I am not by nature an Anglophile, but there is much that investors can learn from British History and culture beyond BREXIT. Many years ago there was a television series entitled, “That Was The Week That Was,” or “TWTWTW” which was a satirical take off on the rather pompous reading of news on British television. As with many theatrical productions from the UK, the concept was brought across the pond and for quite awhile we enjoyed an American version. Investors last week viewed their own global version of TWTWTW.
One of the standard lessons in geopolitical writings is that war is in effect carrying out policies by other means. Commercial and cultural changes are carried out through international conflicts. I believe that in the future historians will view BREXIT as the beginning of the next phase of global commercial and cultural changes which will dictate different investment policies.
But first we need to live in the present and so on to what may have been a turning point for investors in the TWTWTW.
I believe that the US stock market action on July 8th, my birthday, was a gift to most equity investors globally. The putative proof of this is the performance of stocks in the last week when the Dow Jones Industrial Average continued to rise to new highs each day and the broader Standard & Poor's 500 rose for four days and just missed a new high on Friday. Some will say the price movement was just a return to a "risk on" attitude. I see it differently for the following reasons:
1. Instead of the prior stock price leaders continuing to be the performance leaders, it was the laggards that recovered.
2. Based on stock and bond prices, many of the Index funds also underperformed on a relative basis. (This is not surprising in that most of these indices are anything but truly diversified in terms of quality of issuers.)
3. In a similar fashion many of the alternative portfolios also under-performed
4. Many of the non-fully participating institutional and individual investors are complaining that valuations are not at the expected levels for good entry points. They are historically correct, but they are in two traps; first too many financial statements are overstating earnings on a continuing basis. The second trap is that they are only looking at near-term results and at best, next year's expectations not a prolonged view of the future in terms of the issuers and their own needs. (The latter is addressed in the context of the TIMESPAN L Portfolios®.
The Changing Marketplace
Not all is completely rosy. Both the equity and to some extent the high quality fixed income markets are being driven by Exchange Traded Funds (ETFs), and similar vehicles are growing less fast than in the recent past. If the week is an example, ETF investors are riding a bus that is being passed by faster individual cars.
In addition, the structure of the marketplace is changing with capital being constrained by market makers and they are being replaced by hedge funds which from time to time play a similar role of absorbing temporary excessive flows. One can not count on the same level of support in periods of rapidly building tension than in the past. Too many people view volatility as risk and one should expect bouts of volatility which could be as much as six times what we are currently experiencing.
US Treasuries “Risk-Free?”
Global stock and bond markets are tied together and a problem in one can be disruptive to other markets. Government securities, particularly US Treasuries have been viewed as “risk free,” but because of their use as collateral for “carry trades” they can be forced to react to sudden changes in more speculative securities. Hedge fund professionals view that the Treasury market is increasingly crowded with other hedge funds not simple buy and hold players. In other securities we have seen auctions that failed to be completed. Due to changes in the structure of market capital providers it is possible that we could see a US Treasury auction fail. While on a long-term basis this would not be terrible, in a short-term it could shake the confidence of investors in most markets.
While I believe a portion of our money should be focused on the long-term and use future-oriented valuation approaches, I am very aware that at some point in the future our old valuation techniques will likely determine the winners and losers.
The Future through BREXIT and Henry V
The BREXIT referendum "leave" vote was carried by the North of England voters. Some of these had ancestors who were the long bow men that won the battle of Agincourt for Henry V. In this battle some 3500 Englishmen defeated 60,000 heavily armored cavalry led by the cream of the French society who were experts with swords and lances. The English archers impacted the French forces before they could close with the English, and thus won the battle and the war by changing to unexpected and better weapons. I believe this is a model for Mrs. May's government.
The combined arsenal includes currencies, tax rates and rules, lower cost of government and a more efficient bureaucracy, The current French President has already commented that the decline in the exchange value of the GBP was “not helpful.” Interestingly that the fall in the value was not led by the government but by a functioning marketplace that many European governments don't trust. Currently the cost of British exports is high because of EU taxes and regulations. In the months ahead, when freed from these burdens, export prices will drop and market share will grow as trade expands with the Western Hemisphere, Asia, and Africa/Mid East. (This could be a bit deflationary, but positive for consumers. Further, this is part of the trend started by the current leadership in China to favor consumers over production workers.)
I suspect that if the UK government can lower its tax burden, more companies will chose to headquarters there. We are likely to see more tax-motivated inversions from both European and US companies. One of the ways governments can lower their costs and improve the efficiency of delivery is to outsource to the private sector much of what they do now. Undoubtedly there will be a fair number of mistakes made and then corrected. Nevertheless, costs will come down and consumers will benefit.
Insufficient Retirement Capital & Other Challenges
Further I am guessing that the demographic problems the developed world is facing where the dependency ratios are rising, and where the number of laborers is becoming insufficient to create retirement capital for the retired will be solved by rapid changes in the guilds that control primary and secondary education. The fundamental issues are that in the modern world, businesses can not hire qualified workers and far too many of them do not understand how to work in a competitive society. The question is not the number of immigrants, but the ability to absorb them into a productive and growing workforce. This may well prove to be the biggest task for the new government, but if any nation can solve it, the Brits have now the best chance, because they must.
The New PM
It is quite possible that the second female UK Prime Minister will, in her own way, be as impactful as the first. I believe she has a good chance to lead the developed countries out of the wish for only 2% growth to multiples of that.
While history does not completely repeat itself, the current situation reminds me a lot of the time when Mrs. Thatcher became the Prime Minister. One of my early and important mentors on the New York commuter train, the late Arnold Ganz, became a real believer in her. Because of Arnie in the 1980s I started to invest in UK financial services companies and their investment trusts (Closed Ended funds). For the most part, some thirty years later they have proven to be a good investment. So today, I am betting that the long bowmen of the "leave" referendum will once again hit their targets against a larger group of “experts.”
Question of the week: Do you now have a view where the US Senate will lead the US?
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A. Michael Lipper, C.F.A.,
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Contact author for limited redistribution permission.