shows July net inflows to crypto investment products of $474 million. Even cryptocurrency, Ethereum, is feeling the love with a 60% rise in value in the past 6 weeks. But, the biggest news is only hours old… the world’s largest asset manager, Blackrock, has announced a partnership with Coinbase Global to offer Bitcoin access to its customers who manage $20 trillion of investor funds. Whooodathunk!

M&A Activity: Returning to longer-term thinking, the ultimate strategic investor is an actual company embarking on corporate activity via merger or acquisition(M&A). So, who saw Amazon buying One Medical, ABC Fitness buying our own Glofox, JetBlue buying Spirit Airlines, Digital Workforce buying automation local Éclair, TD buying investment bank Cowen and Estee Lauder wooing fashion house Tom Ford? Tougher markets trigger a mix of opportunistic and defensive strategies so it is no great surprise to see M&A activity holding up at 80% of the record-breaking levels achieved in 2021. Pay particular attention to companies accelerating activity in new sectors, for example Amazon into healthcare. And not just industrial sectors. How about universes? Well, not quite, but if crypto’s Warren Buffett, Sam Bankman-Fried, and his FTX trading platform swallows up retail trading firm, Robinhood, then things could get interesting on Wall Street. Sam has billions of dollars to spend on acquisitions so watch that space, even metaverse.

It is all too easy for investors to go into their shells and wait for things to settle down. However, there are clearly some other investors island-hopping for opportunities while the rest of the world sits on the beach. The re-set in valuations and cost of capital (interest rates) in 2022 is a cyclical opportunity to re-visit youth, or, more specifically, earlier stage companies. Investors’ long-term ‘margin for error’, as Warren Buffett would say, has just shifted significantly; in a good way. For illustration, buying ‘early’ Amazon at its lows in 2001 would have generated a long-term return today of just over 45,000 %. Love that.

I’m in time travel form. Not only do I have an upcoming birthday with all its usual emotional trappings of nostalgia, regret, change and hope but now Bernard Cribbens is gone too. A pillar of my childhood soundtrack is no more. The Wombles, Fawlty Towers, The Railway Children, Carry On, Jackanory and Doctor Who represent the BBC and TV at the peak of their powers but provide a timely reminder that traditional free-to-air TV is a fading presence in the Netflix and Tik Tok era. However, TV is not the only sector struggling across the airwaves. I was struck by three stories this week which captured the past, present and future of telecoms quite neatly. Allow me to step in to the good Doctor’s TARDIS (Time and Relative Dimensions in Space actually) and take a quick trip through time and telecoms…..

Telecom Italia: A Twitter snippet this week pointed out that a little more than 20 years ago Palm Inc with its Palm Pilot personal digital assistant(PDA) was valued more highly than Apple and Amazon combined. Palm was dead within 10 years and I’m now wondering about European telecoms giant, Telecom Italia. In a week where Credit Suisse lost another CEO, I was struggling to think of a better investment banking client than Telecom Italia(TIM) back in the glory days of giddy telecoms and TMT excitement. House of Gucci might be Netflix movie material but “House of TIM” was an investment banking Marvel super-hero – stellar IPO fees, multi-billion dollar debt and equity issuance, hungry M&A activity, Latin American expansion, a stunning hostile takeover by tiny Olivetti, operational stagnation, restructuring and an excruciatingly slow TIM break-up to pay off a crippling debt mountain. When Palm Inc was at its peak valuation, Telecom Italia boasted a share price of over €16. Today the share price is barely 20….. euro cent. After billions of euros of investment banking fun and fees, the equity value of Telecom Italia is a lowly €4.5 billion but is swamped by debt of €30 billion. Astonishingly, there is a real possibility that despite having more than 150 million customers globally the equity value attached to the franchise could end up being zero…

Starlink: Arguably, Telecom Italia’s demise was due to its failure to convert voice customers into sufficiently profitable data customers. Not all telecoms companies face extinction. AT&T in the US is in a semi-monopolistic market raking in $170 billion of revenues annually. However, even telecom monopolies face a future challenge. The return of attritional war to Europe has been horrific but war does accelerate innovation. One of the outstanding success stories of the war to date is the use by Ukraine of Elon Musk’s SpaceX Starlink satellite internet service; surely, his PR team can do better! Communications over a satellite-based internet platform has proven remarkably robust in wartime conditions and opens up huge possibilities for other connectivity-challenged populations. So, it was striking to see newsflow this week on corporate activity in the satellite sector as French operator Eutelsat announced the $3.4 billion acquisition of its UK competitor, OneWeb. As recently as June,  Viasat from the US completed their own $7 billion purchase of another UK satellite play, Inmarsat. In fact, M&A activity in the satellite sector in 2021 reached its highest levels since 2007 with more than 60 deals completing.

