Blain’s Morning Porridge – 23rd November 2023: Why we won’t fix the UK by selling Natwest to irrational retail investors….

“How merciful a thing is man’s ignorance of his immediate future… Prunesquallor was in his study..”

Jeremy Hunt tried hard to be interesting, but it was all a bit forgettable. An election is coming. How bad will it be? As for selling Natwest to fund UK growth – has Hunt actually considered the outlook for banks as the risk outlook deepens?

Life is a series of journeys… each apparently teaches us something. Yesterday the lesson was profound: bring the bike next time.

Apologies for the lack of Morning Porridge y’day. I was having a manic day flipping from meeting to meeting around London. Due to some daft scheduling on my part I found myself going that way, this way, East to West and back again on London’s aging Underground system. The Tube sort of works, but it is Gormenghastian – a few parts of bright, shiny newness, but a fading reality of decay and dissolution pervades it all.

A few moments trying to figure out the Circle Line (which is not a circle anymore) from Baker Street demonstrates how seriously stressed and decaying London really is. Still, I found time for a quick lunch with my daughter – which made everything OK – at the cost of a lecture on everything that’s wrong with the economy from GenZ’s perspective. She has a great job she loves, but is on the edge of despair over the unaffordability of London life – I would guess most Londoners have a similar perspective on how the UK is failing them as their wallets and purses suffer the equivalent of an overdose of Ozempic.

Gormenghastian – what an excellent word I’ve just invented to describe the UK economy.  The Tube, the NHS, poverty, decay, infrastructure, railways, roads… Gormenghast is the perfect metaphor. If you’ve never read Mervyn Peak’s excellent trilogy of despair, ritual, madness, denial and conspiracy – then changing the setting from one imaginary decaying gothic palace to the banks of the River Thames at Westminster is not a great leap of the imagination.

Yesterday’s budget statement was oh so formulaic and forgettable. A political set piece that will fix little and was a positioning move ahead of the UK election – Spring next year is now the betting. The Tories will seek to exit with some little honour intact ahead of the risk the UK tumbles into full recession which the outgoing shower will conveniently blame on the new guys.

So let’s not overthink Chancellor Jeremy Hunt’s musings on how he will kick-start the UK economy by charging the highest tax rates in recent memory, deeper doses of austerity, punishing those on benefits, or trapping millions of workers in “fiscal drag”. Let’s think about how he will be using the limited “headroom” the OBR say he has to bribe the electorate with vague more of less promises. The speech will be utterly forgotten, consigned to the dusty vaults of the cycle of history in just a few days time.

I’m not going to waste time analysing it – if you want an analysis I recommend Martin Wolf in the FT: Hunt may be lucky but he has not solved the UK’s growth challenge. I will give Hunt full marks for allowing corporates to expense 100% of spending… and that’s about it.

What I did not hear was anything meaningful on repairing, renewing, making fit-for-purpose, the UK’s decaying state infrastructure? Nope. Over the last 13 years the UK has come to resemble Italy in how fast Prime Ministers have risen and fallen. Multiple ministers have come and gone leaving no discernible mark on the economy. How does the Government intend to repair the last 13 years of disregard for the nations plumbing? Nary a word.

If the UK was a cardiac patient, there would undoubtably be an Aspirin shortage, (and a govt VIP fast-track to solve it), we’d be on multiple statins and blockers, while receiving repeated warnings from despairing doctors. The reality is we need more exercise: equivalent to growth to pay the taxes we need to restore, rebuild, and relaunch the economy.

My ears did prick up on the comments about selling off the government’s remaining 38% holding in Natwest. Really..?? If I was a investor.. I’d run a mile.

One of the key concepts everyone seems to forget in investment economics is the concept of lag – how long it takes consequences and effects to work through the economy. We all know that raising interest rates yesterday will have consequences tomorrow as mortgage costs rise and house demand splutters. We all know higher interest rates plus inflation as are a double assault on discretionary spending that becomes tougher to reconcile with every pay packet. And we will shortly see how the increasing costs of debt on leverage result in rising corporate bankruptcy and default. These consequences are gradual and cumulative.

