Markets over the last three months have fallen slightly but are still much higher than a year ago. This is despite all the negative stories. A saying when I first came into stockbroking was that “Wall Street climbs a wall of worry.” When times are bad often the market rises. That is because the market is looking ahead and forecasting a recovery. The UK and most major economies are now experiencing a strong recovery and the UK economy still has plenty of room for further recovery in the coming year. Estimates for GDP growth are now over 5% in 2022. Consumers are still sitting on significant accumulated savings they were not able to spend during the pandemic. Yes, some are worse off but we estimate UK consumers have saved around 10% of GDP more than they normally would. In contrast to the last recession, house prices have risen by 15% since the start of 2021 meaning that the 65% of householders who own a home feel richer. Interest rates remain very low. Although forecast to rise in November, the current forecast is for rates to settle below their pre- COVID levels. The percentage of income being spent on mortgages and other debt is far below the levels that caused problems in 2008. 35% of households now own their own home without a mortgage and the 30% that own with a mortgage, half have fixed for 5 years. The furlough scheme has ended which has kept 1.6m jobs protected but on the other hand there are currently 1.2 million job vacancies. Not all will be able to retrain but many will. Cheap valuations Added to this UK shares look cheap on several measures. Relative to other developed markets the UK market is now 35% cheaper. This is partly because we have much fewer tech companies, but the gap is now too stretched. We also have a lot of the more ‘boring but stable’ companies in the oil, mining, and industrial sectors, all of which have improved of late as demand has picked up meaning these companies’ profits will increase over the next couple of years. Take over activity is high, with Morrisons, one of the companies, to recently succumb.   Paul Coffin

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It can sometimes be hard to decide what to write about but a cursory glance of the performance statistics for the last 3 months and then viewed slightly differently, over the previous 1 and 3 years clarified a theme that has been developing in my mind recently. Namely differentiating between the fact and what essentially is fiction or noise. Let’s take the oil price. The performance table indeed shows that it has risen 10% during the last 3 months and indeed 98% over the last year! Shock and horror. However, a slightly longer-term perspective of 3 years shows that the price is more a less the same as it was 3 years ago. Those three years have been quite a tumultuous few years and for oil witnessed a period encompassing a complete collapse in the demand for oil during lockdown and a subsequent demand spurt in the recent post lock down months. What is clear though is that we have been here before.    

Table 1. Stock Market Performance  Oct 5th, 2018 – Oct 5th, 2021

    I recall a history lesson at school where we were taught the value of Primary research over Secondary and to look for the original wording and source. This can be especially beneficial when researching companies. Fortunately, the Stock Exchange has a service called the Regulated News Service (RNS). It is a bit like the Associated Press (AP). AP put out the factual story, then news companies take the story, journalists rehash it and if I were sceptical might say that, often the story in the headlines ends up completely different, or at least let’s say, dramatised in one way or another. The RNS service is where a listed company must publish its annual results and any news stories concerning the firm that may affect the share price. So, for example, changes in directorships, new contracts which will significantly affect revenue. When I was relatively new to stock markets an older peer, passed on some good advice, which was to check the RNS each day for companies I follow, or indeed for stories about companies that may look interesting. Today there are literally hundreds if not thousands of these announcements, and while you cannot follow everything, I do still look through the announcements regularly. This is the best way to get the facts, and there are often many facts contained within the statements, such as a company’s set of accounts, that are never noticed or mentioned in the press. It does seem to be becoming harder to separate fact from fiction. During the recent ‘petrol shortage’ I heard several news reports mentioning the ‘petrol shortage’ when there was no such thing. This was also true of the stories around gas. The initial stories made much comment about the UK and how we were at the whim of Russia. A search on the ONS or British Gas website shows the UK receives 44% of its gas from the North Sea and the East Irish Sea. The rest comes from various countries but a large amount from Norway and Denmark with under 5% coming from Russia. 24-hour news and social media clearly make news travel a lot faster but are also making it harder to get the real facts through, although conversely this can create opportunity if a company is sold off when the facts are wrong.   Paul Coffin  