Helium: We have written before about the persistent criticism of crypto/blockchain as a “solution yet to find a problem”. Personally, I have a strong view on the future of blockchain-based tokens, sometimes referred to as “tokenomics”. In particular, I can see the attractions of incentivising users/consumers to contribute to a community or a network. But what about a wireless network? Well, you may never have heard of Helium but its network of IoT hotspots(Internet of Things) is in 65,000 cities and 170 countries connecting more than one million intelligent devices. All of this was achieved by incentivising consumers with tokens/rewards to connect. Now it wants to get involved in 5G and WiFi. We shall watch with interest but it’s not just the cellular spectrum(airwaves) potentially up for grabs in next generation telecoms networks. Get ready for Web3 hardware too. Solana is developing an Android OS phone, Saga, which is designed to navigate the functionality required for Web3 interactions – think NFT galleries, crypto wallets, metaverse real estate and AR/VR applications.

So, our little TARDIS trip has visited the terrestrial past in Italy,  checked activity in space via Ukraine today and then went to infinity and beyond in the metaverse of the future. Not quite Jackanory but it does seem like a new telecoms story is building. Of course, not even a James Webb Space Telescope can help see the future but it is safe to say change is guaranteed. Hopefully, good change. That’s a birthday wish too.

Never before has heat caused so much suffering. It’s everywhere; hot fuel and food pricing, record-breaking heatwaves, oven-ready Brexit, raging wildfires and war. Grim stuff but it could be worse. Liz Truss could be UK Prime Minister….oh……….ahhh they wouldn’t, would they? The Tory party is possibly beyond saving but it’s a resilient world out there with more serious challenges than “woke wars’, and a history of defying our worst fears.

Top of most consumer and financial markets’ lists of concerns is inflation. Furthermore, the knock-on threat of recession is in every portfolio manager, business or consumer survey but let’s cool the doom jets a bit. If we think about interest rates and inflation as dampening “taxes” on economic activity, we need things to cool down but not too much. A “goldilocks” scenario is what Wall Street-types love – not too hot, not too cold – and we’re wondering could China take some heat off the table? Let’s look at three developments in China which are negative/bearish but could ultimately help the wider world…

China Real Estate: The Chinese property market is valued at circa $62 trillion. Yep, that’s about three times the GDP of the USA. However, activity is more important than valuation and the construction/property sector accounts for 25% of annual Chinese GDP. Well, it did. The debt problems of developers like Evergrande have been known for a few years but there’s now a trifecta of pain hitting the sector and causing stress in the banking system:

1. House prices in China have fallen for 10 consecutive months
2. Mortgages held by buyers who purchased homes ahead of construction are currently boycotting payments on more than 300 yet-to-be-completed projects(per Bloomberg).
3. Suppliers to the property sector, spooked by the mortgage boycotts, are in-turn now refusing to pay back loans to their banks until troubled developers pay them. No surprise then that the Chinese bank sector in just the past week has fallen by 8%.

China Economy: China has been on a construction spree for decades. Since 2019 alone a cool $3 trillion of housing stock has been built. Imagine, this is the equivalent of building Great Britain’s entire economy(GDP) in just a couple of years. That huge level of activity has turbo-charged economic expansion and a Chinese Communist Party(CCP) commitment to a minimum 6% GDP growth each year. Until now. Goldman Sachs thinks Chinese GDP growth could be half the norm at just over 3%. That will unnerve the Beijing authorities already dealing with a novel form of civil unrest through mortgage boycotts. Note also, 70% of household wealth is tied up in property so the CCP know the acute political risks of a property crash.

