Small Cap Value Report (Wed 6 May 2020) - SAA, Macro, CARD, HFD, LOOP

6th May '20 by Paul Scott

80 comments 9650 reads

Hi, it's Paul here with the SCVR for Weds.

I'm writing this late on Tuesday evening, because feedback has been very positive when I write about the general Macro/Covid situation, and subscribers seem to like something new to read first thing in the mornings, understandably. I'm a night owl, so it's difficult to balance all this because there are so many distractions when the market is open, even when I have managed to crank my brain into action in the mornings. Hence writing macro stuff late at night suits me well. I'll try to do this once or twice per week in these SCVRs in future, when there is something to discuss.

Embarrassing error - can't remember if I've mentioned it, but I feel a bit of a fool for putting in an incorrect link in Monday's SCVR, which I thought was CNN, but was some mickey mouse website with a similar name. Sorry about that, and thanks to readers who pointed it out. That said, the headlines & commentary in UK newspapers are no less ridiculous very often - e.g. market plunges or collapses, now seem to apply to moves of c.1%!

PIWorld podcasts

Many of us find the professional investor videos from PIWorld very useful & enjoyable. These are made for investors, by investors.

I particularly liked this discussion with Stephen English, which is full of insights. And of course anything with Leon Boros is always worth tuning in to.

What I didn't know, is that for apparently 18 months, PIWorld content has been available as audio podcasts. I've only just discovered the podcasts, and last weekend I really enjoyed listening to the charming & interesting commentator David Buik, being interviewed by Tamzin (very polite, and she doesn't interrupt!) on my headphones, whilst doing oddjobs over the weekend What a great use of otherwise wasted time!

Macro/Covid news & views

In these unprecedented times, I keep an A4 pad by me, and often jot down interesting snippets from the press, news, and CNBC. Here are the latest snippets, with my additional comments, as I'm trying (as we all are) to work out what's going on, and where it might take us. After all, that has to guide our investment decisions. Even if your approach is "do nothing", that still implies that you've decided the outlook isn't too bad, and should recover back…

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Banzii

6th May '20

Jonesj, I use Podcast Addict and can access the PIWorld podcasts as well as Conkers Corner amongst others (e.g. TWs free podcast). No need to covert files or the like. I sometimes need to switch the search settings around (iTunes vs others) but once found and subscribed I get automatic notification of new episodes and download away. I'm on an android phone. Not sure if available for Apple.

jdnthomas

No cmpeckham, I was asking how you create money. QE seems to be the popular way but what is this Ways and Means facility? Not sure any other way is fundamentally different, apart possibly from physically printing notes. If you cancel debt there must be a debt holder losing out. I am clearly not so sanguine as you about the BoE being insolvent. How would you recapitalise it ? (other than by borrowing the same amount of money you have just cancelled?)

trader45

Welcome back to Bournemouth Paul. When all this is over we must catch up over a beer sometime by the seaside

Watchdog

To quote Winston Churchill: "We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle."
Is printing money not much the same thing? If so, I don't see how QE can be successful when people eventually realise that the Emperor is not actually wearing any clothes, and the value of their money has shrunk considerably!

cmpeckham

Re: creating money

- as I said, the Ways and Means is an overdraft. It has nothing to do with creating money. QE does.
- why does the BOE have to be "solvent"? Nothing it does need be affected by "solvency".
- can you really be "insolvent" if your only liabilities are in sterling and you can create as much sterling as you like ex nihilo?
- the BOE is owned by the UK govt (HM Treasury). If UK govt debt owned by the BOE was cancelled, then one department of the Treasury loses and another department gains an equal amount. So what difference does that really make?
- if it was really necessary to "recapitalise" then why not use the sum that the Treasury has saved by having its debt cancelled?

None of the above is to say I advocate wholsale cancellation of debt, but I do advocate understanding what it means and, just as importantly, what it doesn't mean.

Not really sure what you're trying to say, cmpeckham, unless you're just agreeing with me that cancelling government debt held by the BoE achieves nothing very much.

bryans1311

Really excellent comment regarding the macro picture, Donald! Another point I’d add regarding deflationary environments, is that we are spending more or our incomes on subscription services. These are naturally deflationary, in that the more users, the lower the cost per user for the providers eg. Netflix, social media, Spotify etc.