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Post lockdown booms and higher prices have elevated inflation around the world as supply bottlenecks, shipping distribution and recovering demand have been driving up prices.   Higher commodity prices and cost of energy have also been lifting headline inflation. Currently these higher prices have forced some Emerging Market (EM) central banks to already act. Brazil, Mexico, Russia, South Korea, and parts of central and eastern Europe have already started increasing their interest rates, while others are willing to wait.   However, investors should not be too worried about the upward move in inflation across much of the EM’s. It should be viewed as an expected part of the economic normalisation of the post Covid-19 crisis.   Outside EM’s, central banks have so far taken the view that these pressures are transitory and will sort themselves out, but it is not that simple. It is worth thinking about the changing forces behind inflation as they arguably point to longer higher prices.   The UK annual inflation rose to 3.2%, a jump of 1.2% since July. Rising prices for food, hotels, and transport were behind this increase in the consumer price index (CPI). The Office of National Statistics (ONS) has stated this cost-of-living raise is likely to be temporary due to last August’s food prices being artificially lower during the ‘Eat Out To Help Out’ scheme, time will tell.   On 17th October the Governor of the Bank of England (Andrew Bailey) spoke at a virtual meeting of the G30 group of current and former central bankers. Bailey affirmed his view that recent spikes in inflation will be temporary. He also warned that price increases could last until next year, specifically citing the energy sector. This comment comes ahead of the latest UK CPI numbers when inflation for September is expected to remain unchanged at 3.2%, according to consensus. The Bank of England’s inflation target remains at 2%.   Unless wages keep pace with rising costs, inflation is generally negative for consumers, but what does that mean for investors? Inflation is perhaps the biggest topic for global investors, following Covid, the logical question is what action central banks plan to take to tackle it and when.   Leading investment banks are reporting that rotation is happening everywhere, from growth shares and risk assets such as Emerging Markets into classic value sectors such as energy, cyclicals, and financials.   Investor unease is the highest it has been for some time as rising inflation tends to be seen as bad news for markets. For equities, it can make it harder for some companies to increase their earnings growth if they do not have any pricing power and operate in very competitive industries. With bonds, having a fixed return, inflation eats away at those returns. However for other sectors such as, energy shares, real estate investment trusts and consumer staples business inflation can lead to higher profits.   Whatever the conditions choosing the right investments, is what we endeavour to do.   Stephen Lovelock