China Demand: A reduction in Chinese economic activity led by construction is going to change the global “inflation” narrative significantly. Iron ore prices are already down 50% from their highs last year, and copper has entered its own bear market with a 30% decline. This should not surprise given recent reports(from Gavekal Research) that the pipeline of floor space under construction in China is down 40% year-on-year. Of course, reduced activity in the Chinese economy is affecting trade figures too. It is striking to see in an inflationary world that Chinese imports were effectively flat compared to a year ago in May. Exports, on the other hand, accelerated to an 18% growth rate. Clearly, domestic demand in China is cooling due to its domestic property stresses.

These three Chinese bear stories above might appear as yet more macroeconomic woes to add to the risk bonfire but there is potential upside to this development. Size matters. In purchasing power terms China is probably the largest economy in the world. That means EVERY central banker has China on his/her risk watch list. The $20 billion of Chinese bond defaults year-to- date is already double last year’s toll and there will be many more. We already know from the 2008 credit crisis and Covid-19 that central banks will act super-fast if financial contagion is a risk. And, let’s just say an estimated $10 trillion of Chinese property debt will have systemic significance in the global financial ecosystem. So, here’s a few things which could happen if this China story develops through the summer….

• Interest Rates: Instead of global interest rates rising, central banks, like the Fed and ECB, might have to reverse course (ECB hike of 50bps this week is its first in 11 years) and cut rates. Do not underestimate the positive impact of the cost of money falling on business investment and financial activity.
• Inflation: If the world’s largest purchaser of goods, China, reduces activity this could have a double-whammy impact. Not only would prices of goods and services stop rising but it is quite likely the Chinese will pressure Russia to end its Ukrainian war. China will need its European customers to trade its way out of a slump and Europe won’t be able to do much buying if it’s dealing with crippling energy costs caused by war and Russia.
• Incendiary Diplomacy : US House Speaker, Nancy Pelosi, is due to visit Taiwan. Beijing is extremely unhappy at this provocation and all geopolitical risk lists suggest an invasion of Taiwan by China in the next few years is very possible. In fact, this month both heads of the FBI and MI5 in an unprecedented joint appearance in London stated that China was the “biggest long-term threat to our economic and national security”. However, in a scenario of a weaker China battling a property crash and its debt-swamped aftermath it is highly unlikely China will willingly inflict more economic pain on its restless citizens.

The above combination of reliefs via falling interest rates, lower inflation and reduced geopolitical risk, including a possible end of hostilities in Ukraine, could be an unexpected global windfall. Of course, those that have profited from a China growing at gangbusters pace for years will be impacted. So, we should think about the following:

Luxury Leaders: China and its newly minted millionaires have had a voracious appetite for luxury goods. We’re not just thinking Gucci or Louis Vuitton will be impacted by a more cautious Chinese consumer. High-end tech hardware leaders like Tesla and Apple are going to feel a cooling effect too. Indeed, Henley & Partners consultancy are forecasting that 10,000 citizens will leave mainland China this year and take $65 billion of spending money with them.

Germany: In a way, Germany was the canary in the China coal mine. Technically, Germany was already in recession before the Russian invasion of Ukraine. Think back to the earlier data on flatlining China imports and then know that Germany is hugely dependent on its $100 billion of annual exports to the Middle Kingdom. Yes, idiotic Russian gas dependency is killing investor confidence in Germany Inc but China is impacting corporate confidence too. Stunningly, the German stock market (DAX) has no company in the Global Top 100 and the combined market capitalisation of all its companies is approximately equal to that of Apple.

FTSE 100: In Liz we Truss “to hit the ground”. Good grief, if choosing an inert gas as Prime Minister (think her nickname is ‘Radon’) would be bad enough then think again. The UK stock market leaders in the FTSE 100 index are massive plays on China – see HSBC and all the mining giants like BHP and Rio Tinto. A faltering FTSE to add to a brewing Great British Peso crisis will add to Boris Johnson’s legacy as Global Britain’s second worst PM in history and the hubris of his exit interview in Westminster as “mission largely accomplished”

As always, there will be winners and losers. Apart from the weather, many things are already cooling and mainstream financial media(and central bankers?) are possibly guilty of looking in the rear-view mirror. Watch China carefully and hold the counter-intuitive thought that a distracted Beijing might actually be a global good thing. Stay cool.

