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Quotidian Investments Monthly Commentary – August 2018

September 4, 2018

From an investment perspective August has historically been a slow, tedious and dismal month featuring very low volumes of equity trading which leave stock-markets open to volatile intraday movements and day to day see-saw action.  This year has been no different.

In theory, of course, equity prices should reflect a company’s current profitability and its prospect of future growth in profits.  In practice, however, prices can be manipulated to reflect market-makers’ interpretations of political events (or natural disasters) and so, particularly during periods of low activity, share valuations can fluctuate wildly day by day.  Ultimately though, economic fundamentals will reassert themselves and shares prices will reflect the laws of supply and demand.

One of the skills of investment management, therefore, is to recognise the difference between share prices based on the emotional interpretation, corporate opinion and financial self-interest of market-makers as opposed to prices that reflect economic reality.

On 31st August 2018 the FTSE100 index closed the month at 7432.42, a fall of-4.08% in August and it now stands at -3.32% for the 2018 calendar year to date.  By comparison the Quotidian Fund’s valuation at the same date shows a rise of +3.63% for the month of August and the Fund is now up +9.84% for the 2018 year to date.

I have attached to my covering email a screen shot of the 2ndquarter results for all our current holdings. You will see from this that we presently hold shares in 22 individual companies.  Of these, 21 have produced figures that are ‘positive surprises’ (being above market expectations) and only 1 which marginally missed its estimates. As markets returned to normal volumes of trading in the last week of August that positivity has been reflected in their share valuations.

During August the problems in Turkey’s economy have become even clearer and it is obvious that these issues have developed as a result of persistently inept financial management from its ego-driven President Erdogan.

The Turkish lira has fallen in value by very nearly 40% this year to date vis-à-vis the US dollar.  This should make its exports more attractive to the US market but Turkey and the United States have been embroiled in a fractious dispute focused on an American preacher who faces being tried on terrorism charges in Turkey.  Diplomacy has failed to achieve an equitable resolution.

Never one to miss an opportunity to gain a negotiating advantage by kicking a man when he’s down, President Trump has therefore stymied that potential area of financial relief by doubling the tariffs on Turkish exports arriving into America.  It gives a new, fuller and more profound meaning to the phrase ‘being trumped up’.

The wider economic implications relate to the flawed currency that is the Euro. European banks areup to their necks in Turkish debts; Italian banks are exposed to Turkish liabilities to the tune of $17 billion;  French banks: $38 billion and Spanish banks: $83 billion.  Whilst I do not have relevant figures for German banks I have no doubt that their numbers would also show a worrying degree of exposure to Turkey’s indebtedness.

The Lira’s collapse may be forewarning an implosion in Turkey’s economy as a whole and its debt structure too which, in turn, is already creating substantial money inflows to the United States and stress-testing the Eurozone’s viability to withstand Turkey’s potential default.

However, Italy poses an even greater threat to the Eurozone’s stability.  The European Central Bank will be reducing its Quantitative Easing (‘QE’) programme by half in October as a precursor to ending QE altogether on 31stDecember.  From 2019 onwards there will no longer be a lender of the last resort in the Eurozone.

The Italian government has promised to effect fiscal expansion equivalent to 6% of Gross Domestic Product (‘GDP’).  The EU, though, wants to impose fiscal austerity and budgetary control upon Italy but, with a large degree of justification, the Italian government will not accept that.  Italy is not the economic basket case it has historically sometimes appeared to be; it still comprises the EU’s second largest concentration of manufacturing industry and it has a current account surplus of 2.8% of GDP.  Italy is also a net positive contributor to the EU and, whilst its sovereign debt now stands at 132% of GDP (which is an area of vulnerability), it would only risk insolvency because the EU will no longer have a lender of the last resort from 1stJanuary 2019.

Thereafter, any bailout would require the backing of the European Stability Mechanism (‘ESM’) and, as we saw with Greece, the ESM imposes profoundly stringent terms and conditions designed essentially to protect German banks from their own bad debts and to beggar (I think that’s the correct spelling) the ‘offending’ country.

Italy would certainly not accept the draconian terms forced upon Greece and it has already put in place a parallel currency which could be introduced to replace the Euro. If this were to happen (and the new Italian government gives every indication that they are prepared to act assertively) then the structural flaws in the Eurozone would be exposed yet again and Italy’s parallel currency would subvert monetary union from within. 

Italy plans to rebuild its dated infrastructure (and the disastrous collapse of a road bridge in Genoa last week provided stark evidence of the pressing need for that) without budgetary constraints. 

The Italian government has cited “The Golden Rule” as its means of funding the expenditure it intends to make on renewing infrastructure.  In this sense the ‘Golden Rule’ was a device instigated by the slippery, one-eyed and wanton Gordon Brown (once the UK’s financially incontinent Chancellor) and which, by dubious mathematical sleight of hand, excludes public expenditure from the national budget deficit. 

Those of us of a certain age will recall a somewhat different definition of The Golden Rule: “Those who have the gold make the rules”.  In the EU’s case, Germany has the gold and the control over it.  A trial of strength is looming therefore between Italy and its new government (which, for a refreshing change, has not been imposed by the EU and therefore does not contain EU supporting placemen) and the Brussels/Berlin axis; a test of will which could bring down the fragile Eurozone banking system (and cost Germany around 2 trillion euros in loan defaults).  Interesting times.

The latest in the Brexit saga has been the EU’s assertion that British intelligence has been bugging EU working party meetings and had thus penetrated the inner circle of the EU’s negotiators.  By coincidence this revelation came on the very same day that Theresa May was meeting with Angela Merkel in a ‘hastily arranged’ attempt to sell her anaemic ‘Chequers’ plan.  When it comes to negotiation and salesmanship (or indeed any social interaction) miscast May resembles the stiffness of a poker but contrives to radiate nothing even of its occasional warmth. 

In light of the problems now facing the EU from both Turkey and Italy, any UK negotiator worth their salt would now use the blunt instrument of time to put pressure onto the EU.  Despite its arrogant and aggressive approach, the EU needs a workable Brexit arrangement far more than the UK does.  A Brexit deal should therefore be ‘kept on the long finger’ (as they say in Ireland when they mean ‘kept waiting’ or ‘deferred’) to avoid making any agreement until the challenges posed to the EU by Turkey and Italy have played out.

The shabby Brexit letter issued by Toothless Theresa in mid-August is yet a further salvo in Project Fear and is shameless in its negativity, mendacity and bias.  When the UK needs the Iron Lady what it has is Polythene Pam; the weak-willed Myopic May who now lacks even a scintilla of credibility.  In the season of A-Level and GCSE results her tawdry missive earns an A* in the Art of Deception.  Worse still she is backed up by Fireman Sam, the half-hearted, hapless Hammond who is doing his utmost to hinder progress towards successful Brexit negotiations.

Taxes paid by the 26.7 million people working in the UK’s private sector pay for the salaries, pensions and expenses of the 5.4 million people employed in the public sector (teachers, police, firemen, doctors and nurses, politicians and civil servants).  That being so, is it too much to ask our civil servants (the clue is in the name) and politicians to respect democracy and give effect to the majority view rather than pursue their own personal wishes, opinions and agendas.

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