October 2024

“If you drive a car I’ll tax the street, if you try to sit I’ll tax the seat, if you get too cold I’ll tax the heat, if you take a walk I’ll tax your feet. Taxman!” George Harrison

October was the Month of Tax as a number of countries introduced or mooted an increased take from their citizens. While the UK took centre stage with the long-awaited budget from the new Labour government, France raised the prospect of new taxes on corporations and high-net-worth (HNW) individuals while the Italian government approved plans to raise € 3.5 billion from banks and insurance companies in yet another windfall tax. With many countries running debt to GDP ratios of greater than 100% the need to address the fiscal imbalance is starting to get pressing and governments reluctant to take difficult decisions on spending, so taxes must be raised. In the UK however, the tax grab will be accompanied by an “investment” (i.e. spending) blowout, which will see public spending as a percent of GDP get to levels only exceeded in WW II, while taxes, already at historic highs for peacetime, will go higher. Accompanying that spending is a considerable increase in the size of the regulatory state, in what will likely be the single greatest experiment in determining the lower boundary for productivity decline in history. Predictably UK bond and equity markets reacted badly, but whether that reaction will trigger any moderation remains to be seen, but regardless it’s unlikely to be significant.

Elsewhere the markets were focused on macro events, as a stronger than expected US employment report may have put the final nail in the coffin of the multiple rate cuts scenario for 2024. The ECB cut rates as expected, but the stronger US data weighed on all government bond markets, as did indicators that pointed to a bottoming of European activity as well and yield curves steepened as longer duration rates rose considerably. The implication looking forward is that we may once again be entering a transitionary period where the medium-term direction of economic growth is uncertain, and while markets have already largely priced in a move from an aggressive rate cut scenario, yields can move much higher if the stronger data persists. So, not so much hard or soft landing and more fly-by. We also have the added element of the US elections next month, and regardless of ultimate policy direction, markets will very likely move to price its perception of that policy direction. As we’ve noted many times before the data will be key.

October saw the start of earnings releases for European banks, and as expected results remained strong. However, the market’s reaction has been muted, with a sense that the best part of the recovery trade has happened. Credit spreads remained relatively narrow, reflecting the improved fundamentals but AT1s were more muted. Per the previous paragraph we believe the market is too pessimistic about the direction of travel for Net Interest Margins (NIMs), and, even if they’ve peaked earnings, European banks should remain quite capital accretive for some time to come and are certainly supporting credit markets. Given strong levels of capitalization we believe the prospect for sustained repatriation of excess capital remains high. The big question for us is the degree to which bank managements will be tempted to relax their cost and balance sheet discipline to satisfy their more adventurous sides. Already we are seeing signs among the larger players, who are investing in their investment banking activities and geographically expansion, despite the poor return nature of these businesses. Given where we are in the business cycle now is not the time to lose discipline.

For the month, the fund’s A shares rose 0.53%, driven by credit which contributed +95bps in gross performance, while equities lost -31bps. We remain very defensively positioned and will continue to focus individual situations, primarily in smaller banks, which provide the best opportunities while allowing us to retain maximum flexibility to respond to shifting market dynamics.