Oooh that hurt. Not even the 6 billion Panadol tablets manufactured annually in Dungarvan are going to ease the valuation pounding of the first 6 months of 2022. And you thought the Nasdaq or crypto was bad? The 29% decline of the tech-heavy Nasdaq index might compare favourably with a 58% Bitcoin implosion but spare a thought for smaller publicly listed companies who rarely attract the headlines. Yardeni Research have just published a note showing valuations of US smaller caps have effectively halved over the past 18 months to now trade at price/earnings (P/E) multiples of 11.2x. For the additional valuation wince, note the “E” bit in P/E is probably falling too. That’s the stuff of 2008 nightmares but founders and fundraising teams need not freeze in fear. Keep going and keep sensible. The following thoughts might help:

• Valuations: Yes, valuations have moved but they will keep moving. They are always moving. Equity markets in an average year experience ‘volatility’ of somewhere between 18% and 20%. However, understand the difference between price and valuation multiples. Investment decks and proposals must reflect the fact that valuation multiples have ‘compressed’ in recent months. For example, in the previously ‘hot’ sector of SaaS – software-as-a-service – publicly quoted companies (a sample of 123 companies followed by Blossom Street Ventures) have reverted to revenue multiples(EV/Revs) last seen in 2016. Average sector multiples of 24x have cratered to just 8.5x. E-commerce companies have gone from 2.5x to 0.8x but gaming companies have been more resilient shrinking from 6x to 5.3x. Know what multiples are realistic for your sector or story.
• Public v Private Markets: Price discovery and valuations are instantaneous when looking at publicly listed companies trading every milli-second. Private markets are less liquid(don’t trade) and allow for more flexibility and much longer time horizons. Indeed, the mention of time horizons might conjure up wise sayings from Warren Buffett but our message is more blunt. Deal with ‘grown ups’(credible sources of capital) and avoid time wasters or those looking to run the clock down and perhaps force a founder into a last minute valuation crunch as a startup’s cash position becomes more stressed. Choose your funding conversations carefully.
• Cost of Capital: The biggest driver of capital markets by far is the cost of funds/interest rates. Again, investment proposals should reflect the reality of higher costs of capital. Not only does this affect valuations, in certain sectors it changes the risk profile of the proposition significantly. Note the recent fundraising conducted by Klarna whose business is financial services or, more specifically, lending to/funding consumers when they purchase goods online. A year ago Klarna raised money with a $45.6 billion valuation. Last week, not so much. The new valuation was $6.5 billion or a whopping 85% lower than 12 months ago. We have written endlessly about the risks of franchises dependent on “other people’s money”. So, the reality of rising interest rates is that lots of vulnerable business models have been hiding behind capital/money being almost “free”. That era is now over and startups exposed to “other people’s money” need to demonstrate a very robust business model. Be able to tell and sell your business model well.
• Sectors: We have mentioned SaaS, gaming and financial services in earlier valuation comments. While a bear market can sometimes feel like everything is falling in unison (correlations very strong) the more discerning investors will be looking for specific sector opportunities. The opportunities in food(agtech) and energy(renewables) are already receiving substantial VC interest. In Q1 alone the agtech sector(per Pitchbook) attracted $3.3 billion globally across 222 deals. Also, spare a thought for the business climate as margins are squeezed by inflation, higher debt costs, rising labour costs etc. Good old fashioned cost-saving solutions and services will attract serious investor interest too. Show real money examples.
• Revenue vs Cash Flow: Not too long ago it was all about growth. Every pitch, every deck was decorated with fabulous growth trajectories. Revenues were king. They still are but there’s a new queen in town. Guggenheim has published a fascinating analysis of the factors that drive the valuations of software companies, the ultimate growth bunnies. The most striking factor relationship of all was that between revenues and free cash flow(FCF). A year ago revenues as a factor were 4.9x more impactful than FCF on valuation. Now the impact gap has more than halved to just 2x. The big message here is that cash flow(or burn) is becoming a much more significant focus for investors. Note to fundraising teams – make sure founder slide decks address cash flow/burn.
• Storytelling: We can bang on about prices, equity shares, valuations, sectors and macroeconomics but ultimately the exit or funding achieved is what can be achieved on the day of the deal. Don’t underestimate emotion, chemistry and engagement as drivers of that deal. The story is critical to engagement and a shared vision of the future with investors. It is remarkable to see how many fundraisings have lawyers and accountants lined up but have sought zero professional input on how a company story is told. For example, in the current environment trying to be a solution to too many problems (‘Swiss Army knife” syndrome) can be a good ‘platform’ story but might struggle given multiple anecdotes coming from the pitching coalface. That’s the market right now. Focus your story professionally.

