Running towards the flame

The Weekender offers my perspective on market developments and their potential broader implications, written most Friday afternoons. If you'd like this delivered to your inbox on Saturday mornings via Northern Trust, please sign up here .

Pessimists sound smart, optimists make money

Imagine someone with a high IQ telling you about a stock that’s going to skyrocket tenfold within a year. You’d dismiss them as delusional. Yet, if a less credible source warns you about a potential collapse of a stock you own, claiming it’s a financial sham, you’d probably cancel all your plans to hear them out. This is a scenario Morgan Housel discusses in “The Psychology of Money”, tipped to me by our own Northern Trust senior economist, Ryan Boyle . My worst investment decisions? They were influenced either by eloquent analysts convincing me I was wrong or by less seasoned voices bolstering my own biases. The former, like missing out on Facebook at $19 per share, still stings. It’s a reminder to stay cautious of articulate, negative analysts. Ryan pointed me towards Housel’s work on negativity bias, highlighting why some analysts build careers on erroneous bearish predictions. It’s all about psychology – warnings make us feel protected, while optimism raises our suspicions. Housel digs into the psychology of the audience. Expanding on what we wrote last week on evolutionary psychology, when we hear words of warning, we feel the author is looking out for us, trying to protect us. When we hear an optimistic forecast, we put our guard up. What’s this person trying to sell us? As Ryan said to me, it helped explain why they encountered such skepticism of their forecast of no recession last year. It might also explain why you can’t find many who are positive on Chinese equities, commodities, steel or even the UK. But are these now so underweighted that even a lack of bad news could pivot things. Is there a silver lining? Could a case for optimism even be made?

Is it time to run towards the flame?

Could a case be made?

I’m sure many investors wished they had listened to the bearish experts on China. The China benchmark, the CSI 300 is down three years and the Hang Seng Index down 4 years running. India’s stock market was worth about 1/6th that of Hong Kong’s back in 2020. It’s now surpassed it to become the fourth largest in the world. Alibaba’s stock is now valued lower than Campbell Soup and so desperate were Chinese investors to get money out, several Japanese ETFs rose to large premiums, forcing them to halt trading at one point last week. There is news of well-known Chinese investors throwing in the towel, China is a consensual underweight in most global portfolios and some now want EM exposure, ex China. China’s economy is the underdog in most global portfolios. It’s all fairly grim. And if you wanted to build a buy case, who would you listen to?

The best experts

The best forecasts or signals might not lie in financial experts, but in understanding the motivations of Chinese Premier Xi Jinping and the government’s directives. When they targeted housing speculation, corruption, private tutoring, Jack Ma, or Australian wine, it was a signal to sell related stocks. Perhaps they hadn’t foreseen the wider wealth and consumption effects of lower property prices, but it pays to remember a slowing housing market was their official policy. Now, there are hints of a shift. Points around property speculation have been curiously absent from official statements. The People’s Bank of China is injecting liquidity, and there’s talk of a substantial stabilization fund aimed at Chinese stocks. The trade narrative is changing from confrontation to cooperation . And Jack Ma is back, buying Alibaba shares. The Hang Sang is down 4 years in a row. A fifth is historically without precedent. The closest thing was the Dow during the Great Depression when it fell from 1929 to 1932 and then rose +60% in ‘33. Whether that’s a relevant analogy, I’m unsure but I will be watching the SH Property Index and Hong Kong Exchanges as key proxies to see if Xi’s commands get executed. And if they do, and if you can’t bring yourself to buy or even rent China, it surely represents option value in things you can own, like supply-constrained real assets: like iron ore, copper, Birkin Bags, Ferraris, gold, weight-loss drugs, even steel?

The greatest industry comeback ever

Let’s talk about U.S. Steel – once a titan of industry, the largest corporation in America. It was the backbone of the industrial revolution, much like semiconductors are today. But it faced a dramatic fall, went from the majors to the minors and at one point had lost 95% of its peak value. And then last year it doubled. But the more impressive comeback is from the company that just bought them: Nippon Steel?– the very competitor that rose from the ashes of war-torn Japan to become the largest producer in the world. If you had predicted this in 1945, you would have been laughed at. Yet, here we are, witnessing one of the greatest industrial comebacks (not to mention a large dose of irony). It’s a classic example of why sometimes, ignoring the pessimists, especially when everyone else is doing so, might just be the smart move. If Nippon Steel was an NFL team, it would be the Detroit Lions (best of luck this weekend btw).

