European Glory.
So yet another year of European dreams comes {{{*}}} to an end for United, and this time in such harsh circumstances. Last Tuesday in Manchester had it all. As I wrote at the time of the draw for the last 16 in the Champions League, for me, it brought back memories as a kid of 1968, leaving school early, getting home, rushing on the local train to join the throngs to queue and sing to get into the ground, and the ultimate excitement of seeing us beat the almighty legends, Real Madrid, 1-0. The atmosphere last week was electric and until that moment another 1-0 seemed on the cards, just like in ’68. Then the Nani moment happened, a quick bit of Mourinho brilliance followed, and the game was over. Oh well, there is always next year – a familiar European refrain…
Italy.
Away from this little incident, the week progressed and finished for me with a couple of days in Cernobbio, Lake Como for the Ambrosetti Forum, the annual international economic conference held at Villa d’Este. I was hoping to forget about United for a couple of days but chatting with football-mad Italians made that impossible, and the weather was very Mancunian.
I had been vaguely aware that my last Viewpoint had got some media attention but I wasn’t aware of the degree until I arrived at Villa d’Este. Judging by the way I got chased around, anyone would think I had the inside scoop on Wayne Rooney, but it was my comments about Mr Grillo that had caused it. In addition to being generally surprised that I had described his Five Star Party’s election showing as rather exciting, apparently the conspiracy theorists thought it was part of some coordinated Goldman Sachs and hedge fund plot to bring the Euro down. Hilarious! On the contrary, this development might lead to the opposite. I explained to many that without some major shake-up, the Euro would ultimately fail. A monetary union between countries with no growth, rising unemployment and decreasing levels of trade with each other is just not credible. Grillo and his cohorts’ desire to shake up the political status seems quite important to me, and probably more so than any of the vague – and generally odd – economic proposals flying around.
In the more serious part of the proceedings, page 37 of my presentation (see attachment) included a chart of German exports, showing their dramatically changing pattern. I repeated a remark I often make that on current trends, by 2020 Germany would rather be in a monetary union with China than with France. Predictably, most of the people present found it an irritating idea and suggested that either the data wasn’t accurate, the trend won’t continue, or – one idea I often hear – that Germany benefits from a weaker Euro which would not be the case with the (stronger) Deutsche Mark still in existence. These kinds of answers are partly reflective of the broader European problem: Denial and the lack of desire for change aren’t the sort of things to help bring a better economic future. The world is changing dramatically, and with it patterns of world trade. Concepts created for a more stable post-World War II world need to be adapted to survive.
Richard Koo of Nomura presented a Japan-style outcome for Europe, suggesting it faces the same balance sheet problem as Japan, and offered two interesting ways to help break it: First, policymakers should introduce a differential risk-weighting system that favours investors holding their domestic bonds (hardly in the spirit of a free trade and capital movement zone, but so is the rest of much else emerging to save the Euro, such as directives over industry compensation and financial transaction taxes, etc). Second, the fiscal agreement should be adjusted to have independent experts opine on limits constrained by balance sheet constraints. Others offered good reasons why these steps weren’t necessary – not least because capital has behaved more rationally than perhaps inferred.
On Italy itself, I didn’t hear much about likely changes in the absence of a Grillo-influenced government. And on that, I think the left would like to work with him, but no one seemed to think it is feasible. Of course, and despite the rain, discussing Italy from this location, it was easy to remember that the country has lots of qualities and assets. At current absolute and relative valuations, I think Italy is a better place to invest than a number of other places, as can be seen on page 47 of my presentation. A bit more chaos perhaps, maybe another election soon, and some shaking up in Berlin, Brussels and Frankfurt as well as Rome might all be needed to prompt the value to be extracted but I think it could come. Or perhaps, just like United, this is another European dream?
Grillos Elsewhere. Abenomics?
Some people suggested to me that the Five Star movement type developments are spreading all over the place, and even that the UKIP here in the UK and Abe’s leadership in Japan are similar. I sort of get what people mean, but I am not sure one should be jumping that far, especially regarding the Japanese leadership.
It does seem as though monetary policymakers are jumping ship with one of the more hawkish BoJ members making noises this week that appears to suggest that the new 2% inflation target is getting more and more palatable. The relentless decline of the Yen, helped by last week’s excellent US data, suggests some of the same. When I started to believe that Abenomics was going to be important for the markets last autumn, I suggested that within two years the Yen could be between Y100-Y120. The first stage would be driven by domestic changes, and the second would require more evidence that the US is in better shape than widely expected. And after Friday’s payrolls and last week’s ISM data, the conditions are starting to fall into place.
Despite this, it is interesting to see the Chinese now starting to add their voices to the ongoing currency war type mood, and this is much more important to me than other countries making noises. I recall the critical role that China indirectly played in bringing the Yen’s decline in 1997-98 to an end, by threatening to devalue, sufficient to get a policy reversal on intervention from the US Treasury as well as their help to stop Yen weakness. The circumstances today are completely different, and if Yen weakness reflects policies to boost Japanese domestic demand (and not just a deliberate play to achieve a competitive boost), then it will be tolerated. But I suspect not in a straight line, and not without quite some questioning.
The UK Itching for Recovery?