So, don’t be paralysed by the mainstream financial media headlines. There are lots of deals being done. Would you be surprised to know that there were 239 ‘unicorns’ or $1 billion valuations achieved in the first 6 months of 2022? That’s not far off the 267 achieved a year ago. Sounds like a lot of stories being told well.

What’s your story?

Civil war? Surely not. How about an attempted coup? Surely….. oh wait, too late. We learned last week that January 3^rd was the really frightening date in 2021 rather than the Capitol Hill insurrection on January 6^th. On the earlier date the US Department of Justice (DOJ) narrowly escaped being taken over by a rogue Trump regime and was only saved by the threatened resignation of hundreds of DOJ staff. Incredibly, that was not even the biggest news of the week, or even of the next 24 hours.

The shocking 50 year reversal of women’s privacy and healthcare rights established by the Roe v Wade case had been flagged weeks earlier by a leak from the offices of the US Supreme Court (SCOTUS) but there was so much more to digest in the 6-3 ruling. In fact, freedom of choice on abortion is just the thin edge of a lethal politico-judicial wedge. ESG may seem like a strange place to start our analysis given the human tragedy facing the US. However, ESG is a useful framework to understand where the US is going. First, let’s look at governance, the “G” in ESG, and see why the SCOTUS ruling sets the United States of America on a path to civil war between “two countries” within the borders of one federal entity.

The 6-3 majority judgment in Dobbs v Jackson Women’s Health Organization does not actually restrict choice on abortion. Instead, it removes the constitutional protection of that freedom of choice. In other words, Federal institutions, courts and government since 1973 had blocked any legislation in individual states which could restrict those constitutional freedoms. So, the consequences of this judicial reversal are likely to manifest themselves in three significant ways:

1. Individual states are now free to use their own laws to restrict abortion services and use the criminal law to underpin that legislation. Already, thirteen US states have automatically criminalised the provision of abortion services thanks to “trigger laws” awaiting the overturning of Roe v Wade. A further 9 states have restrictive legislation in place but will likely move to outright bans on abortion.
2. Women and medical professionals will be watching closely the ‘colour’ of state control. Unified control of the governorship and legislature of each state will divide the US into ‘red’ and ‘blue’ states. The current count looks like 25 red states, 17 blue and 8 ‘purple’ where state-government control is divided. The chances of socio-political divergences between red and blue states will grow irrespective of national/federal consensus. For example, at a national level up to 80% of the population support abortion rights. A powerful minority is punching way above its weight and is about to punch many more…
3. The concurring opinion(with the SCOTUS majority)of Justice Clarence Thomas in the Dobbs case is a worrying read. He appeared to offer a preview of the court’s future rulings in cases involving LGBTQ rights, contraception rights and same-sex relationships/marriage equality rights with the potential use of the Dobbs precedent to overturn those protections, or delegate legislative power to individual states. Decades of constitutional precedent are clearly under threat from a right-wing majority SCOTUS advancing the agenda of a powerful political minority.

Before we consider the Social consequences or “S” in ESG it is important to recognize a significant development in US democracy. The attempts by the Trump regime in the days leading up to January 6^th to illegally hang on to power should not be dismissed as a once off aberration in the history of US Presidential transfer of power. The GOP in red states have been working furiously since the 2020 election to install extremist individuals in positions of influence at a local state level to maintain political dominance. The relatively quiet legislative frenzy to make voter registration more difficult and the imposition of blatant gerrymandering frameworks on voting districts has ensured indefinite control of many red state legislatures. In effect, one-party states have been established.