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The words ‘A Perfect Storm’ are being used increasingly in recent days as several chickens come home to roost. The evidence that the recovery in GDP from the COVID-19 pandemic may be starting to slow down is gaining credence. There are twin brakes on prosperity. These are supply chain frailties and the rise in inflation. Central banks from the Federal Reserve to the Bank of Japan and our own Bank of England deem the spike in inflationary pressures to be ‘transitory’. In other words, it’s here today and gone tomorrow. How then can one reconcile that with the Bank of England’s statement that inflation could breach 4% later this year? Given we are already in October, that suggests the inflationary spike is strongly positioned. Of course, the Bank will be looking at its chosen Consumer Price Inflation (CPI) measure inflation and not the old-fashioned Retail Price Index (RPI) which due to the way is calculated would show a much higher rate. In my opinion, it is a much better guide. Many UK Inflation linked government bonds are still linked to the RPI and therefore, holders of those will do well as their investments will keep up with what I believe is the real rate of inflation. Inflation is just one of the things that markets are worrying about. Many are asking why so many investors are worried, given that markets like a modest degree of inflation? The answer lies in the threat of higher interest rates as just about everyone from consumers, companies and of course, Governments have got used to cheap money. This is true not just of the UK, but worldwide. The pressures have come in two ways. The supply chain problems and the apparent loss of those willing to supply labour. We may think that the UK is a special case with EU workers not returning after the COVID break, but it appears to also be the case in the EU and US that less people are willing to join the Labour Market. There just seems to be less people wanting to be in the workforce. Maybe Covid has radically changed some people’s living habits after a long period of Government subsidy. Many situations exist in the economy which cannot be explained by traditional analysis. Take for example the jobless rate and house prices. We are told that up to a million EU workers are reported to not have returned to the UK. If this were true you would expect high vacancies for rented property and reduced demand generally for housing. Given the lack of supply and increase in house prices this analysis seems unlikely. Certainly, one of the side effects of COVID seems to be disruption in many areas. Uber drivers leaving the industry to set up at Amazon warehouses means Uber fares are skyrocketing; staff in restaurants, pubs and bars are retraining. This is quite understandable as those industries had no work for 18 months. We are still living with the disruption caused by COVID. Now we come to the energy price rises that are taking place. Something that COVID but also the race for renewables has disrupted. One small business I know came to the end of its electricity contract a couple of weeks ago and the new price offered was 100% higher. Strangely, because they were slow to respond, the business was put onto an emergency one-year tariff. These are normally much higher than a standard tariff, but the one-year tariff had been fixed at the start of the year and was only 50% higher than the last one. Lucky, but still a huge increase. The last time there was an energy crisis in the 1970’s it ended in inflation and a recession. That was OPEC induced. This time is it the Russians? We hear about gas supply restrictions, but the reasons go deeper. Russia only supplies 1% of the UK’s gas. The switch to new sources of energy has meant that less time has been devoted to finding readily available fossil fuels.  This is particularly true in countries that have closed coal fired power stations and replaced their electricity output with wind turbines only to find that sometimes winds are subdued, and turbines are stationary. This all suggests that massive changes in how we live need to be handled very carefully and planned for a long-term outcome. This does not seem to be happening around the world and there will be many bumps along the way if planning is inadequate. Replacing gas boilers for example with air-source heat pumps will be another big bump. Electric charging infrastructure is another awaiting us – will it be in place before we all have to buy electric cars? Is the stock market taking any notice? Apparently not as valuations remain at high levels. Albeit some of the recent new issue froth has begun to diminish as planned flotations, such as Marley, have been side-lined. Inflations looks less than transitory as the Bank of England has increased its year end rate from 4% to 5% just while I am writing this article and more importantly, Chinese factory prices are now running at an inflation rate of 10.7%. The careful investor will be moving away from highly rated equities on PEs of 20- and 30-times earnings and seeking value situations. It’s probably also the wrong time to sell any index linked gilts, given the inflationary storm ahead.   Barrie Newton

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The stock market now has some interesting features, some of which have not been seen before in my time.  At the moment, I am being bombarded with a volume of what were once called ‘New Issues’ or ‘Flotations’, but are now badged as ‘IPOs’, or ‘Initial Public Offerings’. A term we appear to have imported from Wall Street, just as CEO (Chief Executive Officer) has replaced the Managing Director in Britain.   So why are we seeing such a tsunami of Companies seeking a stock market quotation, so that the volume is swamping meetings with existing quoted companies?  There are many reasons, several interrelated. First, there has been pent up demand from the start of the pandemic. After all, no company could float in March 2020, given the uncertainty meant management had no story to tell. Secondly, corporate brokers are keen to stimulate the high fees that New Issues generate after a fallow period. A third reason is that Companies too are opportunistic and see the present time as being receptive to their prospects.  Fourthly, the investment industry is currently confused about the long-lasting impact of the pandemic. Many consumer habits may have changed for good, such as more online shopping, but in several others the change may be temporary.   Many of the New Issues being seen have been beneficiaries of the pandemic and management’s assurance that those benefits will stay and grow is questionable, particularly when the flotation is at a very high multiple that does not reflect that risk. A good example being the recent Deliveroo IPO at 390p per share and which now trade 20% lower.  Another high-profile trend is the increasing presence of Private Equity (PE) in business transactions. Perhaps the most familiar example being the £6.3bn bid by Fortress for supermarket chain Wm. Morrison. We know that supermarkets have done well during the pandemic as other retailers had to shut and many have even made home deliveries profitable. So why has PE alighted upon Morrison? Most likely it is because it has the highest level of freehold property amongst the major supermarkets. Indeed, over 80% of its stores are reported as freehold. That will make an enticing sum on any disposal to leave the main supermarket business at a very cheap net price. We have not heard the last of this bid, with a bidding war quite possible and even MPs taking an interest in the situation.   Private Equity has a reputation for extracting value from quoted and private businesses, increasing debt significantly and later on looking for a profitable exit.  Currently, a most popular exit is through a stock market listing during the present tsunami of IPOs.  I would say that I have not seen so many IPOs that I can remember, where stock has been sold entirely or partially by Pes.  Acquisitive quoted companies are consistently telling me that their main competitors in the acquisition of private businesses is now Private Equity. Certainly, the main fact that makes the PE business model so effective is the low cost of capital, which means that gearing a business is really cheap. Indeed, the only consideration for a private company seller that would make a sale to a quoted company preferable is in cases where the prospects for staff and the longer-term future of the business are paramount.  Certainly, PE holds lots of cards in terms of price.   Inflation is another current topic.  The authorities in the US, UK and Europe all say do not worry, it is temporary.  I am not so sure.  Consumers have lots of savings in many cases.  Supply chains are disrupted and the expected unemployment due to the pandemic has not materialised.  Indeed, there are labour shortages in most countries.  If the authorities have got this wrong and interest rates must rise, then the halcyon days for Private Equity may be shorter lived than expected and IPOs less frequent.

