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Please see the ‘Monday Digest’ article below, received from Tatton Investment Management this morning. 

Tatton Monday Digest Politics, where policy takes a back seat

Last Friday marked the end of the second quarter, culminating in the day after the first 2024 US Presidential debate, widely seen as disastrous for Biden, yet financial markets have remained relatively steady. Institutional investors are currently engaged in their scheduled portfolio rebalancing, however, this time it is causing minimal disruption across asset classes. 

Thursday’s debate was anticipated to scrutinise presidential fitness rather than policy details. Biden’s disastrous performance raised concerns even among loyal Democrats, potentially jeopardising his electoral viability with any loss of voter support being very damaging.

We think betting markets show a more unbiased indicator than polls, reflecting a notable shift post-debate. Trump’s odds improved to 54.8%, a 4% gain, while Biden’s plummeted below 25%, a decline exceeding 15%. Betfair Exchange Politics indicates a 60% likelihood of Republican victory, signalling diminished prospects for Democrats if Biden remains their nominee.

Amidst debate fallout, California Governor Gavin Newsom emerged as a prominent alternative in market discussions should Democrats opt for a candidate change. The viability of such a shift hinges on internal polling and strategic calculations within the Democratic Party, which may in flux at the moment.  

Market reactions following the debate were almost blasé. US stock futures saw modest gains, contrasting with a decline in US Treasury bond prices (indicative of rising yields). The dollar also rose. International stocks were a little weaker. This implies that investors are currently expecting a slight near-term benefit for US growth should Trump win, but that it may also mean a worse budget deficit.

Looking beyond the US, global elections share common themes: aspirational manifestos mean that most important policies will not be clear until well after the elections are finished amidst heightened voter polarisation. In France the right wing did well in the first round of voting, but outright victory may be hampered in the second round by tactical voting simply to prevent the Le Pen from winning. In the UK, Labour’s centrist manifesto seems less alarming to markets, yet clarity on actual policies also remains vague.

Compared to the start of the year, global economic data remains mixed with a slight positive bias, bolstered by upward revisions in world growth forecasts. The Chinese economic policy push to bolster economic activity has driven down goods inflation, but this signals weakening domestic demand. The US shows a loss of growth momentum with slew of profit warnings from consumer-facing companies ahead of Q2 results. Consumer caution over inflation has tempered spending, impacting sectors like housing and consumer goods.

Gentle economic slowing that allows the Fed to cut rates, should lead to rebounding growth amid an otherwise stable dynamic characterised by tight labour supply driving business investment into productivity enhancing technology advancements. Europe is in a similar position although admittedly with softer underlying growth.

Looking ahead, companies broadly remain on a positive path, but market risk will continue to emanate from policy volatility uncertainties. We’ll know a bit more next week after the UK elections and possibly a lot more after the second round of the French election 

Basel III banking regulation – the Unending Endgame

Last week marked the 50th anniversary of the Herstatt Crisis, a pivotal event that triggered the establishment of the Basel Committee on Banking Supervision by the G-10 nations. In 1974, Herstatt Bank’s collapse during currency trading left a $620 million loss ($400bn today) on the global banking sector, prompting G-10 nations to form the Basel Committee on Banking Supervision to mitigate such risks.

Initially overseen by the Bank for International Settlements in Basel, Switzerland, the committee aimed to regulate an increasingly interconnected global financial system. It took 14 years, until 1988 for Basel I, which introduced international banking regulations focusing on capital adequacy, classifying assets into risk categories and requiring banks to maintain capital equal to at least 8% of their risk-weighted assets.

It was hoped Basel I would prevent bank failures spilling into the global financial system, but it failed. The Barings Bank collapse in 1995 and the Long Term Capital Management debacle in 1998 underscored its limitations and led to Basel II. Introduced in 2004, it aimed to enhance risk management and transparency by assessing asset risks more accurately, however it also failed spectacularly to prevent the 2008 financial crisis. This led to the development of Basel III, implementation of which began in 2010 and continues, albeit slowly, with the final phase known as the “Basel III Endgame.”

Basel III extended Basel II’s focus on risk management – increasing minimum capital requirements, raising common equity levels from 2% to 4.5% of risk-weighted assets. It introduces capital buffers to absorb losses during economic stress, mandates liquidity ratios to ensure banks maintain high-quality liquid assets and imposes stricter requirements on globally significant banks.

However, Basel III places greater weight on banking regulation but not on other financial institutions such as private equity and credit firms, which are now seeing stronger equity returns. Last week US bank shares rose when the US Federal Reserve Recent announced revision to moderate the impact on large banks with sizable trading operations reducing the increases in capital adequacy to about 5% from a potential 16% rise.

In Europe, implementation has been delayed pending alignment with potential US revisions. Politics may disrupt the final outcomes as well. It is worth remembering, that Trump removed some of the regulations for US regional banks in his first term and he may seek to allow US banks more latitude.

Perhaps more likely is that the non-bank players, especially the private equity and credit firms, will seek to prevent similar regulation being applied to them, as highlighted by the Bank of England last week when it reenforced the need for international co-ordination for private equity  cross jurisdictions.

So, for the banks, “Endgame” might be applied to this Basel episode. For private equity firms, their episode will probably be called “Opening Gambit”.

The rise and fall of Ocado

Ocado, known for its distinctive green and white delivery vans and association with M&S, began in 2000 as a pioneering online grocery service in the UK. Initially praised for its innovative technology and logistics, including automated Customer Fulfilment Centres (CFCs), Ocado quickly gained market traction. Its 2010 stock market debut saw shares rise from an initial 180p to nearly 600p, buoyed by efficient operations and a partnership with Waitrose, which bolstered its IPO.

A turning point for Ocado was licensing its Smart Platform technology globally, securing deals with major retailers like Morrisons, Kroger, Casino, and Aeon. This expansion underscored Ocado’s tech prowess and potential for substantial revenue growth, reflected in its share price peak of around 2886p in 2020.

However, the grocery sector’s fierce competition and narrow margins strained Ocado, despite its technological edge. High costs associated with building and maintaining CFCs, alongside increasing competition from Amazon Fresh and traditional grocers going digital, pressured Ocado to continually innovate.

The COVID-19 pandemic briefly boosted Ocado as online grocery demand surged. However, the temporary spike strained operations and inflated costs, raising concerns about long-term sustainability post-pandemic. Analysts, including Morgan Stanley, now project prolonged cash flow challenges and debt accumulation.

Morgan Stanley’s cautious forecasts include fewer CFC deployments and heightened debt levels, signalling ongoing operational and financial hurdles for Ocado. This shift in sentiment has driven a significant decline in Ocado’s share price from its peak to just 281p last week, underscoring investor scepticism about its ability to manage these challenges effectively.

Looking ahead, Ocado must focus on cost management, margin improvement, and expanding its technological services to new markets to regain investor confidence. While its innovative approach sets it apart, navigating the competitive and cost-sensitive grocery sector remains a formidable task.

Ocado’s journey serves as a cautionary tale in the tech industry, highlighting the complexities of sustaining growth amid operational pressures and competitive forces. Its evolution underscores the volatile nature of high-growth enterprises reliant on borrowed potential, where minor shifts in profitability drivers can lead to significant market reactions.

Please check in again with us soon for further relevant content and market news.