In today’s issue:

  • Getting growth going is easier than you think
  • The state is the problem, not the solution
  • Contemporary Argentina provides an example

Politicians often contradict themselves.

In a major speech last week, Chancellor of the Exchequer Rachel Reeves said she was prioritising growth.

During the subsequent Q&A, she refused to rule out further tax rises.

So, which is it?

To be honest, we doubt if she even knows.

A key reason why growth is so anaemic at present is the series of tax rises in recent years. It has taken the total economy tax burden to the highest outside of wartime, ever.

Is adding yet another straw to the UK economy’s back good for growth?

Of course not.

Nor is government spending. Borrowing costs are higher today than at any time in the past 15 years, in part due to inflation.

More spending from here, especially if in the form of higher public sector pay as in the October budget, would almost certainly push inflation and borrowing costs still higher.

The fact is, the only way to get growth going when the practical limits of taxing and spending have been reached or exceeded is to do the exact opposite: tax and spend less.

Whatever resources are not taxed and spent by the government are left to the private sector.

Now imagine: if more resources were made available to the private sector, what do you think it would do with them?

Would it build a third runway at Heathrow? Would it build thousands of new EV charging stations? Would it complete HS2 or abandon it?

I don’t know.

But I do know that the private sector would do whatever had the highest expected rate of return on investment.

That’s how the private sector works. It uses whatever resources it has to generate the largest profit possible.

Sometimes an industry that had once been high-growth and strongly profitable and attracted much investment becomes less so. Consider the basic materials and industrials companies that built Britain and much of the world.

Many of those companies still exist in some form, in many cases as subsidiaries or divisions of today’s international conglomerates.

They’re not the high stock market performers they once were. They’re cash-generative and profitable, to be sure. But they generally trade at fairly modest valuations when compared to the higher-growth companies of today.

Take materials giants Glencore plc (GLEN), Rio Tinto Group (RIO) and BHP Group Ltd (BHP). Their average price-to-earnings (P/E) ratio is a little below 12.

Compare that to today’s “Big Tech” highfliers. Their P/Es are an order of magnitude higher. In some cases, triple digits. This reflects their perceived excellent growth prospects.

Now, who do you think is attracting more new investment? Who is driving growth?

The answer is obvious. But obvious doesn’t mean easy.

Embrace the destruction

Industries come and go, expand and decline. It’s a fact of economic life.

And every time resources flow from one industry to another there is some friction, some disruption, some destruction even. That’s a fact of economic life too.

Nobel Economics Laureate Joseph Schumpeter called this “creative destruction” and considered it absolutely essential to long-term economic growth.

When resources get constrained in a relatively low-growth place, that’s when you get stagnation.

Sometimes governments stand in the way. They protect jobs in declining industries, impeding the flow of workers and capital to newer, faster-growing ones.

The lowest growth place of all is government itself. Oh, sure it can grow, but only by appropriating private sector resources via taxation.

If Britain wants to get growing again, it needs to allow resources to flow to where they are most productive and profitable. It needs to shrink the size of the state.

The chancellor is probably loath to admit this as she’s ideologically oriented far away from the free market. But if she wants growth, she’s going to need to get out of the way, allow the state to decline in size and allow the free market to work its magic.

Milei and Trump set the growth example

This is what President Donald Trump is now doing. He’s put two million federal workers on notice that they need to return to the office if they want to keep their jobs. If they don’t, he’s offering a buy-out.

The more productive of those workers will likely take the buy-out. They’re the ones with the best job prospects in the private sector.

The less productive are likely to remain. But that’s OK as government is not where the growth is anyway. Just because some jobs are essential doesn’t mean that they are the source of economic growth.

Over a year ago, following his election as president, Javier Milei of Argentina set about doing something similar to Trump. Although he was even more aggressive. He showed many public sector workers the door.

Yes, this caused some disruption. There was no way it wouldn’t have done.

One year later, the economy is booming. Inflation is lower and government spending has declined dramatically to the point where it’s no longer running a deficit. Not surprisingly, Milei’s popularity is high.

Schumpeter would have been impressed, were he still around.

So that’s how it’s done, Rachel. You can go for growth and be popular too.

How optimistic am I that she’ll see the light? Not very. I suspect she lives in something of a statist echo chamber with her Labour colleagues.

Global Britain, global opportunity

Fortunately, Britain is home to some great companies. Many of which are global in their orientation and able to take advantage of the better economic prospects elsewhere.

The FTSE 100 companies source about 75% of their revenues abroad. That’s a huge proportion. Investors less sanguine on the prospects of domestic growth have plenty of good options to participate in growth elsewhere.

But they should avoid those companies with a relatively high domestic revenue concentration, especially if those companies are cyclical. They’ll be the underperformers if Britain remains stuck in its present stagnation.

Of the major cyclical FTSE 100 sectors, the banks are probably the most exposed to disappointing growth. They’ve had a good run over the past year as the Bank of England reduced interest rates.

That improved their net interest margins for a time. But that time is now probably over.

There are growing signs that the housing market has stalled. Lending volumes have slowed. Real estate investment trusts have performed very poorly in recent months.

Spanish banking giant Santander is now considering leaving the UK market as it continues to struggle to make its operations sufficiently profitable.