The recent socially conservative legislation has attracted more headlines but as any ESG analyst will tell you the most significant factor in corporate performance has always been the ‘G”. In a sovereign and political context it’s all about POWER and how it is wielded. Here are a couple of developments which suggest power at a local level is about to challenge the cohesion of the United States as a federal entity:

• Borders are a critical feature of sovereignty. However, in recent months the Texas Governor, Greg Abbot, unilaterally imposed “enhanced safety inspections” on the Mexican border by executive order. This flexing of power was merely electoral grandstanding against federal immigration policies but caused billions of dollars of commercial damage.
• Elections are essential to a functioning democracy. But what if one party won’t accept election results? If you believe the November 2020 Presidential election was an isolated event involving a delusional mobster think again. This month a Republican controlled county commission in New Mexico refused to recognize election returns citing unfounded conspiracy theories about voting machines. Sound familiar? Get ready for more, a lot more, ahead of mid-term Congressional elections this November.

The prospect of power being effectively seized and conservative laws being imposed at state level could be dismissed as merely another ugly social trend in US history to accompany out-of-control gun deaths, opioid fatalities and a hard-to-believe decline in US male life expectancy. However, the recent mass shooting at a supermarket in Buffalo, New York, highlighted the dangers of politicians and media figures stoking fear. The accused, Payton Gendron, was just 18-years old but had written a hate-filled manifesto citing ethno-nationalist motivation and support for a far right “Great Replacement” theory which references “white genocide”. Hmmm…..where did he pick this theory up?

Interestingly, since the Buffalo atrocity, the Fox TV channel has gone curiously quiet on “replacement theory” but it has been documented that its star fear-monger Tucker Carlson has referenced this theory a whopping 400 times on his show. It’s not just the media fanning the flames of conflict. Some politicians seem to wish for conflict too. Take former Iowa Congressman, Steve King, who shared a Twitter meme about “another Civil war” and then posed this delightful question – “Wonder who would win…. One side has about 8 trillion bullets, while the other side doesn’t know which bathroom to use”. We should be worried and so should ESG investors. They might have to choose sides.

At a corporate level many of the US’s largest companies have announced they will cover the travel expenses for their employees to access abortions. However, these companies also make political donations and have invested in the same states who are ripping up legal precedent and ignoring the “S” in ESG. Something has to give, or no longer give. The following areas in ESG frameworks are in need of urgent attention:

• Supply chains: Are a company’s suppliers based in red states?
• Finance: Does a company insure or finance investment in red states?
• Customers: Does a company sell goods/services to companies and individuals in red states?
• Environment: The “E” in ESG will come under pressure as Federal power is challenged by fossil fuel-friendly states.

This might seem like a rather extreme extension of ESG considerations. However, the Roe v Wade reversal has shone a global light on the power grab occurring in the US. Businesses can expect employees, customers and investors to begin asking questions and we should be watching Federal-state tensions very closely. Even the Pentagon is concerned. Actually, it has gone far further than expressing concern. The top brass have effectively announced it will not recognize the SCOTUS judgment and will continue to provide women’s healthcare to its sevice members and their families. Excuse the militaristic phrasing but that is “tanks on the lawn” defiance. Sadly, military phrasing could become very real, and required a lot sooner than most expect.

“Crime is contagious. If the government becomes a lawbreaker, it breeds contempt for the law; it invites every man to become a law unto himself; it invites anarchy.”       

– Louis Brandeis

Anyone hear of Mick Lynch before this week? No, me neither but now I’m obsessed with the guy. Who knew train strikes could be box-office viewing material. Well, not quite the strikes. Britain’s once-proud railway system is far from perfect but Lynch as leader of the railway workers union, RMT, has become an overnight media star and exposed something far more dysfunctional; media “sponsorship” of political agendas. Interviews of Lynch by leading media figures featured blatantly ill-informed attempts to paint the RMT man as an evil Trotskyite bent on class conflict. The tags tossed into the ring ranged from the predictable “Marxist” to the historic “Scargill” picket violence to the bizarre villainy of the “Hood” character in the ‘60s animation series, The Thunderbirds. Yes, really.

The media agenda was clear but the outcome was brutal….for the interviewers. Lynch destroyed Richard Madeley, Kay Burley and Piers Morgan in a 24 hour period with a powerful mix of calm straight-talking, patient listening and quick wit. If it was bad for the journalists, the hapless Tory government mouthpieces rolled out to challenge the union bogeyman on national TV endured even worse humiliation. The hilarious Paxman-Ben Swain mega-blink in the BBC comedy series “The Thick of It” did spring to mind as Jonathan Gullis, Rachel McLean and Robert Jenrick floundered, clicked their heals and wished they were in Rwanda. Brutal stuff but why the initial over-enthusiastic mission to bury Lynch?

