Quotidian Investments Monthly Commentary – June 2018
Global stock-markets were benign to moderately positive for much of June until the last week of the month when prices were subjected to dramatic see-saw action. This was largely based upon exaggerated fears of a potential global trade war which, in our view, is nothing more than media-inspired market noise for the time being.
June 30this, of course, also a quarter-year end and, as such, is the expiry date for a range of futures and options contracts. It is hardly surprising therefore that equity prices fluctuate in the lead up to that. However, short-term equity market downgrades simply create the chance to buy shares at attractive prices and so we took the opportunity to top up our holdings in those companies that we think highly of and that we trust to perform.
In past reports we have highlighted President Trump’s well established negotiating techniques; initially he seeks to intimidate in order to put the other side onto the back foot and focus their attention. This is particularly so when dealing with the Chinese and EU leaders (he doesn’t need to adopt the same tactics with the UK because we don’t currently have one) by using theatrical statements designed simply to bring his target audience to the negotiating table.
Trump’s initial threats of trade tariffs brought a petulant reaction more suited to the primary school playground from the EU followed, without a shred of irony, by ineffectual complaints and reciprocal threats of their own. The fact is that trade between the USA and the EU is carried out under World Trade Organisation rules and has for years been characterised and tainted by EU protectionism and disproportionate tariffs. For example, new cars exported to the US from Europe are subject to just a 2.50% tariff on arrival in the USA and yet new cars entering Europe from the US are penalised with a 10% EU tariff. The list of similar tariff discrepancies in Europe’s favour is a long one. Hypocrisy or arrogance? Either way, Trump is no longer prepared to turn the lazy and complacent blind eye favoured by his predecessor.
Like him or not, Trump has a clear trading strategy and knows how to play his negotiation cards. The aces up his sleeve are that EU and Chinese manufacturing industries are highly dependent upon the US consumer whereas the US, as the world leader in technology (and which China and the EU are particularly reliant upon) is not nearly as dependent on selling its industrial output to them.
After a period of typically tedious political posturing, the current storm in a teacup is highly likely to blow over soon enough simply because none of the parties involved can afford the dystopian reality of a full-blown trade war. In time, Trump will no doubt achieve his aim of fairer trade between the USA and its main commercial partners and the empty threats of a global trade war will die away again. Stock-markets should then emerge from their torpor.
It is worth noting that the FTSE 100 index has only recently exceeded the peak it reached on 30thDecember 1999. It was then at a reading of 6930 and today it stands at 7636. In other words, it has taken the main UK Index just over 18 years to increase by 10%; roughly equivalent to just 0.55% p.a. Of course, that is a somewhat simplistic measure because it ignores the inherent dividend yield achieved. Over the period, that yield has been running, on average, at 3% per annum and whilst its overall performance has therefore just about kept pace with inflation it is hardly a strong endorsement in favour of passive tracker funds.
The lifeless and unexciting tone of global equity markets continues as we reach the halfway point of 2018. Only two of the world’s stock exchanges are now in positive territory for the year to date as political uncertainty and unsustainable levels of sovereign debt continue to weigh on market confidence. In the UK the stock market still awaits a positive resolution to the monotonous Brexit negotiations whilst in Europe they face additional political, social and economic problems which the EU desperately tries to deflect attention away from.
The eurozone has problems aplenty although you would not necessarily think so from the propaganda flowing out of Brussels. In economic terms, over the eight-year period from 2008 to 2016 the eurozone’s real gross domestic product (GDP) increased by a meagre 3% in total; an average annual growth rate of less than 0.4%. And they trumpet this as success!
Putting that figure into better focus by comparison with US economic performance over the same period; in 2000, just one year after the euro was introduced, the US economy was only 13% larger than that of the eurozone. By 2016, however, it was 26% larger (and it is salutary to note that this significant outperformance has occurred despite the fact that during this period the US economy suffered the bursting of the dot-com bubble, the sub-prime loan catastrophe, the failure of Lehman Brothers and the subsequent banking crisis leading on to the ‘Great Recession’). And now the eurozone economy is faltering badly yet again.
Expanding that theme to some of the largest individual component parts of the EU:
Italy’s new government is refusing to ratify a long-awaited EU free-trade agreement with Canada, a refusal which is threatening to derail the EU’s most ambitious commercial deal thus far and is driving Brussels’ eurocrats to distraction.