However, consequences are not always slow and observable. They can stack up and suddenly tio over. Some of the consequences of higher rates and inflation will only become apparent in a sudden and apparently chaotic moments.

Interesting then the ECB – not known for its market hyperbole – warned Eurozone banks are seeing early signs of stress. I am going to send ECB vice president Luis de Guindos, one of my coveted “No Sh*t Sherlock” awards for spotting the downright bleeding obvious. I wonder if he noticed just how suddenly a bunch of banks (Silicon Valley and Credit Suisse among them) collapsed earlier this year? What brought them down was the perceived losses on their hold to maturity loan books – US Treasury Bonds rising from 1% to 5% created enormous notional holes in their accounts as bond prices collapsed 30% plus. That scale of losses would overwhelm capital buffers and sink any bank if these portfolios were actually sold in a period of market stress.

The truth is: In banking it doesn’t matter what real or notional losses are. It’s all about confidence. Banks do not die slowly. They die very, very fast. A sure sign its terminal is the pace of withdrawals – queues of angry depositors outside the front door means you are too late.

Yesterday the ECB made some soft murmurings about how the “risks to financial stability may appear less acute, but they remain elevated.” But rising loan defaults, late payments, crashing asset quality, and capital buffers under pressure are a clear problem. They are also cumulative. At some point they can capsize the ship. What is not clear is just how resilient European banks will be to such a tip risk as the solids hit the air conditioning if/when a full-scale recession bites and the problems escalate?

Just a few weeks ago I expressed my doubts about banks and the market’s lack of memory when I lambasted the UBS Additional Tier 1 (AT1) Contingent Capital Bonds. I was delighted to hear from some Australian chums of mine – they quoted the article at length in The Inside Investor: Market’s goldfish memory on display in oversubscribed UBS CoCo deal.

Call me over sensitive, but the recent slew of bank capital AT1 deals – from a screed of European names – highlights a cardinal rule of banks: raise capital when you can, not when you have to. Banks are not stupid; they know the terms of capital are moving against them as the economy becomes increasingly difficult for them, hence they are raising whatever capital they can.

Investors are funding these deals because they sniff great returns – but are they underestimating the risks? Next year Europe and the UK are likely to remain sluggish if not in full recession. Credit losses will be rising. Consumer debt losses will be increasingly problematic. The schedule of capital refinancing for banks is going to become problematic as losses and provisions deepen. And, it’s likely the ECB will be more focused on strategic issues at sovereign debt level, rather than the tactical issues of funding banks.

Which rather puts Jeremy Hunt’s plan to solve the UK’s leaky wallet by selling its 38% of discredited Natwest Bank into perspective… Don’t.

And finally… More about OpenAI once the dust has settled. Time I wrote more about Crypto. And it’s not a great day for turkeys in the USA. May our American cousins enjoy their Thanksgiving feast. This time Next Year we all might be contemplating something very different indeed…

Five Things to Read This Morning:

BBerg               Hunt’s Tax Cuts to Squeeze UK Public Services Beyond the Election

FT                     Hedge fund short sellers suffer $43 bln of losses in market rally

FT                     Anglo American’s high-stakes bet on a new way to feed the world

WSJ                  Larry Summers is OpenAI’s Surprise Pick to Mend Fences

WSJ                  Inside Binance’s Guilty Plea and the Biggest Fine in Crypto History.

Podcast Special: Discussing OpenAI, Real Assets & Global Economy Trends

Shard’s Head of Research, Ernst Knacke, alongside Market Strategist, Bill Blain. Together, they delve into pivotal market developments and headlines: from dissecting the recent OpenAI transformation and its impact on Microsoft, to an insightful exploration of real asset markets, spotlighting enduring commodities like gold and gas. Explore their in-depth analysis of global economic trends, political competency, and corporate governance, backed by real-world examples from Argentina and Greece.

Out of time and too much to do..

Bill Blain

Market Strategist – Author of the Morning Porridge