Firstly, looking at the current economic and stock market situation around the world, when thinking about international financial matters in recent months emerging markets such as China and India have stolen the spotlight. Their scope for population growth and urbanisation provides them the most potential to catch up to their wealthier, more developed counterparts. By contrast, Continental Europe and Japan have been seen as the less attractive cousins.
Since Europe has been receiving a great deal of attention in recent months, we thought we might investigate that region more closely than usual in this Bulletin. The case for investing in Europe, either by purchasing shares in companies located there or by investing in UK companies doing business on the continent, is difficult to make at face value, not just because of Brexit. Growth over the past decade has been substantially lower than in the United States or the United Kingdom. Supranational organisations such as the International Monetary Fund (IMF) have recently reduced their forecasts for European growth. Official interest rates remain negative, a policy that was put in place following the euro crisis of 2013. Given the anaemic growth that has gripped the continent, central bankers have been loath to raise them. Additionally, Europe’s much-vaunted political stability has been challenged by a rising tide of populism, most notably in Italy, France and Farageland. Unsurprisingly, company share prices, investor confidence and general levels of dynamism all remain noticeably lower relative to North America.
However, Europe is definitely not out for the count. Despite what some of us may think about Jean-Claude Junker or Donald Tusk, it still matters, despite all the current complications. The European Union’s 28 member countries account for 22% of global GDP, just behind the United States (25%) and ahead of China (15%). The euro accounts for 34% of global transactions, second only to the US dollar (45%). Given that – even if the UK is excluded – it also holds three G7 seats and four G20 seats, Europe still carries significant diplomatic clout.
The key question for Europe is this: is it stuck in an insurmountable malaise? In answering this question we need to remember two things. First that the European Central Bank still has the ability and scope to undertake huge economic stimulus when required. Second, the political elite in the EU is fully committed to “The Project”, i.e. creating a United States of Europe and are willing to spend an unlimited amount of our grandchildren’s money to achieve that object. We say grandchildren because our children’s money has already gone. This commitment will in future involve taking on even more government debt that can never ever be repaid; imagine that.
The biggest impact on much of northern Europe’s economic growth rates in 2019 rests on broader concerns. A pragmatic Brexit outcome (the UK not actually leaving in any true sense of the word, which was always going to be the case) would be a boost for all regional countries given the ending of uncertainty and the high levels of trade between the European Union and the UK. Ultimately, this is the only possible outcome. The other issue for northern European countries such as Germany, Holland and Scandinavia is avoiding a broader global trade war (as has threatened to bubble over between the US and China). Progress to date in trade discussions between China and the US has helped buoy global stock markets, including those in Europe. Part of the reason is that a material part of Europe’s wealth has come from exports, specifically to the emerging markets, especially China and the United States. These exports have been boosted by the relatively cheap value of the euro over recent years. However, this also indicates that Europe can be an attractive supplier of a broad range of goods and services for the global market, a view which is at odds with the pessimism surrounding Europe’s potential for innovation and productivity.
If you had to pick the most important date in the European political calendar for 2019, it would not be the finale of the Brexit process – it would be the European Parliamentary elections that are due to be held between 23 and 26 May. It is highly likely that in these elections so-called populist parties will make significant gains, though they will still be short of a majority in most cases. Populist parties tend to focus on local and national issues, meaning that pan-European co-ordination between populist parties is likely to remain low. However, the collective threat to the established parties is real. This could, in certain circumstances, increase pressure to leave the European Union. However, it is also true that the policies launched by populist parties that do obtain power in specific countries struggle to get traction elsewhere. We have seen in Greece and more recently in Italy that it is always easier to talk than govern. Overall we aren’t too worried about the populists, indeed their rising popularity may just be the nudge that more conventional politicians need to step up and inspire. It’s surprising what people can do when their government limousine is at stake.
The Bible and archaeology have recorded various agricultural cycles, often tied to weather but also the expansion of crops. Humans are driven by fear and greed. When they are in rough balance, we tend to be both disciplined and careful. However, when either side is predominant humans tend to do extreme things and concentrate all their resources to gain more wealth/power or horde them to avoid current or future crises. When a mass of people does the same thing, like all siting on one side of a boat, they can capsize the boat. That is why we have always needed recessions to correct the excesses of a prior period. Also, the power of ‘destructive capitalism’ is great and comes when inefficient firms are driven out of business so that more successful and productive entities can thrive. We see nothing that has repealed this need and thus we expect we will have a recession at some point in the next couple of years (unfortunately we can’t give a date for the top of the market prior to the beginning of the next recession).