To quote Joseph Stiglitz (an Economics Nobel Laureate): “The euro was a system almost designed to fail. The backlash in Italy is another predictable (and predicted) episode in the long saga of a poorly designed currency arrangement in which the dominant power, Germany, impedes the necessary reforms and insists on policies that exacerbate the inherent problems.” Germany, of course, has been the main (arguably the only) beneficiary of the euro construct.
In Germany, durable goods orders have fallen for the fourth consecutive month which clearly signals an economic downturn in Europe’s largest economy. As a consequence, the German Institute for Economic Research has just cut its growth forecast for Germany, partly due to its unexpectedly weak start to 2018 and partly because of the potential financial disaster (in terms of a default on huge German credits) which could ensue from the actions of Italy’s new government. Even a well respected German economist, Claus Vogt, now predicts that “The party in Germany is over.”
Yet despite these obvious signs of weakness (which one would expect to be countered with a stimulus programme) Germany’s finance minister has just announced a further dose of austerity. He wants to reduce investment, cut defence spending and lower the country’s contributions to the EU budget. Brussels is aghast but is powerless to stop him.
Meanwhile, Germany’s anti-EU “Alternative for Germany” (Afd) party continues to gain strength whilst Merkel’s cobbled-together, wishing-and-hoping coalition government (which is held together only with string and sealing-wax) struggles to keep its head above the waterline.
From the latest figures available, Germany runs a current account surplus equivalent to 8.7% of its GDP. According to EU rules, a surplus this large is illegal but it’s strange how the EU’s bureaucrats always seem to find a way around their ‘immutable rules’ when it suits them to (and particularly when it suits Germany).
In simple terms it means that Germany sells to its trading partners far more than it buys from them. Ecomonic theory (or, at least, Keynesian theory) holds that a country with such a huge current account surplus should use it (indeed, has a duty of care to use it) to increase the amount it buys from those countries with a current account defecit and thus kick-start demand in those countries (which in turn will motivate supply and ultimately create profit in what then becomes a virtuous economic circle). The fact that Germany steadfastly refuses to do so could be interpreted as it maintaining a substantial financial buffer in recognition of its own social and economic difficulties.
Trump, of course, is fully aware of Germany’s economic weaknesses, ergo the timing and precision of his threats to introduce tariffs. It is very obvious and commonly held wisdom that, in business or in sport, one seeks to identify the weaknesses of one’s opponent and then exploit them. Trump has focused on German economic weaknesses (and it would be cruel to also mention the travails of their football team so I won’t) which may explain the speed and naivety of the EU’s initial response; he has clearly hit a nerve or two. The bargaining power that Trump now has with the EU (using Germany as a proxy) will, in due course, probably secure the fairer trading terms he has been seeking. He also, quite understandably, reasonably and rightly, wants the EU to pull its weight in terms of financial contributions to the costs of maintaining NATO.
As for Brexit, it is the least of the EU’s worries. EU negotiators are still using time as their blunt instrument in the hope (or expectation) that shortage of time will lead to an abandonment of Brexit altogether or, even better for them, a fudged deal that leaves the UK in thrall to the EU but without a say in any of its policy-making.
Whilst Michel Barnier is the suave face of the EU’s Brexit negotiations (exhibiting all the arrogance and complacency befitting a member of its all-powerful but unelected elite), the real terms of the UK’s departure are set by Germany and, in particular, by a department of the European Commission headed by Martin Selmayr. Selmayr is an honours graduate of the Arthur Scargill School of Charm and has made it his aim to force through a Brexit deal which papers over all the cracks in Germany’s economy at the UK’s expense; a deal that leaves Germany with all the economic advantages and the UK with nothing.
The EU’s unity is crumbling as disagreements over the migrant crisis continue to rumble on and there is an enduring failure to complete new trade agreements (particularly with China, with the USA and now with Canada). In fairness, the UK is not being dealt with any differently from other member states. EU mandarins are nothing if not even-handed; they treat us all with equal contempt!
Whether by accident or design, the timing of Trump’s trade threats is very helpful to the UK. If those in charge of Britain’s end of Brexit negotiations were bold enough to take a leaf from Trump’s strategic approach and assertively exploit Germany’s multiplicity of economic and political weaknesses we might actually see some positive progress towards an acceptable exit deal. That would certainly help to cure the UK stock-market’s current constipation.