Sandwiched between Old Trafford and Cernobbio, I spoke at a couple of big UK events last week: The annual EEF National Manufacturing Conference in London, and a huge True Potential investment advisors conference in Birmingham of all places. Against a background of continued mixed and contradictory data – an extremely weak manufacturing PMI and then a better than expected services sector PMI, for example – you can feel people wanting more from our policymakers. We will soon see whether the Chancellor will find any wiggle room in the forthcoming Budget. Plan A is offered still as being irreversible but coalition self preservation in the last two years of life suggests something will have to give. Perhaps it will indeed put more onus on the Bank of England as media speculation suggests while we get closer to Mark Carney’s arrival on the scene. If nothing gives and the reported recovery remains as elusive as United winning in Europe, then Mr Grillo, we await you!
As for the UKIP focus, from what I read, their noise on Europe is not what is really helping them. Detailed polls apparently show that Europe remains a very small interest of voters, which I guess should be good news for business that seems eager to preserve or perhaps even strengthen the UK’s relationship with Europe. I argued in my Cernobbio speech that the pro-business lobby has to articulate their case stronger and clearer as the same trade patterns affecting Germany are affecting most of us, albeit in the UK’s case, somewhat less. Page 38 of my presentation shows the UK’s changing export patterns. Late in the week before last, Kevin Daly and Huw Pill from Goldman Sachs published a thorough piece on why the EU is positive for the UK. But I continue to believe that the case is less clear-cut than I thought a few years ago, especially if to preserve the Euro, policymakers in Europe introduce measures that will clearly impede parts of the UK – especially London to continue to thrive as the world or BRICs capital.
The US Improving Further.
The strength of last week’s US data is leading the consensus to revise upwards their forecasts for 2013 real GDP. Having been notably higher than the consensus since autumn 2012, GSAM is rather pleased about that as a number of investment strategies have prospered from it. Of course, and as I discussed last week and in recent Viewpoints, this is despite the ongoing and sometimes unchosen fiscal tightening in the US, and is a marked contrast to Europe. Not surprisingly, all of the US bond, equity and currency markets are reacting accordingly. I am not that confident about what happens next and as to whether all these trends are going to continue, not least because May is now less than two months away and the infamous “Sell in May and go away, come back on St Leger’s Day” (which I am physically actually going to be doing post retirement, of course!). US equities seem set to strengthen further in the near term, given the momentum in the data, but as page 47 shows, they are hardly bargain basement these days from a CAPE perspective. As for bonds and the Dollar, the market is adjusting its future profile for the Fed and starting to think that the Fed will have to change its own views, but I am not sure, in light of the actual (and prospect of more) fiscal tightening means the Fed will jump too soon, especially given their output gap views and the strength of conviction of their leading players. Of course, if this data improvement continues, then the Fed will have to adjust.
China and the World.
Probably the most important slide of the presentation is page 8 which shows global and regional GDP since 1980, and what we are assuming for this decade. A number of important features are worth mentioning. Firstly, for each of the past three decades, world GDP growth has been essentially the same, around 3.4%, despite big regional variation and of course all the various shocks. This would support those who believe the links between real GDP and investing are, at best, tenuous, at least superficially. Secondly, despite this reality of the past three decades and despite China slowing to 7.5% in the decade ahead, the world may grow by just over 4% this decade. Of course, given the reality check of the past three decades, this is indeed quite a statement, but given what is going on with China, how will it not? As I pointed out in Cernobbio, China growing at 7.5% is essentially equivalent to the US growing at 3.75%, given China is now $8.2 trillion in size. My pal Nouriel Roubini argued that the BRICs slowdown suggests the BRIC thesis was overhyped, to which I responded that indeed it may, but if anything, I said China is “underhyped”. In the first two years of the decade so far, China has averaged 8.5% growth. So, unless it grows by 7% or less the rest of the decade, it will contribute more than we are assuming.
To complicate matters, the slew of Chinese February data was published over the weekend and it suggests that the economy has slowed again and inflation picked up more than expected. Amongst other things, this is yet more refuting of the never-ending idea that China manipulates its data for the better. It also suggests that some policy measures might have worked too well. In particular, the reported sharp slowing in retail sales might reflect a tougher New Year celebration than normal under strong guidance for lavish parties and gifting to be stopped. Whether it is this or not, this slowdown in consumption would be quite worrying if lasting and is not welcome. It is also the case that the February trade data surprised on the upside, and while mechanically this will help Q1 GDP, in my book, it is the “wrong sort of growth” that China needs. I suspect it is not the underlying story and might reflect odd patterns around the New Year. But to top off a bad month, the 3.2% rise in CPI was higher than expected also, and if sustained, not great news either. Perhaps in hindsight the big February equity market correction in China was more justified than otherwise thought.
North Korea. Big Changes?
Last week I mentioned an interesting FT article on China shifting its support on North Korea, and now we have them supporting the US for a stepped-up UN sanction. Something is cooking. Not surprisingly, North Korea has not reacted well and this might spook a few people. But I wonder whether this is the beginning of something big? Perhaps South Korea is going to be getting a demographic dividend to help its strong growth and environment score. Early days, but this looks like the beginning of something changing.
Long-Term Investing.
A couple of interesting conversations I had with people last week about long-term investing reminded me that while I was in Chile, the G20 statement was probably more interesting on this topic than the Yen and FX markets: They added a new statement, albeit brief, saying they were focusing on doing things to try and improve the environment for long-term investing, including specific research on it. It simply adds to my view, as also evidenced on page 45 of the attached presentation, that given the continued high equity risk premium (ERP) it is actually a great time for long-term investors. Perhaps soon, sovereign wealth funds will be joined by more pension funds and insurance companies in being able to take advantage of this. It seems to me that the deck of cards is shifting towards these three groups relative to the rest and a reversal of the relative trends of the past 20 years perhaps.
Meanwhile, roll on the 20th league title and bring on next year’s Champions League – again!
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