So, even if you’re concerned that Ms “growth is my priority” Reeves is going to deliver stagnation instead, there are good global, defensive, income-oriented investment prospects in the FTSE 100.

But… I’d avoid the banks.

Until next time,

John Butler
Investment Director, Fortune & Freedom


Not just any port in a storm

Bill Bonner, writing from Baltimore, Maryland

Licker talks mighty loud w’en it git loose fum de jug.

– Uncle Remus

You might be wondering… what’s our choice for the Desert Island Challenge?

Today, Tom Dyson, our Investment Director at Bonner Private Research, comes forward.

‘I’m so excited by this, I’m considering taking out a loan against my life insurance policy and buying them…I’m expecting these stocks to produce at least 15% a year in dividends… The thesis is very simple…’

But first we confront the possibility that there is no Big Gain to be had… not between Heaven and Earth… neither today… nor ten years from now.

For every action there’s an equal and opposite reaction.

But when the Fed began intervening heavily, after 2000, the ‘licker got loose fum de jug.’ Things got weird. And now we face the shocking disappearance… of nothing. With nothing to rise up to take its place.

What happens when you subtract zero?

Take the $Trump coin. Suppose it goes pffft... and vanishes? Holders will lose money. But who will make money? Nobody?

Official Trump Coin, Market Capitalization $5.48 billion

Let’s say, we launch a new coin. We limit the number to one million. And, like Trump, we make some available to buyers, while retaining 900,000 for ourselves in our own ‘wallet.’ If one person buys one coin for 1 penny, all of a sudden, our cache is worth $9,000. And if someone buys a coin for $1… we’ve got $900,000 – on paper!

The trouble is, there’s nothing there. Which doesn’t mean it is worthless… but that its value could be a billion dollars… or absolutely nothing. The beauty of this boat is in the speculators’ eyes. There is no safe harbor of goods or services to moor it safely. Instead, it floats on an ocean of mist and mood swings.

If the Donald falls out of favor… and the meme loses its magic… in the space of a few days, the coin could drop back to a penny. Wealth disappears. But there was never any way to realize the gain that Mr. Trump supposedly made anyway. Had he tried to ‘cash out’… his own selling would have quickly collapsed the price.

Real companies produce real wealth, which we use to determine how much they are worth. Imagine a builder who puts up ten houses a year… and makes a 10% profit on each one. Investors think he can keep it up, and buy shares priced at ten times his annual gain… or the equivalent of ten complete houses.

So far, we are on solid ground. But along come Br’er Rabbit… and Br’er Fox from the Fed… ’sassy ez a jaybird’… an’ fetching up al’ kynz o’ mischuf.

As the Fed manipulates interest rates to the downside, the P/E of the builder goes up. Instead of being worth the profit on ten houses per year… it might be worth twenty.

Today, according to the CAPE ratio (cyclically adjusted price earnings), the average P/E is over 37. Whoa, the builder is now worth 37 houses. But there are still only ten new houses per year being built. So, as many as 27 out of 37 of the houses in the P (price) don’t exist. They could go pffft at any moment.

There’s the potential Big Loss. Where’s the Big Gain? Where’s the home builder priced at less than it is worth? Where’s the industry that the Fed’s interest rate manipulation missed? Where is a stock that might go up… even if the rest go down?

The secret, says Tom, is…

Aging fleets. There are enough [tankers and bulkers] now. But over the next decade, many need to be scrapped and we just aren’t building enough new ones to replace them. And the surviving fleet will require heavy maintenance…Assuming no gigantic market or economic collapse, as the old vessels get scrapped, dry bulk and tanker vessels are going to become scarce…and command freight rates that will likely be much higher than they are today… It’s why I want to visit the Alang shipbreaking yard in India next month.

Tom says tankers are likely to float higher in the next storm, rather than sink to the bottom:

‘The shipping industry has been traumatized by a decade of over capacity following the financial crisis. There’s a palpable reluctance to invest in new vessels because a) they’re expensive b) they take a long time to build c) it’s not clear what fuel the ships of the future are going to burn and d) it’s not clear that China will ever grow again and e) it’s not clear we’re going to need a bunch of new ships for transporting old-economy materials like oil, coal and iron ore.

‘It all points to the conclusion that the industry is going to kick the can on fleet renewal for as long as possible… until rates rise high enough that shipping executives can overcome some of these objections. Fortunately, no one’s asking us to pull the trigger on a brand new $125m VLCC that won’t be delivered until 2027 at the earliest. All we have to do is buy into the existing fleet and collect dividends (and maybe benefit from some consolidation as most of the stocks are trading at sharp discounts to NAV and it’ll be easier for shipping executives to buy other shipping companies than buy new ships.) 

Looking for an investment that might bob when others weave?

Shipping stocks have a history of underperforming the broader markets (12 of last 15 years have been down), they are not in any indexes or benchmarks, they don’t receive any passive investments, they’re blacklisted in Europe for being dirty. They’re maddeningly volatile and have a reputation for fleecing investors.

But what if a $100 trillion meltdown sinks the customers?

Tune in next time…

Regards,

Bill Bonner
Contributing Editor, Fortune & Freedom

For more from Bill Bonner, visit www.bonnerprivateresearch.com