Aren’t we tired of that word? On any particular day you can read or hear around 5,000 different opinions ranging from “…it will all be a total disaster…” to “Britain will mightily prosper thanks to all the wonderful opportunities that will be available after exiting the E.U.” Hard Brexit, soft Brexit, so-so Brexit, deal, no deal and no Brexit – what a confusing omelette has been served up to the British people.
Regular readers will be aware that we have always looked favorably on the “get out” option but have been distressed by the extraordinary hash the politicians and bureaucrats on both sides of the channel have made of Brexit since the referendum.
The problem is that the tangled mesh of E.U. bureaucracy that has been overlaid over virtually all aspects of the U.K. economy for several decades is proving difficult to untangle – although, it must be said, that various vested interests have no incentive to assist with the untangling. It seems, also, that important chunks of the U.K. civil service prefer the status quo so that makes exit negotiations tougher.
We have no crystal ball so we will not attempt to forecast what will eventuate over the remaining months to the theoretical Brexit at the end of March 2019. We will, however, suggest that if we had the opportunity to look back from ten years hence, and assuming a genuine exit does occur, we believe that Britain will be doing quite well as an independent economic force.
Net receivers and net contributors
The E.U. is made up of 28 countries, a number of which were formerly in the Eastern bloc and uniformly suffer from extremely adverse demographics. According to United Nations forecasts six of the top ten percentage declines in population expected between 2015 and 2050 occur in E.U. member countries: Bulgaria, Latvia, Croatia, Lithuania, Romania, and Poland.
Most E.U. countries are net “receivers” – that is, they receive more from the annual E.U. coffers than they contribute. The “receivers” are: Belgium, Bulgaria, Czech Republic, Estonia, Ireland, Greece, Spain, Croatia, Cyprus, Latvia, Lithuania, Luxembourg, Hungary, Malta, Poland, Portugal, Romania, Slovenia and Slovakia. The few countries that make a net contribution (in order of importance) are: Germany, France, the U.K., Italy, the Netherlands, Sweden, Austria, Denmark and Finland. Close to 80% of the total net contribution is made by the “big 3” – Germany, France and the U.K. (Source: European Commission, 2016 data). It can be of little surprise, therefore, that the bureaucrats and politicians in the E.U. are desperate to keep the U.K. in the E.U. fold – or, at worst, make the price of Brexit extremely steep. It all comes down to money – and control.
One of the Brexit conditions so-far negotiated by the E.U. and U.K. is that “…no remaining Member State is made financially worse off by the U.K.’s withdrawal.” Now that is going to be a ticklish calculation and is it a fair and reasonable condition? The U.K. government has estimated the “divorce bill” at around £35-39 billion although it admits the figure remains rubbery. One way or another, a pound of flesh is going to be extracted from the U.K.
We find it interesting and pertinent that since the Eurozone started in 1999 the U.K. economy has shown all of its 19 members a clean pair of economic heels – even though the U.K.’s performance can hardly be categorized as “stellar”. Even Germany has substantially lagged the U.K.’s growth in real GDP over that period. The U.K. has, of course, benefited from a floating currency and an independent monetary and fiscal policy, something that is unavailable to the 19 countries locked within the euro-straight-jacket. It is curious to us that so many within the U.K. are pressuring for even greater political and financial integration with Europe. Free trade, which we avidly advocate, can be achieved without progressing to a “United States of Europe”. History may teach but it often falls on deaf ears.
Trump meets with Putin
During July President Trump maintained his daily dominance of the headlines. His meeting with President Putin was yet another “great success” but apart from the interpreters no one has the slightest idea what was discussed or agreed. The fact that Trump is prepared to meet with one of the world’s renowned tyrants who has scant regard for the rule of law isn’t, prima facie, a bad thing, but the secrecy and double-talk in the press conference following the meeting does leave an uneasy feeling. Putin is past-master when it comes to dealing with world political leaders. Mr. Trump is not.
Venezuela has moved into the “absolute disaster” category with the IMF forecasting a slump in GDP by 18% this year whilst inflation is projected to reach 1 million percent by the end of the year. President Maduro is planning to chop 5 zeros off the value of the currency – providing scary echoes of Germany’s Weimar Republic in the 1920s. The President has, naturally, blamed everyone else for the country’s woes.
