4 Nov 2024
Here is a top tip for finding something that you have mislaid. Don’t look for it. Instead, adopt a Rodin posture and think.
I call this the Sherlock Holmes method based on his mystery-solving technique that once you have eliminated all the most likely explanations, whatever remains, however improbable, must be the truth. The strong chances are that you will find what you are looking for during the process of eliminating the most likely explanations. I can report that the Holmes method often irritates other people because their instinct is to race around in pursuit of the most unlikely answers. But they like it when you have correctly worked out where their sunglasses/passport/pet hamster are most likely to be.
Holmes’ technique is often misleadingly referred to as “eliminating the impossible”, which is nearly the exact opposite of his advice.
As an investor I am committed to judging probability. Possibility is by definition always assumed. It is very rare that an outcome can be judged to be impossible. And when something that is highly unlikely is treated as impossible, disaster can follow. See the global financial crisis of 2008, sometimes characterised as a “black swan” event.
The circumstance in which impossibility might be profitable for an investor is when the world, or a large part of it, appears to be in denial. I am thinking of two examples now. They are the idea that government debt can rise inexorably and still be treated as if it will be serviced and repaid and secondly that “Net Zero” will be achievable or acceptable.
It is an unspoken assumption that major first world governments are good for their debt. This might be credible in the case of the US which borrows in the world’s default currency – even Bitcoin and gold depend on the continuing credibility of the dollar. The fact that Japan is the global emperor of state borrowing (268% of GDP) is remarkable but it is usually explained that domestic institutions and individuals are loyal buyers of government debt, long conditioned to low nominal returns.
For Eurozone countries the topic is much hotter, as we saw when “Grexit” seemed to be a thing. (Grexit was a made up word for the possible exit of Greece from the euro after the global financial crisis). Grexit is no longer a thing but the gossip about the credit of individual European nations certainly is.
And then there’s the UK. Following the first Labour budget, the predictable realisation is sinking in that this looks like a traditional Labour borrow-and-spend government. Although people are complaining about tax rises, there will never be enough taxation available to balance the books. The only chance is economic growth but Rachel Reeves’ proposals are widely judged to be hostile to economic growth.
On the 9th August I wrote:
Pushing up wage costs for employers is a strange way to seek low inflation and private investment – it seems quite possible that it will achieve exactly the opposite.
As an investor I am attaching a high probability to the continued growth of the national debt and continuing problems with inflation. As such, I will demand a good price for lending my savings to the state. In other words, I am not now a fan of the gilts market, especially the long-dated end.
So, the big financial issue here is not about taxation and spending – it is about whether markets are willing to endorse the idea that the UK will one day make good on its debts. And by “endorsing” I mean continuing to fund the nation’s ever-growing debt pile.
There is a price for everything and the UK Treasury will have to pay it, despite the probability that higher debt servicing costs will be part of a deteriorating financial spiral. In mid September 2024 10 year gilts yielded 3.76%. Today we are nudging 4.5%. There is plenty, one might almost say infinite headroom. In case anyone cannot believe their own memory, 10 year gilts yielded 0.2% in 2020 – and 15% in 1981.
It is not impossible that UK debt will in the future be regarded as sound but it does not look probable enough to be predictable.
But here is something that is impossible – the eco-fanatical syndrome known as Net Zero.
I don’t need to explain why net zero is a ridiculous idea because commodity prices can do it for me.
The batteries that will power the cars and heating pumps will demand the use of great quantities of metals that are in very limited supply. Given the brave targets for phasing out conventional vehicles it would seem like a no-brainer prediction that the prices of lithium, cobalt and graphite have to go up. Yet they are down this year, in some cases substantially.
I don’t know whether these metal prices have fallen in anticipation of EV targets being abandoned or due to disappointing sales that clearly spell trouble for many car producers.
In 2024, 81% of global car sales are expected to be of traditional petrol or diesel vehicles, Electric vehicles will be 13% and hybrid 6% according to forecasts (source Autovista/JD Power). The notion that sales of 20th century car types will be phased out by 2035 (the current consensus in most leading countries) does not look serious. Aside from the missing supply of special metals, there is little sign that the capacity of electricity grids is being expanded with the necessary urgency, pretty much anywhere.
The implicit truth is that net zero is treated as impossible. You cannot profitably invest in the impossible but, as Holmes supposedly said, you can eliminate it. In the case of cars and domestic heating this might mean sitting on what you have. Second-hand car values have been good in recent years because new car buyers do not trust the functionality of EVs or the predictability of new regulations. Moreover, in my view, the improving efficiency curve of petrol and diesel cars has been flattened in recent years as investment has been directed at EVs, in line with government orders.
It reminds me of twenty years ago in the UK when house builders obeyed government instructions to overproduce. That had calamitous results and probably will again if the new government’s objective to build 300,000 new residencies a year is not quietly treated as impossible.