We expect American interest rates to rise in the period before President Trump’s re-election in November 2020. The current crop of Democratic candidates is proving just as hopeless as Hilary Clinton, maybe even more so. US business is getting better and the reduction in income taxes at almost all levels has helped.
We have known some very successful fund managers over the years who have invested our clients’ hard earned money partly on the basis of their personal use of the products or services a company produces. For example, 30 years ago we met a manager working for an insurance company called Sun Life and he ran their Distribution Fund. This has been a star performer ever since, delivering good returns from a relatively low risk fund, the ideal combination. He told us how he had bought shares in Tesco in the 1980s as a result of him shopping at one of their stores. He had always been annoyed by consistently losing one sock out of a pair and never being able to wear a matching pair, when he discovered that Tesco sold socks in packs of seven and each sock had a different day of the week embroidered on it. He felt that any company going to these lengths to look after its customers simply had to be worth investing in. The principle of buying a company’s shares if its product tastes good also explains the dazzling success of McDonald’s of course.
In another example, an American fund manager we have sometimes used for clients wanting direct exposure to a single market, noticed that a company’s logo had become a body tattoo, establishing a body of trust with its customers that might give the company enough time to execute a well-founded turnaround plan coming out of bankruptcy. Many sound turnaround plans take too long to reach fruition as existing and potential customers’ patience is worn out waiting for the new and improved products. In this particular case with the tattooed bodies, the present customers and the potential customers waited for a couple of years for Harley Davidson’s new and significantly improved motorcycles. The fund manager recognized the potential power of the relationship that the tattoo created, buying the needed time for recovery. Shares in Harley Davidson subsequently rose by several hundred percent. The world is changing in both identifiable and unidentifiable ways, but good fund managers perform creditably most of the time.
The careful investor should always look at what could go wrong. At present this can be summed up in one word, China. Whilst on his deathbed, the 13th century Italian explorer Marco Polo was given the opportunity to retract some of the more fantastical observations from his book detailing his visit to China. Instead he responded with the famous last words: "I have not told half of what I saw". It’s the colossal scale of China that makes it so difficult for business to overlook. As Charles de Gaulle once sagely noted: “China is a big country, inhabited by many Chinese.” Stock markets are beginning to worry about the intentions of China in terms of their stated ambition of global domination. At stake is one of the 21st century’s most important issues so far: the future trajectory of China’s $14 trillion economy. President Xi Jinping assumed power in 2013, since when China has in some ways gone backwards. The present path of undiluted state capitalism leads only to instability, lower growth, more debt and technological isolation. Economic and social reforms are increasingly popular at home and many Chinese are secretly hoping that American pressure will get through to Mr Xi in a way that they cannot. A more economically open and capitalist China would end up wealthier, healthier and make fewer enemies.
Overall we take quite a balanced view for the rest of 2019. There are many dangers of course, such as the enormous amount of global debt owed by companies, governments and consumers alike, but there are also great opportunities. We expect our star fund mangers to be able to ride out any storms and come out the other side smiling.
Almost finally, some free advice. If you hear a helicopter flying above your head, start running towards it because it might be raining down £10 notes. On the same subject, you will be hearing a lot about MMT in the next couple of years, starting as soon as Jeremy moves into Number 10 (shurely shome mistake, Ed.). MMT stands for Modern Monetary Theory, often known as ‘helicopter money’ and it is an idea rapidly finding its way into mainstream economic thinking. It’s completely potty, but that won’t stop it from being adopted by John McDonnell. It is based on the principle that a country able to print its own currency can never go broke and doesn’t have to worry about how much it borrows, it can simply print more and more money. If the economy starts to overheat, or inflation takes hold like it did in the 1970s, things can be cooled down with tax rises on the filthy rich. This idea has already been seized upon by the left in America, which now proposes vast public social and infrastructure spending programmes. It sounds too good to be true, which it is of course, but in the age of social media and at a time when inequality between rich and poor, north and south, young and old is greater than ever, where eight private schools provide more students for Oxbridge than 2,800 state schools put together, where food banks are being used by embarrassingly large and increasing numbers of people, when no one is putting forward the case for enlightened capitalism, dangerous nonsense has a nasty habit of becoming conventional.
Finally, the first two men setting foot on the Moon from Apollo 11 in July 1969 were of course Neil Armstrong and Buzz Aldrin. But who was the third astronaut piloting their spacecraft? And, (without consulting Google if you please) the only musical in the history of musical theatre that is worth watching, On the Town, featured three American sailors on 24 hours’ shore leave in New York. They were Gene Kelly, Frank Sinatra and who else?
If you have any comments on the above please let us know. It’s always lovely to get some feedback.