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Dear reader,
The concept of scapegoating has its origins in ancient Israel. According to the Book of Leviticus, a goat was driven into the wilderness to die as a way to atone for the sins of the community. Currently, UK banks feel somewhat like that goat. One moment they are quietly going about their business, and the next they are being held responsible for various financial misconducts.
It is worth noting that banks take a portion of the higher base rates that are meant to punish Britons for inflation. However, scapegoats received no personal benefit from the sins of the community.
Lex believes that the political attack on UK banks is both contrived and overdue. Many critics of the banks inaccurately compare interest rates by mismatching durations. For example, they may compare a 6.5% charge on a two-year mortgage fix with a 2.5% return on an instant access savings account. It would be more accurate to compare the two-year fix with a two-year savings account offering a higher return of 4.9%. Furthermore, Lex believes that net interest margins, which indicate the benefit banks gain from rising rates, are currently at their peak. Deposit betas, which represent the proportion of rate increases passed on to savers, are already at 40% in the UK, twice as much as in the eurozone.
The current situation is not favorable for challenger bank OSB Group either. Rising rates are causing its mortgage holders to quickly replace expired fixes with new ones, resulting in reduced profits from default variable rate charges. The sharp decline in OSB Group’s share price points to deeper concerns. The bank specializes in serving subprime borrowers and buy-to-let landlords, both of whom are vulnerable in the current economic climate. Ultimately, this will negatively impact cash-strapped tenants who will face rising rental charges.
UK supermarkets are also facing challenges due to the cost of living crisis. Last month, Chancellor Jeremy Hunt criticized them for engaging in “greedflation” by raising prices more than inflation. However, Lex has observed a more subtle form of opportunism in the quarterly numbers reported by J Sainsbury. The grocer attributed its rising market share to the success of its Nectar loyalty card, which has seen a 10% increase in membership since April. Discounts hold greater value for customers when household budgets are tight. In addition to increased volumes, Sainsbury’s also gains valuable customer data in exchange for offering discounts.
Supermarkets are considered defensive stocks rather than cyclical ones, as explained in this week’s Lex Populi column for private investors. On the other hand, Currys, which maintained its final dividend this week, can be categorized as a cyclical stock. Consumers are more likely to splurge on electronic goods when interest rates are low and the economy is strong. However, the company’s fundamental issue lies in the threat of obsolescence, which retailers are particularly susceptible to. According to S&P CIQ data, Currys’ revenues have remained stagnant for the past seven years, implying a decline in real terms.
Adding to the list of inflation-related concerns is the high cost of living that many middle-class Americans are finding increasingly unaffordable. This segment of the population is comparable to the skilled working class in the UK. American conservative pundit Oren Cass compared the price of reasonable aspirations such as a nutritious diet and a three-bedroom dwelling with the median male income, resulting in a disheartening realization of the challenges faced by this group.
While the chances of this cohort ever being able to afford a decent annuity are low, wealthier individuals on both sides of the Atlantic are benefiting from higher interest rates, which have made annuities more valuable. Insurers, like Legal & General in the UK, are experiencing a surge in demand for annuities. Annuities provide agreed-upon payouts as long as the beneficiaries live, placing significant long-term risks and capital requirements on insurers. However, stock market investors are not as enthusiastic about the annuities boom as corporate finance directors. The latter see it as an opportunity to offload legacy final salary pension scheme liabilities at a reasonable cost.
Chancellor Jeremy Hunt aims to redirect some of the estimated £1.3tn worth of corresponding assets into preferred areas of the economy. However, Lex sees this as a form of “financial repression” where ministers appropriate private capital for their own purposes. Readers seem to agree, based on their comments.
Alternative asset managers have a more favorable view of insurers compared to the stock market. Insurers generate steady cash flows that can be used to fund other investments. Apollo, with its annuities business Athene, is one example frequently cited. The real progenitor of this strategy, however, is Warren Buffett, the world’s most famous investor. Brookfield recently paid $4.3bn to acquire annuities group American Equity Investment Life, a move that reveals a touch of irony. One of Brookfield’s executives resigned from American Equity’s board without informing CEO Anant Bhalla just a few months ago. Now Brookfield is paying a premium price for the business that Bhalla has built up.
One hopes that Brookfield will be a more successful owner than Cinven has been with Eurovita. The Italian insurer had to be rescued after entering administration. While the UK private equity group provided additional capital, it fell short of expectations. As a result, European regulators will scrutinize insurance buyouts more closely.
No business round-up would be complete without mentioning Elon Musk. As the CEO of Tesla, Musk is a prominent figure in the business world and a source of entertainment. This week, Meta, formerly known as Facebook, launched a social media app called Threads, directly competing with Twitter, a platform that Musk has criticized. Threads will draw from Meta’s Instagram service, making it an easy win for owner Mark Zuckerberg, who would likely prevail over Musk in a cage fight as well.
Musk’s success in the electric vehicle industry is notable. Tesla is delivering record numbers of cars, and Volkswagen plans to adopt Tesla’s North American Charging Standard, which could become the industry norm. Chinese competitors, such as BYD, may capture a significant market share at lower price points. However, Xpeng is causing some concern. Although the company’s G6 electric SUV has garnered many pre-orders, its shares have sharply declined, and short interest is at an alarming 12% of the free float.
Some highlights I enjoyed this week include a humorous column by Robert Shrimsley, who cleverly parodied Wes Anderson’s latest film, Asteroid City. The column emulates the offbeat mood of a Wes Anderson movie without relying on the director’s typical plot devices. It is a challenging feat to pull off.
I am currently reading “Revolucion” by Arturo Pérez-Reverte, an exciting historical novel set during the 1910 Mexican revolution. This is a great way to learn about Mexican history while also picking up some Spanish vocabulary related to explosives. You never know when that might come in handy.
Enjoy your weekend,
Jonathan Guthrie
Head of Lex
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