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  Thoughts from one of our Investment Managers Stephen Lovelock.   2021 has been labelled as the “year of the reopening”. Markets are now moving out of the pandemic period and entering an ‘in-between’ stage, where investors will have to be far more astute to discern which companies just rode a Covid wave and those that can capitalise long term. As talk of the end of the Covid-19 pandemic builds, concerns of inflation are on the agenda. Is the current talk and concerns about inflation just a flash in the pan as a result of the rapid recovery, after last year’s Coronavirus slump? The question on many investors’ minds, is if inflation is to continue, how high can it go and is it here to stay? There are some that say the US and UK are eager to run their economies “HoT”. If things slow down and inflation cools later this year, they may well pour more fuel on the fire. Inflation could become entrenched.   Inflation in the UK measured by the consumer prices index (CPI) rose to 2.1% in May from 1.5 per cent in April, exceeding market expectations and the Bank of England’s long-term target rate of 2%.   As we know inflation can eat away at investors' returns, with cash, bonds and growth stocks on high valuations particularly susceptible. Investors may wish to think about diversifying away from the assets that have served them well over the past decade if the recent spike in inflation becomes a longer-term issue.   Investment trusts are good at protecting investors from moderate levels of inflation, as many trusts have revenue reserves and can support their dividends. However, because of widespread dividend cuts during the last year, some trusts reserves were diminished. Historically, trusts investing in property, infrastructure and commodities offer some protection from inflation. With shares in Real Estate Investment Trusts (REITS) also having a history of outpacing inflation.   There are other issues and concerns, which Covid-19 trends are here to stay, and which will soon be a distant memory. Will we return to offices? Will the high street survive? Will international travel bounce back?   Another factor to consider is despite progress in US-China relations, the Global economy is still under extreme stress and the path to a full recovery is unlikely to be smooth. We have yet to see the full impact of reopening the country but remain optimistic about the ability of vaccine delivery and the human adaption to normalise economic and social behaviours.  

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After The outbreak of Covid-19 in March 2020 has resulted in the worst human and economic devastation the world has seen for many years resulting in governments and central banks around the world, cushioning the considerable fall in economic activity by introducing fiscal and monetary support on an unprecedented scale.   Equity markets, which were sold off at the peak of the pandemic, initially recovered as a result of this stimulus being introduced. Then in the final quarter of 2020, with vaccines being developed and rolled out, we have seen further recovery in global equity markets.   The UK was one of the worst-hit developed markets in the Coronavirus crash of last year after the FTSE All Share lost 9.82 percent, compared with gains of 14.12 percent from the S&P 500 and 2.13 percent from the MSCI Europe. This was not surprising, given the services focus of the UK economy. However, while this pulled the UK down in last year’s crash, it should also help it to bounce back harder. So, we can expect a recovery this year.   For the UK there were two significant catalysts in the fourth quarter of 2020; the Brexit agreement signed on Christmas Eve and Pfizer announcing an available vaccine in early November. This was a trigger for investors worldwide to have confidence in the sustainability of the recovery. It can be argued that the UK market has looked cheap since the vote to leave the EU in 2016 and lacked the catalyst to realise that fair value until the agreement was signed. These two catalysts are releasing several opportunities in the UK making it investable for the first time since 2016. Many international investors have understandably, not bothered with the UK as the currency was vulnerable. They waited until we gave them confidence to invest.   After the decade-long bull run was halted by last year’s Covid-19 crash another reason that the UK could do particularly well in the recovery, was characterised by the out-performance of growth over value. However, increased inflation expectations (in response to the massive amounts of fiscal stimulus pumped into the economy) have led to a sudden reappraisal of value stocks   As we enter the second quarter of 2021 and hopefully look to a new period post-pandemic with the UK equity market back on investor’s radars, the UK could do particularly well in the recovery.   Stephen Lovelock

