Mid Monthly Update – August 2018
While many will have attended a village summer fayre in recent weeks, the existing political climate is about fairness in society manifesting itself through populism which has been in focus since the Brexit referendum and the Trump election. While some political campaigning has targeted voters’ fears, more recent non-political campaigns have been about gender equality, especially pay but also opportunity and not least in the financial industry. Basically, less discrimination against minority groups or where minorities exist, e.g. women in finance.
At the heart of the matter is the divide between the wealthy and the not-so-wealthy and the chasm that has been accentuated by extremely loose monetary policy following the Great Financial Crisis. This resulted in quantitative easing (QE) which in turn led to a significant rise in the value of most assets – great if you owned some, not so great if you didn’t. For the most part, the major asset owners are the wealthy; many less wealthy people have benefited from low mortgage rates but haven’t enjoyed the same wealth appreciation.
This has been the case in the UK and US. As the chart below from the Wall Street Journal, who sourced it from Ray Dalio of Bridgwater Associates, illustrates how populism emerges at times when the majority of a country’s wealth is held by a small minority of the population – described in more detail below the graph.
The red line is the share of US wealth owned by the bottom 90% of the population, and the green line is the share held by the top 0.1%. Right now, they are about the same, but notice the trend. The wealthiest 0.1% has been increasing its share of wealth since the 1980s, while the bottom 90% has been losing ground.
Populism is prevalent and the fastest way to deal with inequality as depicted above is by loosening the national budget purse strings. This has been done in the US largely to benefit US corporations not the less wealthy and the US didn’t go through much austerity and budget improvement beforehand.
Interest rates and taxes or monetary and fiscal policy are changing as the aforementioned QE is removed. Recent talk from the Bank of England is of slow and gradual bank/base rate increases. Fiscal policy is clearly becoming more accommodative as the public sector pay cap is removed for a number of professions. With a tight labour market, wages are clearly under upward pressure and inflation, aside from the upward pressure from a weak pound, is likely to follow. Unlike the US, tax receipts have been good and the effect of previous austerity means the Exchequer does have some manoeuvrability. But I’m not sure if the economy is ready to deal with base rates of 2% to 3% as mentioned last week by a Bank of England representative, however long it takes to get there.
Deal or No Deal
Perhaps Noel Edmonds has a better idea of the outcome of Brexit than most but the raised potential of a ‘no deal’ with the EU over Brexit has caused sterling to be weak against most major currencies. That doesn’t include Turkey where the lira is in freefall – good for holidaymakers, bad for investors.
Anyway, March 2019 is the deadline and isn’t so far away. Frankly we don’t know whether there will be a deal or not or even an extension to the deadline but the outcome is too binary to build a portfolio around.
We know Donald Trump likes to get his own way which isn’t always easy if you’re up against China but when its Turkey, a country with a large current account deficit, low foreign exchange reserves and led by a dominant person like Recep Tayyip Erdogan, there’s only likely to be one outcome. Turkey has been given a stuffing in the markets and the question is whether this roasting is confined to Turkey or will it spread to other markets, especially those with similarly poor sovereign balance sheets? It should be containable but markets are twitchy at this stage late-on in the economic cycle. President Erdogan is a beneficiary of populism but also an example of how too much power isn’t necessarily in the best interests of the country he represents.
University Challenge II
On the subject of fairness, I am re-visiting the student loan question as students receive their A-level results and grades that might gain them entry to their university of choice. Scottish students have already received their equivalents. I expect there will be fewer students attending university as their next educational step mindful of not wishing to incur a £50,000 student debt (average student debt calculation according to the Institute of Fiscal Studies). Part of that debt is magnified by the Government’s desire to rip students off by (sur)charging them twice. Once by using the Retail Price Index (RPI) which is no longer deemed fit for purpose by the Bank of England as an inflation measure but is about 1% higher than the Consumer Price Index (CPI), the Bank’s preferred inflation measure. Secondly, by then charging students an extra 3% above the RPI! Scandalous.
We remain defensive and when markets rise in this environment, we may not fully participate but are mindful of capital preservation over chasing each undulation in the financial rewards’ road. Many have enjoyed the renewed vigour of the US equity market even if some large tech stocks have had a serious wobble. Compared to the rest of the world, can the US equity market’s outperformance be sustained? The following graph from the Wall Street Journal’s Daily Shot asks just that question.
Of course, as regular readers will know, we eschew geographical allocation in favour of thematic investing – it’s more logical to invest in long-term themes than attempt to predict the economic growth of individual nations or regions. And why market capitalisations of companies or countries are of any relevance, goodness knows?!