Perhaps the stakes were a little higher than railway worker wage negotiations. Inflation to date has mainly been characterized as a global ‘cost of living’ crisis. Bluntly, that form of inflation hurts poor people hardest. However, if wages rise to respond to increased prices of goods and services there is the possibility of triggering an endless spiral of wage inflation which moves in waves across various sectors of the economy in a hopeless attempt at ‘catch up’. That sort of inflation hurts businesses, their profit margins, their share prices etc. Oh, and it hurts richer people. Hence the suspicion that the politicians and media were ‘encouraged’ by establishment-types to keep the little people in check. However, there’s a huge elephant in the labour relations room and Mick Lynch communicated this incredibly effectively this week.

Unlike almost any previous period of sustained inflation rising worker incomes cannot be blamed for contributing to price inflation. Mick Lynch has correctly pointed out that wages across many sectors have seen minimal increases over the last 10 years but that the cost of living is seeing annual increases 2-3% per annum every year before spiking almost 10% this year. Let’s be clear – wage increases of 5-7% over ten years are no match for 25% price inflation. The really scary truth is that Lynch could have made even more powerful points. But allow me…..

• We have written many times about income inequality levels (between rich and poor) being at their most stretched since the 1930s. That’s an uncomfortable fact for those urging “restraint” in current wage negotiations.
• In the past 40 years the relationship between labour(working wages) and capital(asset ownership) has completely broken down, in an unhealthy way. For the first time in generations children can expect to grow up to be poorer than their parents as the affordability of housing, transport, education, healthcare, childcare etc becomes more challenging.
• In other words, asset prices have been rocketing for years as real wage growth stagnated. Note the “real wage” reference. The real bit is inflation adjusted. So, even if you had been getting a pay rise of 3% every year and inflation was 2-3% you really weren’t making much progress in income generation terms.

So, is wage inflation inevitable and does that spell business and economic turmoil? Maybe the short answer to that is that if the 1930s type level of inequality continues we could easily end up with 1940s type catastrophe. Labour and capital(asset owners) need to find a new equilibrium. That might sound like bad news for business margins, share prices, GDP growth and productivity but this is not the 1970s. The workforce and businesses are more flexible, less unionised and technology driven/supported so it is entirely likely that wage inflation will not end up in a multi year spiral. If that is the case, there are real opportunities to see economies and societies enjoy the following additional benefits of a period of supra-normal inflation:

Debt: There is still way too much debt in the world. Inflation reduces the ‘real’ weight of that debt burden on individuals and governments alike. In fact, not that long ago the most extreme fear of central banks and governments was DEFLATION.

Government/Fiscal Health: The Trump presidency, apart from proving that the US was closer to Venezuela than any map would illustrate, showed that the establishment/right-wing mantra of the “trickle down” effect of tax cuts(for the rich) was utter “twaddle” as Mick Lynch would say. Instead, the Covid pandemic support payments showed how poor people when they receive an incremental dollar, do in fact spend that dollar. That dollar then feeds into the economy and the multiplier effect means multiple transactions generate sales taxes, VAT, regulatory fees etc. This also means governments recover a lot of that incremental dollar. So, what if poorer workers had some extra dollars to spend? Yep, government treasuries should be happy. 

Pensions: Inflation prompting a re-set of interest rates should be considered pension healthy. More normal interest rates generate higher yields/incomes across asset classes and also prevent high-risk speculative investing when yields are too low.

Innovation: Inflation is a challenge. Businesses and societies are already making adjustments but challenge also spurs innovation. Companies which were built in challenging economic periods include Apple, Microsoft, McDonalds, Disney, IBM, Sony, Fisher-Price and General Electric. If we go back to the last serious inflation period in the ‘70s we saw Japan completely change the world of manufacturing. Perhaps, this time the war-accelerated transition away from fossil fuels will not only save Ukraine, but also save the planet

We have very short memories. Only a few years ago the big fear was Europe and Japan falling into deflationary spirals. Believe me, that would be very ugly.The truth is that every central bank wants inflation but not too much. It’s all about balance and, if Mick Lynch gets his way, a little bit of fairness too.