I can’t see an overall inflationary environment ever returning, so maybe central banks buying up and cancelling govt debt might just work. (Famous last words...)

kevfle

It seems to me that if the Government draws from the overdraft under Ways and Means and the BoE subsequently agree that the overdraft does not need to be repaid, then that is no different from the BoE printing fresh £20 notes and dropping them from a helicopter. It is going to permanently increase the supply of money.

GrahamF

As far as I aware, Modern Monetary Theory basically says government spending is not constrained by tax receipts as it is spending that creates those receipts. And you can spend as much as you like as long as inflation doesn’t take off.

That seems to imply to me that we could reduce taxes to nothing (as long as inflation doesn’t take off). But this seems absurd to me so I cannot help but think either I have misunderstood or the theory is built on a fallacy.

So, on that basis, at the moment, I believe that governments cannot spend vast amounts of money they don’t have (on the basis that if they have their own currency they can always pay their debts by “printing” money) without a negative consequence appearing somewhere - perhaps high inflation, perhaps a breakdown of faith in the currency so people refuse to accept it as payment.

But perhaps what you can do is just pay the debts off very slowly (like we did with the war debt to the USA).

Well, you asked a lot of questions like "what is this Ways and Means facility?" and "How would you recapitalise it ?" etc ... and it's an area I have experience in, so I answered them for you, did I not? You're welcome.

p.s. You're wrong to say that cancelling government debt "achieves nothing very much". On the contrary it would be very significant, but perhaps you don't really want answers from me, so I suggest taking it up with someone who has a working knowledge of macro.

stegga1000000

Hello Purpleski,

There is an excellent book by Chris Mayor called 100 baggers in which he describes an actual example of a coffee can portfolio.
My vague recollections of it is that a broker looked after the investments of a lady and when the husband passed away, she asked the broker to manage the husband’s investments. The broker found that the husband had been buying the stocks he recommended to his wife and never sold them. He had one stock in the portfolio which was a hundred bagger which made all the other stocks which had either made losses or gone bust insignificant. The broker realised that the husbands portfolio had performed better than the wife’s.

All the best.

The overdraft facility is for short term mismatches in funding flows. It is rarely non-zero and has always been repaid promptly. There is no point in using it for long term funding anyway because the govt can get any long term funding it needs at close to zero interest rate.

The BOE controls the money supply not the Treasury. This wouldn't happen, but If for some bizarre reason the WAM (overdraft) did affect the money supply, then the BOE would allow for it and would simply mop up what it didn't want to be out there via its daily open market operations. Bottom line: the WAM does not affect the money supply in any meaningful way.

Wilbraham

Interesting snippet on Boohoo (LON:BOO) today https://www.cityam.com/boohoos-understanding-helps-it-avoid-lockdown-tears/

Selling to 11% of 18-24 yr olds (presumably just ladies?) to my mind show huge market penetration, given the range of retailers and online sellers.

I too was guilty of anticipating a lockdown demand plummet. Wasn't it a Next or M&S spokesperson who recently said "No one buys new clothes to stay at home"? I still can't quite grasp why people would buy 'seasonal' gear if they can't wear it to impress their mates but no doubt that's what Zoom is for!

Johns

It strikes me that if the BoE was insolvent, it's more a technicality than anything else. Money at the central bank is base money, meaning an account holder can't actually "take it out" of the bank anyway. They could withdraw notes, but they be printed endlessly and is only exchanging one IOU from the bank for another. A bank note is only IOU from the BoE but there is absolutely nothing you can get for that IOU. We are not on a gold standard anymore.

So from what I can see the central bank can't really go bust.

davidelliott52

thankyou for you macro ramblings, very thought provoking and very interesting. Like everybody else, we dont have a clue what will happen but my gut feeling is a temporary revival in going outside, working etc and then a second wave and a second lockdown but i do hope i am wrong. I do believe that there are now three certainties in life. 1 - death, 2 - taxes and 3 - mike ashley to behave like the selfish, waste of oxygen and vital organs that he is.

2ShedSam

Like Banzii, I Also use Podcast Addict. Having tried most, this works best for me. Not yet been unable to find a podcast I was searching for and has an excellent playlist capability so i can sort in any order I want. Free Ad Version and an Ad Free version for £3.99. Try Ad version first (ads not that intrusive) but then give the geezer his £4. It's well worth it. Accept others will have their preferences but playlist on this is magic!

ed_miller

7th May '20

Yes, we all pay for it via inflation - the ultimate stealth tax and very politically expedient.

