HyperNormalTimes

Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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May 28, 2023

AI, Fiscal Policy & Axe Throwing on AIM

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Mentioned this week: Nvidia, Google, Guy Hands, Andrew Bailey, Inflation, Fiscal Policy, Drax, Harbour Energy, Kistos, Intel, TSMC, XP Factory, Dechra, Revolution Beauty, John Lewis of Hungerford, The London Stock Exchange, Aquis Exchange & Abcam.

AI Not Copied

The Fed’s memo about popping the duration bubble last year decimated asset values. Yet no one thought to add AI to the circulation list. In the days following Google’s AI strategy announcement, Alphabet boosted its market value by $250bn. Last week it took just a couple of minutes following its quarterly release for Nvidia to do the same. As the picks and shovels provider to the AI gold rush approaches its trillion-dollar status, NASDAQ heads towards an up 30% YTD performance; this is tech’s strongest start to the year since 1991. None of this was supposed to happen as far as the Fed was concerned. But the deflationary impact of AI will prove a more effective means of tempering long-term inflation than central bank monetary policy. Much more of this NASDAQ rally, and it will be like 1999 all over again.

Stubborn Inflation

Meanwhile, the UK is fretting over the stubborn refusal of its retail price bubble to deflate. If the UK’s April inflation data were lower than expected, we would have been warned not to read too much into one month’s data. However, having surprised to the upside, rate markets hit the panic button, mortgage lenders withdrew deals and media accounts confidently predicted the UK would soon join Argentina and Sudan in the permanently entrenched inflation category of emerging markets. But inflation’s path is variable, and even the US’s measure of PCE core inflation rose in April, indicating the UK is not alone in this battle against the long and variable lags to monetary policy.

Emerging or Submerging UK

The idea of a post-Brexit Britain leaving the developed world to a future among emerging markets is not new. Talking to Bloomberg, Guy Hands seemed appalled that Poland might be wealthier than the UK by 2030. Yet if Hands’ submerging UK narrative proves correct, consider BoE Governor Bailey’s part in its downfall as he explained to MPs that he and his team still have “lessons to learn about inflation.” Pardon me, but people who learn on the job are called apprentices and typically earn minimum wage. Bailey gets £500,000 a year to learn on the job while he lectures us on why the level of inflation the BoE caused is the fault of Vladimir Putin, the supermarkets, and workers expecting pay rises. The case for diversity of thought at Threadneedle Street has never been stronger. The monetarists deserve readmission to the MPC, and soon.

Fiscal Dominance

However, the financial historian Russell Napier contends that the UK has more of a fiscal problem than a monetary one, and in times of financial repression, central banks are less relevant. But in a world of fiscal dominance, the UK government’s balance sheet cannot compete with the US or the EU as such it is unsurprising that both Jeremy Hunt and Rachel Reeves agree that the pension funds are their next targets.

Pet Projects

The proposed UK semiconductor funding package is illustrative. The UK cannot hope to compete with the US or the EU’s fab grants to Intel or TSMC. So the focus is sensibly on niche competencies, such as compound materials and quantum technologies. Jaguar Land Rover has played the UK off against Spain to increase fiscal support for its new giga-factory, but UK energy company Drax has signalled it would follow oil and gas companies by allocating capital outside the UK. Harbour Energy reduced its UK staff numbers to focus its search for hydrocarbons outside the UK following the windfall tax. Gas producer Kistos has started allocating capital to Norway’s high but stable tax regime, complaining that last year it paid 65% tax on its UK profits while it expects to pay over 85% this year’s lower numbers. Now power generator Drax is being lured by the US’s ironically named Inflation Reduction Act.

We Have a Problem

At its CMD, Drax said that the supportive environment created by the Inflation Reduction Act is stimulating action and robust pricing for Carbon Dioxide Removal (CDR). Drax is establishing a Global BECCS (Bio-Energy with Carbon Capture & Storage) headquarters in Houston. These are jobs and investments not destined for the UK, mainly because the UK government won’t (and can’t) match the generous US fiscal regime.

Mending Windows

However, while the UK economy has lost real value in future oil and gas production and employment, BECCS is more likely to prove a case of what economist Claude-Frédéric Bastiat called the broken window fallacy. Mending a broken window (or capturing CO2) doesn’t increase overall output – it merely shifts an economy from productive work to maintenance of the existing situation. Oliver Shah makes a strong case for a common sense fiscal policy and acceptance that the UK cannot compete with the US and the EU on vanity projects.

