25 Jan 2022
Do we get the leaders we deserve? In many ways we do – as people who rise to the top have a habit of reflecting the mood at that point in time.
Looking at last week’s news I was struck by the geopolitical themes that were whirling around. Russia was to the fore, with tension on the Ukraine border. The responses of leaders in the West were, to say the least, confusing. President Biden mis-spoke and suggested that minor incursions would be treated less harshly. This was later corrected but the damage was done. From an American perspective, however, Russia is secondary to the concerns about China – and the Pacific is now the US’s main geopolitical hotspot. Over to Europe to sort out.
The German leadership, as far as it can be identified, wants Russian gas and to prioritise trade. This is a big problem – as the continent’s economic giant lacks equivalent political clout. Moreover, a giant who will not spend adequately to defend itself – and relies on others to do the ‘hard lifting’ lacks moral authority. President Macron, following a Gaullist line, wants Europe to take the initiative on Russia, downplaying NATO, but ignores the fact that no one else wants to follow that course. Prime Minister Johnson talks tough on Russia as if the UK was a superpower of old rather than a country failing to come to terms with its loss of economic, military, and political status.
The respective leaders in Russia and China have returned to models of leadership more familiar to past generations. The West’s hopes of political liberalisation, as these economies become more globally integrated, have been dashed. But it is not that the leadership in Russia and China are unpopular. Russian and Chinese nationalism, and the concept that these countries are returning to their rightful places in the geopolitical pecking order, are powerful domestic themes.
Does this matter to markets? Yes, it will if we get gas prices spiking on a Russian invasion or the semi-conductor market is disrupted through a Chinese move on Taiwan, irrespective of the risk aversion that such developments would cause. Perhaps western leadership has become complacent, thinking that the tide of history was bound to work in their favour. But that probably reflects the mainstream view in western societies. We get the leaders we deserve.
There was an interesting development in markets last week: the decoupling of ‘growth’ equities from long-term interest rates. Basically, the story of recent years has been lower discount rates (long bond yields) being correlated with the outperformance of ‘growth’ equities. The rise in long bond yields over the last month brought a halt to this trend – but last week we saw lower long bond yields and lower equity valuations. Indeed, it seemed that lower equity prices were pushing down yields – as a risk aversion trade. So, in spite of an inflation surprise, 10-year UK government bond yields ended broadly unchanged whilst 10-year US rates moved down to 1.75%, despite more hawkish messages from the US Federal Reserve. Implied inflation was lower as real yields did not match the fall in nominal yields.
Looking at the UK inflation data in a bit more detail: The December UK Consumer Price Index (CPI) came in at 5.4%, the highest rate since the early 1990s, whilst Retail Price Index (RPI) jumped to 7.5%. Alongside robust labour market data it is now hard to see the Bank of England not hiking rates to 0.5% in February (although it did catch markets out in November by not moving). This will further squeeze disposable income at a time of higher energy prices and national insurance hikes (if they actually happen). Adding to this gloom, UK retail sales fell well short of expectations in December.
Sterling continued to make ground – despite the internal tensions within the Conservative Party and doubts about the future of the Prime Minister. The good news is that the success of the vaccine programme and the UK’s early encounter with Omicron puts us in a good position to return to more normal conditions earlier than most.
Credit appeared less impacted by risk aversion than equities. In investment grade sterling credit, the index spread moved 2bps wider and at times bids looked away from expectations. But we were not inundated with offers either. In our global strategies we looked at a lot of new issues. An interesting case was Ceramtec, a German manufacturer of advanced ceramic components. Although rated CCC-, and against the ‘risk off’ background, the issuer was still able to raise nearly over a billion euros of debt and loans. Emerging market credit was impacted by the Russia / Ukraine tensions but Chinese property company Cogard was able to do a convertible deal. So, despite the less helpful background high yield markets remained relatively well behaved.
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