Am loving your work, as ever, Paul. Thanks for all you do for us private investors.

Miguel Martins

Definitly mass unemployment but i cant see big inflation. In the long term 50%-100% inflation, and i think we heading for stagflation...

jwebster

"Can anyone please explain how the Bank of England can just create £1.6 trn of money?"

The Bank of England has it's own bank account and can change the number of Pounds within at will, both up or down. It is the magic money tree bank account. Yes, they just change the value. Type 100 million into the value stored in the computer's ledger. In the very old days money was paper-based and had to be physically printed to make this happen, hence the term 'printing money'.

So two examples, one traditional QE and the second, deficit financing

Traditional QE. The economy is glum and firms are not taking out loans, expanding their businesses.
The BoE decides one day to buy govt debt (gilt bonds) from private companies, in this case an insurance firm. So on that day, the BoE increases their bank balance by £100m and then buys 100m of bonds from L&G and duly transfers 100m cash into L&G's account. L&G is now free to spend this money as they see fit, in the real world. In practice L&G just swapped gilts for cash and actually need to keep holding assets for their business to run, so they go out into the market and buy higher yielding corporate bonds with that cash, thus pushing up corporate bond prices, pushing down yields, making loans cheaper out there, thus encouraging firms to borrow more at cheaper rates, thus stimulating the economy. Happy days all round. The BoE still has 100m of Gilts sitting on its desk, so one day later decides to sell these back to the private market, Aviva steps up, hands over 100m in real cash to the BoE in return for the gilts. The BoE then goes back to its computer and deletes the 100m from it's account. Round trip over. Crisis averted. Good job too.

Deficit financing. One day the Uk govt decides to run up a huge spending deficit to support the country. Normally, the Treasury goes out to the private sector and sells gilts to raise the cash. Insurance companies, banks, foreign investors etc are the usual suspects handing over their money in return for a gilt which pays them interest and repays the original principal at the end of the loan term. But, now the deficit is massive and there are not enough private actors around to buy it all at a reasonable interest rate. What to do? BoE steps up to the plate, enters 1,600 billion pounds into its own bank account, as above, and gets buying those gilts. Yum yum! The Treasury is ecstatic, suddenly it can sell a lot of gilts, collect real cash, and spend it on anything - benefits, civil servant wages, infrastructure projects, pensions, business loans. Everyone is very happy. The general public are getting a lot more from the government than they pay in taxes. Let's party.

Of course, problems eventually surface. Firstly, the BoE begins to notice something odd. Foreign investors stop buying gilts, in fact they sell all their holdings back to the BoE. The rating agencies Fitch et all downgrade the UK's sovereign rating. Even though the BoE is still buying gilts willy nilly the interest rate doesn't seem to drop any more. The Pound drops against all major currencies which pushes up the price of imported goods, inflation rises, but nothing to worry. Oddly, fixed assets of constrained supply, like property, boom in value. The Pound drops a bit further and savvy investors notice gold, in Pound terms, is zooming up and get buying. The general public get uneasy, prices of imports are up, housing is up, petrol up a lot, they feel poorer and demand wage increases from their employers. Civil servants go on strike and the govt ladles out 20% across the board wage increases, paid for by more gilt issuance. Suddenly mainstream figures it out and panics, there's a rush for the exits, gold is snapped up you can't get your hands on physical gold, the pound plunges 25% in one day as people rush to buy USD, Euros, anything. BoE wets the bed. The next morning the BoE raises the base rate to 5% to defend the Pound. Gilts crash, yields surge. People wake up to variable rate mortgages reset to 7%. The Pound drops another 25%. BoE raises rates to 7%. then 8% eventually 15%. Capital controls are imposed, buying foreign currency is limited. The property market implodes under these interest rates. The BoE stops buying gilts the govt is bankrupt and heads down to the IMF for a rescue package. The IMF agrees in return for a long period of brutal austerity.

ok, the last one is a bit extreme, but it does happen from time to time. My real concern is the govt keeps pushing on this until the markets give them a slap.

Dan Cal

19th May '20

This was a great read, thank you. In relation to CARD, I've seen a number of figures in relation to their debt, what actually is it? I have seen 3 figures across a number of communications, 137m 171m and 316m?

Small Cap Value Report (Wed 6 May 2020) - SAA, macro, CARD, HFD, LOOP

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Paul Scott

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