By Nick Watts, Non-Executive Director
There is never an easy moment to write about the outlook for economies and markets, but when the world is being turned upside down on a daily basis, there is a temptation to opt out completely. While retail investors might be able to to take this option, it is not one open to companies, institutional investors and their advisors. The difficult thing is to try to distinguish between noise and signal and there certainly has been a lot of noise since the beginning of the year! In this article, I am going to try to avoid commenting on the noise (US politics) for two reasons. Firstly others are better placed to do so and secondly anything one writes today may look extremely foolish tomorrow given the unprecedented unpredictability in policy making.
Usually politics are dwarfed in importance when looking at other factors such as interest rates, inflation, valuation and growth when assessing the market and economic outlook. As an example Wall Street was fearful when Joe Biden was elected but during his presidency the S&P 500 doubled. This outcome was driven by numerous factors but some of Biden’s policies contributed to the rise. Wall Street welcomed Trump´s re-election (if for no other reason than self interest), but ultimately economies and markets will be driven by the fundamentals and the impact that policy has on them.
This reality brings me to my greatest concern. In a 50 year investment career, the only thing I have learnt is I know nothing and this has been key to my survival. I have seen too many investment and corporate strategies undone by certainty. Sometimes it is ideological, sometimes it is arrogance and sometimes it is hubris but in all cases it leads to an inflexibility in thought processes which can be damaging. Uncertainty is very difficult for investors to cope with and those who achieve success are the people who can adapt and cope with uncertainty better than the crowd. Uncertainty on US economic policy has never been greater in my life-time as it is today and this makes the challenges for corporates and investors alike huge. Trust is an essential ingredient to making short and long term investment decisions. It is currently in very short supply.
Despite the above, we can draw some tentative conclusions from the last couple of months. Any kind of trade war is inflationary and disproportionally affects the average consumer. Not good news for growth or interest rates. Tariffs don´t usually achieve their aim. Yes, a few more jobs may be created, but the net effect is almost always a negative. The debate between free trade and tariff reform was one of the cornerstones of British political life in the first decade of the 20th century and demonstrated that at a time when the size of the state was growing and an increase in public funds were needed, tariffs were shown to be economically damaging and just as importantly, politically unpopular because of their effect on food inflation. While it is impossible to be dogmatic about what the US administration’s attitude to tariffs will be over the next few years (it seems to change daily!), I think we can conclude that protectionism will be bad for the global economy and it is likely that the US economy will suffer more than most.
Every year the Economist, among others, construct a democracy index. Not surprisingly it has been cratering recently. Depending on which side of the political spectrum you sit you will either be fearful or pleased that this is happening. However what is clear is that there a symbiotic relationship between democracy and capitalism so a demise in democracy will pose a threat to the economic model of many countries especially if the inequality of wealth is stretched even further. The economic consequences of Brexit are a living example of what can happen.
How markets respond to the current situation will be significantly driven by policy responses. For example in Europe if there is a major recalibration to spend more on defence, there will be many unforeseen consequences. So far, all we have seen is words and very little action. However something has to give. Will countries apart from Germany borrow to make defence spending with consequent reactions in the bond market? In the mid 1980´s, the UK was spending 5% of GDP on defence so frankly moving to 2.5% by taking from oversea aid (a significant source of UK soft power) is just not going to cut it. There are over 9 million people in the UK who are economically inactive, please do not tell me there are all too ill to work! So meaningfully addressing the welfare bill needs to happen in any event. Wes Streeting has publicly said giving the NHS more money is not the answer to its numerous problems but radical reform is. Time to live up to this statement! Yes, grab as many Russian frozen assets as you can and when are we going to see convictions and repayments from all the corruption (amounting to multiple billions) from the PPE procurement scandal. Covid started 5 year ago! There is sufficient money to materially increase defence spending but is there the political will? I have been a defence analyst in a former life and have seen the economic stimulus that greater defence spending can create. Let´s face it, something has to spark the UK economy into life.
I assume I have offended a few people in this article, maybe more than a few so now I am going to offend a few more! There is not much point to ESG investing if the world does not exist in a few years time because it has been nuked. Reservations about investing in defence companies from institutional investors would be political correctness gone mad. Wake up and smell the coffee!