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This month has many interesting topics on the horizon, and I will cover a good few in this article.

If clients remember, last time, I voiced my concern over potential inflation and the rising level of state-owned debt along with a likely continual depreciation of the US Dollar. In 1980, only 40 or so years ago, the US deficit was just $1Trillion. In 2025, it is expected to be $50 Trillion. Those projections of Dollar weakness are already starting to come through.

The Pound Sterling has ticked up to $1.38 against the Dollar, after having hit £1.40 briefly and it has even begun to show strength against the Euro at1.17. Commodities are starting to increase in price, although this has not really hit the consumer yet. Timber, Specialist Polymers and Base Metals being to the fore. Our two stock selections, with a copper bias, RTZ and Atalaya both continue to look well placed, with the latter up by nearly a third.

Expect those economic trends to continue.

It has been a stark feature of the US market, that certain growth companies have achieved astronomic ratings despite the fact that they are not making profits. The Technology sector has been at the forefront here. People can see how the likes of Amazon and Google have become very profitable as they have changed people’s habits. The NASDAQ technology index, has, however, had a few nervous days and is lower now than it was in February. Is this trend over?

The UK has lacked those sorts of technology companies, with the FTSE 100 index dominated by Mining, Oil and more traditional overseas earners. More recently, the UK has got in on the act with the Hut Group, a digital FMGC business, had a very good start after floating at the end of 2020, but it too is lower than it was at the start of the year. Its value is still very high at £6.3bn.

Moonpig, the online greetings cards business had a good debut too, but the price is now not much higher than the early levels. It still has a £1.5bn market capitalisation. Is this online/ digital boom over? Certainly, these companies were definite beneficiaries of the lockdown as people changed their habits. More recently has come the Deliveroo debacle, with the share slumping by 28% on issue. It was also a lockdown beneficiary as people opted for home deliveries of meals and restaurants saw the service as the only way to trade, despite its high costs. Yet it still has a £5.2bn value and is yet to record a profit. I am sure some will still love the service, but others may return to collecting ‘takeaways’ themselves when freedom to do so increases. Some institutions refused to invest due to the employment policy at Deliveroo, especially after the recent Uber case ruling. Time will tell how the business fares, but I think it is a warning that unprofitable technology companies carry very high risks when high valuations are attributed to them.

To me, it emphasises that the market is unsure how the post-pandemic world will be. I prefer to stick with old fashioned investment criteria, growth, value, dividends and balance sheet strength. Our job now is to find value with a slight edge in the new situation. I came across one the other day in SCS, the furnishings business, specialising in Sofas and Carpets. Yes, this is not an easy sector by past records, but this £90m company has no debt and a lot of cash. Even allowing for customer deposits and seasonal factors, it probably has nearly a third of its market value in cash. Yes, it needs to see its stores open again for recovery and the ability to resume dividends, but the risk looks a favourable one. One thought might be worth considering. If people have a hybrid solution to office and home working, will they wear out their sofas and suites quicker? The average replacement cycle is currently seven years. It used to be five years before 2008.

Lastly, I thought that I would end on the subject of Rare Earths. Many people will not know how important they are to modern life. First, they are not completely rare, but they are essential in things like mobile phones, defence systems etc, but particularly for all the new generation products in the so-called ‘Green Revolution’ such as wind turbines, solar panels and electric cars. The problem is that once again luck has favoured China, which currently has a near monopoly on the supply of Rare Earths, as it supplies around 80% of the world Rare Earths.

