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The West owns the watches but the Chinese own the time

16th May 2017
What a few months it’s been. Apologies for the gap since the last bulletin, but every time we wrote a piece and were about to send it out, something fundamental would change and we’d have to start all over again. However, now that normality has returned to the universe and Newcastle United is once again back in the Premiership where they belong, it’s time for another soupçon of what passes for wisdom at Scholes & Brown.

Who would have expected a General Election in June? Another surprise for the experts! Makes you wonder if it’s worth making predictions about anything these days. Rather than comment on the short term political, economic or stock market noise though, we thought you would prefer us to concentrate on the long term global picture and how this might affect your hard earned money. So that’s what we’ll do.

To start with, we should note that we’re all information junkies these days; it’s really a question of trying to find out what might be primarily important and what is just froth. We remember Albert Einstein saying: “Everything that can be counted does not necessarily count and everything that counts cannot necessarily be counted.” Einstein recognised the meaning of what was known, but also what was not captured in the data. He identified what was missing. If only the pundits who were wrong about the outcome of the Brexit referendum and the USA and French elections knew how to look at the data that was and wasn’t, they wouldn't have been so embarrassingly wrong.

First of all in our global tour, let’s look at what is happening in China. To our mind there is no more important topic for long term investors than China. Many believe that it is only a matter of time before China will become the largest economy in the world and all that occurrence implies. We would be badly misled if we applied the lessons from our own history to China. First, we come from political cultures where our leaders for the most part were trained in politics or law. Most of the current leadership in China spent time learning engineering. As part of that experience they were indoctrinated into rigorous planning as a dominant discipline. While there may be periodic disruptions there, their life is much more orderly than in the West.

When Chinese Premier Li Keqiang states that there will not be major problems as their economy shifts to fulfilling internal demand for goods and services from being export driven, we are reasonably confident that the records will show that he was correct. The Chinese political class want to be seen as good generals that are never surprised. Also the leaders know that shifts in global leadership are gradual, not abrupt. Their planning doctrine allows them to be patient as long as they are making progress every year. While in the USA they are waiting for the new President to start the ball rolling on the surge in infrastructure spending to repair railroads, roads, bridges, tunnels and airports, China is well ahead in its construction phase. Large economic projects are always dependent upon detailed planning and a high level of engineering, both of which the Chinese have in abundance.

There was a meeting recently between Xi Jinping and Vladimir Putin to discuss “One Belt One Road”. This is essentially a development strategy proposed by the Chinese President in 2013 that focuses on connectivity and cooperation amongst many countries, but primarily between the People’s Republic of China and the rest of Eurasia. It is based on the Silk Road, an ancient network of trade routes that were for centuries central to cultural and economic interaction throughout regions stretching from the Korean peninsula and Japan to the Mediterranean Sea. As an example of how massively important this project could become, China plans to invest up to $50 billion in infrastructure projects in Pakistan over the next few years. To put this into context, in 2015 Pakistan’s Gross Domestic Product was around $270 billion. While there has been some news coverage of the One Belt One Road meeting, most of the US attention has been focused on the dismissal of one employee at the discretion of the President. As long term investors, we believe this is a misplaced focus. On the Chinese side the implications of the One Belt One Road initiative may have implications into the next century. The USA focus appears to be on next week.

Why is China doing this? Well, from an economic vantage point it is a brilliant way to export their excess steel and cement capacity in building long line railroads and some internal subway systems. It also would reduce shipping costs of Chinese manufactured products that potentially could be exported to 60 countries.  This is somewhat like President Eisenhower's USA interstate highway building programme that required new federal highways to be built with the ability to handle the transportation of heavy tanks. As the rail and port facilities are built, China will have strengthened its ability to influence all of the surrounding countries.    Compared to the Russian leader in attendance, the USA sent a lowly director of the National Security Council. While there may be a military threat in the One Belt One Road initiative, by far the bigger threats to the West are economic and political.

The situation in America looks increasingly glum. We see a range of issues dragging down the USA’s productivity, such as ballooning student debt, which makes people increasingly angry about how much money they owe, felony convictions for petty crimes marginalising individuals and the fact that 40% of maths, engineering and science university graduates are not eligible to work in the USA when they complete their degrees. Any one of these issues is damaging, but taken together they are a serious hindrance to America’s effort to achieve healthy economic growth. Workforce participation is declining, inner city schools are simply not good enough and failing children, with fewer than 60% of students graduating with acceptable qualifications. USA infrastructure is creaking and the country has not built a major new airport in over 20 years, during which time China has built 75. As in Europe, excessive regulation is hampering industry and stifling smaller companies and innovation. The new French President, Emmanuel Macron, a former civil servant and investment banker (no engineering there, Ed), is determined to push ahead with even more Europe and a fundamental restructuring of the French antiquated labour laws (good luck with that).

Here in the UK, we expect to see Mrs May re-elected on 8th June with an increased parliamentary majority, allowing her to negotiate more robustly with our EU friends. The markets have already largely factored in a Tory win, but we could still see shares rising even higher this year as a collective sigh of relief is breathed by investors, particularly international investors.

The real problem for markets in the near term is not France, terrorism or even President Trump, although DJT does seem to have the ability to conjure defeat from the jaws of victory on a spectacular and regular basis. No, it’s falling real wages in the West that has alienated large swathes of workers who feel left behind. Here in the UK nurses are again thinking about taking industrial action. It is all too easy to respond by saying that they should never do that sort of thing, wouldn’t have happened in my day etc., however the plain fact is that nurses’ real earnings in terms of what they are able to buy in the shops have fallen by 10% since 2010. In round figures average pay has risen by 7% while inflation has totalled 17% over the same period. There are many other groups who feel similarly disgruntled. This will result in increasing pressure for the political elites to ‘do something’. In the UK this ‘something’ will likely take the form of greater redistribution of wealth between rich and poor, old and young, north and south, black and white and men and women.

So what does all this mean for your investments? Even though the global economic acceleration that began last spring has strengthened, we still think that shares are overvalued at present and will become cheaper at some stage. But not yet. On the balance of probabilities shares will go higher, perhaps much higher, in the immediate future. By building truly diversified portfolios we want to protect our clients from the volatility that sharp market movements entail. This can sometimes mean that we might not capture 100% of the gains, but we do avoid increasing your blood pressure medication.

Penultimately, we thought it was a good idea if we showcased some of our clients’ many talents in these bulletins. We advise many business owners and it struck us that these could be promoted within our little community to everyone’s advantage. So here goes.

One of our favourite clients (you’re all our favourites, Ed.) started off running a stairlift company, but now offers a wide range of products aimed at helping people to live independently in their own homes. The Independent Living Showroom was formed in 2012 when Dolphin Lifts and Mobility joined forces with Shape Adaptions to create a firm offering comprehensive solutions including ramps, stairlifts, wet rooms and even complete home adaptations. They have an excellent reputation and aren’t pushy salesmen, so if you or a family member needs some advice please contact the Independent Living Showroom on 0191 286 0200 or you can email help@independentlivingshowroom.co.uk  No commission changed hands for this advertorial by the way.

If you have a business or service you would like us to mention in a future bulletin, or have any comments or questions about this newsletter, please get in touch with Philip Brown: pbrown@sb-am.co.uk

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