Transitionary, return of cyclicality

Transitionary – return of cyclicality

Transitionary is defined as ‘the process or a period of change from one state or condition to another’

Although there was a risk the term ‘transitionary’ would be worn out in its recent application to inflation, it will now be used more often and more correctly with reference to the many dynamics of change being experienced domestically and globally – government in a UK context, policy rates, energy, global stability and asset markets. Markets have partially reset but in reality many measures of dislocation remain within normal bands – volatility and skew (options supply/demand characteristics) being two. We remain in a period of change on many fronts and that process is far from over. The pressures are clear, but market psychology has not yet moved to full bear-mode. The idea inflation was transitionary was a neat and palatable construct and in one respect true. Elevated for a period and then returning to more normalised levels, the issue was and remains the duration of that change – more protracted than most would suggest will be the likely out-turn.

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In asset market terms, this cycle has just been a more extended version and with more amplitude, but it is still a cycle. Policy rate tightening both at home and abroad is necessary and to be expected, we have seen a decade plus of loose policy in all respects and the pendulum needs to swing the other way. As with inflation, the swing tends to be faster and more extreme than anticipated. There is the additional overlay of an employment picture that is still to a degree artificial post Covid (at least in its initial and most extreme form) and furlough.

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The cost-of-living squeeze was already a factor, just further exacerbated by the energy price implications of the conflict in Ukraine, highlighting the fragility of the more general global political landscape. The recent soft commodity activity around the conflict is also a reminder that Ukraine features in the top ten for production of many soft and hard commodities beyond the second derivative energy price issue. The product of industrial action, collective bargaining and the disruption to economic activity that these frictions bring adds to the negative feedback-loop. One must have some sympathy for holding the line on the degree on wage price inflation, as once reset – higher wages will prove ‘sticky’ when conditions cool and in and of themselves, add to the inflationary loop.

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As much at the revenue attribution of the FTSE specifically is weighted to international drivers, the interplay of factors should be considered when looking at the likely direction of the medium-term travel in the price of assets. The heavy weighting that housing has in the UK is key, an owner-occupier market beyond many others in Europe. The elevated fiscal frictional costs of moving, the rising cost of borrowing and in time the drift towards more careful and considerate lending criteria – tightening credit rationing, will mean the extreme level of price/household income multiples that currently prevail will fall. This might be more of a stall than a crash, but it will weigh on household and therefor broader investor sentiment. The ‘extend and pretend’ approach on lending and policy around housing debt will feedback into more prudent investor sentiment. I do not suggest a further and full move from growth to value but the hunt for cheap and underwritten income will be a feature – lending itself to the UK market on a relative basis.

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Funding in all its forms, both private and public (debt and equity) will become more circumspect and require better terms. The rush for innovative technology related and unrelated to the energy transition will need nearer-term and more material revenue and profit visibility and better down-side protection. Real ESG considerations will grow in importance, but more speculative situations will struggle. Given the raft of more traditional energy prospects with lowly valuations in the listed sphere, well-constructed and presented opportunities should receive backing.

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The near-term, after a brutal listed stock multiple de-rating, will be about marrying up the degree of ensuing downgrades with valuations. The complicating factor will be the way in which this feeds back into private valuations as the pass the parcel VC/PE game comes to an abrupt stop – down-valuations in many areas will become the norm and unwinding exposure will be problematic. This is a natural and required process but one that will not be casualty free. The corollary will be that where there is a strong fundamental case for investment, presented correctly – there will be many tremendous commercial opportunities. The cycle of business delinquency and rebirth needs to run its course. After such a prolonged period of benign conditions, it will just be a tricky for the period of change but one that should see a stronger outcome when the sifting process concludes.

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Gneiss remains committed to supporting quality energy, energy transition and renewable corporate situations with dynamic and experienced expert advice to help management achieve their corporate goals. In addition, our sister business Acasta guides management through the specifics of ESG strategy, offering bespoke, holistic advice to corporates across all sectors.