A case for steel?

On steel – it’s not the trendiest of topics. Who wants to talk about spot-welding when there are sexier industries out there? But steel is fundamental, not only to our current infrastructure but also to transitioning to a cleaner future. It’s crucial, and if we move towards a more nationalistic world order, it could gain even more significance. Throw in potential tariffs under a Trump administration, and the narrative around steel and national champions might just resurface. After reading Ed Conway’s “Material World”, I’ve become even more curious in steel. Conway believes a good measure for economic wealth is steel used per capita, which in rich counties is about 15 tonnes per person. It’s less than 1t/person in poorer countries or those with larger populations, like India and Africa – the regions most likely to see rising populations and urbanisation. As he suggests, if the RoW was to get to the West’s level of wealth and development, it implies increasing the global stock of steel to 144B tonnes, or nearly 4x what’s ever been produced . I wonder if this is why Rio Tinto believes global iron ore demand will keep rising despite China hitting peak consumption. And why China seems to be producing more of it, despite a weak property market?

A home bias? Codswallop

AG Bell has come out against a British Investment Savings Account (ISA) saying "given most investors have a natural bias towards UK companies and funds anyway, the most straightforward answer would be to simply to increase the ISA allowance". I’m sorry? A natural bias? Yes, we once had a home bias. Indeed we had a thriving equity culture on the eve of World War II! Of the share-capital on listed UK markets, 80% of it was owned by UK individuals (per John Plender in That's the Way the Money Goes ). Fast forward to today, the equivalent figure is 10.6%, below the Dutch, half the French and one third the Americans! And it’s not being squirrelled away into UK managers holding UK stocks. As the UK Finance study concluded: “Institutional investors, including UK pension funds, invest less in equities, specifically UK equities . Nearly two-thirds of the shares on the LSE are held by foreign investors, compared with only 18% in the US. The only other country with this sort of set-up, think domestic share ownership of about 10%, that has recently shaken up its own ISA program (ironically inspired by the UK ISA) is Japan. To be fair to AG Bell, they are calling for a bigger shake-up as well, but the idea the UK retail investor has a home bias is, well, codswallop.

Buy shelter

Finally, for now, on the topic of homebuilding – I was sent some homework, and this video . It’s an interview with Gary Channon of Phoenix Asset Management. It provides some context?for the growing supply-demand imbalances. The UK, for example, hasn’t seen a new homebuilder since 1974 and 1989 was the last time housing construction outpaced household formation. In the U.S., the housing market inventory is at levels not seen since the ’90s, despite a 20% increase in population (information again courtesy of Northern Trust’s senior economist, Ryan Boyle). The trend towards build-to-rent (BTR) is becoming more pronounced, possibly reshaping the housing market, and this seems driven as much by demographics as it does economics. I was staggered to learn the median age of repeat homebuyers in the US has increased from 36 years old in 1980 to 58 years old in 2023. 58! So, like in the UK, BTR is becoming a “needs-based asset class” and is likely to attract more capital, and more value to incumbents, as time goes on.

Do you know where gold comes from?

Outer space.

Yes, gold. It’s not just a precious metal - it’s a cosmic gift. Its origins lie in the vast expanse of space. Oh, and the use of ‘tokens’ that act as a medium of exchange or as a way to promote a business or technology - and which can be traded - was happening way back during the reign of Elizabeth I, in the 16th century. These were just two facts I learnt when visiting the museum of one of the oldest and largest gold repositories in the world: the Bank of England. I had time to kill before a meeting and was triggered by the CEO of the World Gold Council’s ambition – as mentioned in last week’s edition – to put gold on a blockchain to provide provenance and transparency, remove illegal mining; and then issue a digital token, backed by real gold (thus solving the boomer issue of intangibility) with all the millennial verve of divisibility and portability. And thus aim to rekindle gold's historic use as means of exchange, rebrand it as an appreciable asset (not solely a defensive one), provide incentive to everyone in the ecosystem (a higher gold price) and solve that intractable problem of bitcoin: a fantastic “solution without a problem”. Ironic, don’t you think, that the best application for DLT could be created by the industry most at risk of its adoption: Gold.

Watch this space.

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