China has been dealt a very strong hand with the supply of the seventeen elements that comprise the Rare Earth category. Nevertheless, Greenland has been identified as a rich source of Rare Earths, which is why Donald Trump tried to buy it two years ago. What is topical is that when you read this newsletter, Greenland, the world’s largest island, with a population of under 60,000 people, mostly Eskimo and heavily dependent upon Denmark for funding will have had a key election which could change the prospects of getting a significant amount of Rare Earths not controlled by China. Rare earth extraction is high on the election topics. The two main parties have different policies. One pro extraction and one against. The outcome will be important for the Chinese, in terms of pricing and supply constraints, as well as for all of us in the Western world and the cost of new technology.

  Barrie Newton

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Markets rose across the board over the last quarter. Most markets had been trending up since the April 2020 lows, as COVID restrictions were reduced. New momentum was induced by the positive vaccine news. UK stocks advanced strongly. For much of the year UK stocks were the poor relation, particularly compared to some US Tech stocks. With the vaccine news and a Brexit trade agreement without tariffs UK stocks began to perform. The pound rose to its highest for some time against the USD which will help with those hoped for summer 2021 holidays if the COVID situation allows. Some areas of global stock markets have started to look expensive when viewed historically but it was the year of tech and the markets are reflecting the great changes taking place at pace. Some other themes entered in the last quarter. With Biden winning the US elections, environmentally sensitive and companies considered socially responsible received a boost. Biden has promised to invest $2trillion into this sector both to push the environmental cause but also to rebuild. This looks to be a theme alongside tech that will have longevity and could also quicken and lead to disruption in many older industries and ways of doing business. I noted that at times during the lockdown, on occasion 59% of the UKs electricity came from renewable sources – mostly wind and solar. The UK is far ahead of its US cousin in this sector and if the US follows that is going to create some interesting investment opportunities. Another area which has raised its head is the potential for inflation. In order to pay for the pandemic and schemes such as investing in the environment above, the US and many governments are printing more and more money. As a result, commodity prices have started to increase. My colleague Barrie Newton looks at this area in more depth and my colleague Steve gives his views on the economic impact of COVID-19.

UK Stock markets

The UK market has been held back from some years with the various uncertainties that have been around. Some of these key uncertainties are now behind us. It is quite likely that overseas investors and pension funds start to invest in the UK again, which could be very good for UK stocks. The UK stock market is much cheaper than many of its peers. Dividend yields still sit at around 4% and therefore still look very attractive against bank rates. There are many World class engineering, software and pharmaceutical companies in the UK and listed on the UK stock market. At CFM we expect to see inflows of investment and bid approaches for many of these stocks.

Interest rates

Since the New Year, the US Federal reserve banks have begun to suggest they may raise rates quicker than expected. This has not yet been set in stone but may be a sign of things to come. This is set against a backdrop of massive borrowing for COVID and in the UK the money supply is growing at around 20% per annum. Such statistics have not been followed much for years but are now coming back to the fore. There has been a debate bubbling away for a while now with some suggesting inflation targeting, which is generally accepted as having been responsible for creating price stability for several years, with a new regime which targets real economic growth. Naturally, there are pros and cons. What does this mean for your investments and mortgages? Interest rates have been falling for 30 years. We now see a situation of massive printing of money and potentially the policy framework changing to allow more inflation into the system. We may not immediately see high inflation in the statistics, but prices are likely to rise somewhat. Commodity prices are already rising sharply. Fixing a mortgage perhaps for longer than the 2 years we most do and choosing 5 or 10 might be worth considering. For investments, bond prices have gone up and up for years. UK Stocks, the FTSE at least has not made much headway for 15 years. If there is inflation, companies that are able to increase their prices will see profits in nominal terms at least increase. Those stocks might outperform. High interest rates would hurt shares but if interest rates are held down and the companies’ underlying earnings increase, it will be good for shares and not good for bond investments. At CFM we will be holding more shares in balanced portfolio’s going forward. With government bonds paying out 1% and corporate bonds 2% against UK shares 4%, shares look better value and should offer some protection against inflation.   By Paul Coffin

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