Axe Throwing & Alcohol

We can spend our money and time in better ways than capturing greenhouse gases or building semiconductor fabs. The new “new thing” for UK investors is combining alcohol with axe throwing. AIM-listed experiential leisure operator XP Factory reported that its revenue had increased 228% compared to last year and continues to perform ahead of expectations. XP Factory has 30 Doom Battle Bars and says that so far in 2023, it is trading up 44% on a like-for-like basis. What could possibly go wrong?

Animal Test

What has gone wrong for animal health company Dechra is that ongoing de-stocking means its sales will be lower than expected for the year to June. This is disappointing for shareholders but, more significantly, casts doubt on the appetite of PE firm EQT which has an agreed indicative offer of £40 a share offer on the table for Dechra. This £4.6bn offer is a critical test for the wall of PE money supposedly earmarked for the undervalued UK market. Dechra shares ended last week at a 25% discount to the proposed offer price, indicating fears that EQT could walk. The put-up or shut-up date for EQT is this Friday.

Turning Ugly

Private equity and public markets sometimes mix poorly, as revealed by delayed results from the suspended Revolution Beauty last week. So toxic was the financial report for the year to February 2022 that newly appointed clean-up CEO Bob Holt refused to summarise it for the RNS, saying shareholders should read all 134 pages for themselves. Valued at £500m at IPO in July 2021, affording an exit for its PE backers and big paydays for the co-founders, the shares were suspended at a tenth of that value last year. The report for the year ending February 2022 reveals multiple financial reporting and control issues often found in businesses driven too hard for top-line growth. The cohort of 2021 AIM IPOs, including THG, Made.com and Revolution Beauty, provide salutary lessons for those now reviewing the suitability of the UK for primary listings. (Well worth listening to Max King’s comments on the Money Makers podcast, link below, about avoiding IPOs when there is a glut but going for ones that get onto the market in more challenging times. A positive backdrop for Onward Opportunities, which arrived on the market at the height of the US banking crisis in early March).

What's the Point

At the Mello investor event last week, was a panel discussion on the topic of “What is the point of AIM”. The panel identified the high costs of maintaining a listing for microcap companies and the advantages of going private. Kitchen maker John Lewis of Hungerford featured as a £2.5m market cap case study. And there was an overwhelming argument for this asset-rich but barely profitable company and its tight band of shareholders to exit AIM. However, this does not negate the purpose of AIM or any other UK listing venue for ambitious companies.

Mission Creep

As the London Stock Exchange pursues its primary strategy of becoming a data provider to financial institutions, its listing venue legacy becomes more vulnerable to competition. The UK needs cost-effective and adaptable listing venues by which small, growing companies can provide new shareholders adequate protection without stifling entrepreneurial innovation. With AIM increasingly driven by the tax benefits afforded to its investors, there is an opportunity for some healthy competition.

Focused Exchange Venue

To this end, the 10th birthday celebrations of Aquis Exchange and its innovative initiatives at the Aquis Stock Exchange (AQSE) are of more than passing interest. While still a fraction of the size of AIM, AQSE listed more companies last year than the LSE junior market, partly due to its flexible strategy to accommodate the different requirements of young growth companies. The return of the IPO market will be an acid test for this upstart disrupter.

Be Careful What You Wish For

One of AIMs biggest entrepreneurial successes over the last 25 years was the listing and development of Jonathan Milner’s biotech enabler, Abcam. After a 2 000% return from listing to his departure from the CEO role, Abcam did last year what many companies are threatening to do now, delisting in London in favour of NASDAQ’s broader and deeper capital market. However, Mr Milner, who remains a 6% shareholder, is not pleased with how things have gone since he left and has called an EGM demanding his reinstatement to the board as Executive Chair. While the NASDAQ listing is not the main reason for Abcam’s recent poor performance, its move to become a small fish in a big pond has not helped matters. If needed, this episode is evidence that the grass is not always greener on the other side of the fence, and the UK is not the only place where companies go wrong.

Jeremy

 

 

Some Suggested Listening …

Why the UK is Still the Trade of the Decade

US value investor Robb Arnott’s perspective on why we should not give up on UK equities.

Money Makers podcast: 27 May 2023

Russell Napier talks about financial repression and the growing irrelevance of central banks, and Max King discusses his views on broader investment markets.

John Hope Bryant on Financial Literacy

Entrepreneur John Hope Bryant talks to Barry Ritholtz about financial literacy and capitalism’s role in human rights.

Jim Rogers on the Demise of the Dollar, Inflation and China

Folksy charm from the legendary investor but packed with sage-like advice and humility.

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