It is ironic that Venezuela has vast oil reserves yet is currently producing only around 2% of the world’s total (source: BP) and in absolute terms its production is less than achieved in the 1950s. Mismanagement and endemic corruption have taken their inevitable toll. It is tragic that millions of Venezuelans are living in poverty and dependent on food handouts. Such is the modern world.
Troubles at Facebook
Facebook had a challenging July. A disappointing second-quarter earnings report shocked the market causing its market capitalization to plunge by over U.S. $100 billion in a single day – the largest one-day fall in U.S. corporate history. Mark Zuckerberg, Chairman and Chief Executive, saw the value of his shareholding fall by around U.S. $16 billion. Now that is surely the definition of seriously rich – if your net worth can fall by double-digit billions but still leave you as one of the wealthiest people in the world (he has now slipped to just sixth on the Forbes global list!).
We have mixed feelings about Facebook. We recognize it as a useful communication tool but also appreciate it can be a massive time-waster. Perhaps, like many other “hot” products, its cachet will fade over time.
World Economic Outlook
The IMF has released its latest update to its World Economic Outlook. The overall global growth forecasts for 2018 and 2019 have remained unchanged at 3.9% but the “mix” has changed somewhat. The IMF comments: “While the baseline forecast for global growth is roughly unchanged, the balance of risks has shifted to the downside in the near term and…remains skewed to the downside in the medium term. The possibility for more buoyant growth than forecast has faded somewhat in light of the weak out turns in the first quarter in several large economies, the moderation in high-frequency economic indicators, and tighter financial conditions in some vulnerable economies. Downside risks, on the other hand, have become more salient, most notably the possibilities of escalating and sustained trade actions, and of tighter global financial conditions…Growth projections have been revised down for the euro area, Japan, and the United Kingdom, reflecting negative surprises to activity in early 2018. Among emerging market and developing economies, growth prospects are also becoming more uneven, amid rising oil prices, higher yields in the United States, escalating trade tensions, and market pressures on the currencies of some economies with weaker fundamentals.”
None of the IMF comments come as a surprise. Most advanced economies have potential long-term trend real GDP growth of around 2% – a combination of subdued work-force and productivity growth. A notable exception is Japan which has a much lower prospective trend figure of around 1% (thanks to negative work-force growth). A few countries are currently spiking above their long-term trend potential but that is normal in the roller-coaster of economic life. The economic expansion is now long in the tooth and the threats the IMF discusses are tangible. At some point (which no one will forecast accurately) the world will slide into the next down-turn. That’s when the build-up in debt since the financial crisis will become one of the most discussed items on the evening news – it may even bump Trump.
Latest from the markets
In the government bond markets Japan caused some market anxiety when it was rumored that the Bank of Japan may be about to increase interest rates or change guidance on bond yields and asset purchases but in the end it did nothing of significance. The “target” 10-year bond yield remains at precisely zero and it finished the month at 0.05% having progressed from 0.03% at the end of June. It is hard for the government to make proud claims of a robust economy when the target 10-year yield is zero and trillions of yen of assets continue to be purchased by the central bank.
Elsewhere, we saw modest increases in 10-year yields over the month: U.S. from 2.86% to 2.96%; U.K. from 1.28% to 1.33%; Germany 0.31% to 0.38%; Canada 2.13% to 2.30%; Italy 2.69% to 2.74% and Australia 2.63% to 2.65% (Source: Thomson Reuters Datastream). The U.S., therefore, still tops the bond-yield pack.
Equity markets were strong during July. Utilizing MSCI U.S. dollar price indices EAFE was up by 2.42%; the G7 by 2.96% and the ‘World’ by 3.05%. Expressed in local currency MSCI price indices we saw the following robust improvements in European markets: Switzerland +6.21%; Denmark +5.51%; Portugal +4.74%; Germany +4.08%; the Netherlands +3.87%; Sweden +3.55%; France +3.39%; Spain +3.23%; Italy +2.67%; the U.K. +1.47% and Norway +0.82%. Only Ireland turned in a negative monthly performance: -0.30%.
Elsewhere, and again utilizing MSCI local currency price indices, the U.S. was up by 3.47%; Canada 1.21%; Australia 1.60%; Hong Kong 1.64%; Japan 1.46% and Singapore 0.96%. New Zealand was a laggard with negative performance of 1.01%.
So all-in-all it was a great month to be holding equities. What on earth have we been worrying about?
Pyrford is registered as an investment adviser with the Securities and Exchange Commission and is a wholly-owned subsidiary of BMO Financial Group. Find out more about our international equities team here.