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Diary of a fund manager - Matters of the Mind - 20.05.19

David Miller, Investment Director, Quilter Cheviot

Rising tension in the Middle East, more trade trouble and Brexit mired in the UK political system are all in the headlines. This week’s Diary is about why some events matter to financial markets, whilst others pass by seemingly unnoticed.

After the Twitter tantrum of the week before, equity markets were quieter, ending higher apart from the US. Government bonds continued to rally as did the dollar. Gold and oil closed marginally ahead. Quieter yes, but these days something is always happening. For example, events in the Gulf might have been expected to unsettle investors, or at a bare minimum push up the price of oil, but hardly a murmur. We might be asleep at the wheel and will wake up with a jolt just before the collision. Alternatively, investors have looked through the posturing by both the Americans and Iranians and decided that they are Paper Tigers. Accidents can happen and that would be a problem for financial markets, but collectively we may be gaining immunity from scary headlines and fake news. Under-reaction is neither ignorance nor complacency.

The main game in town remains the trade dispute between the US and China. Threat and counter-threat laid siege to the daily news and the capacity of my inbox was strained by a flood of fascinating reports dealing with the implications. This is now getting serious. Tariff influenced price rises seem to be sticking in the US, pushing inflation forecasts slightly higher. A ban on the use of Huawei 5G telecom equipment in the US and the possible extradition of the company’s chief financial officer and deputy chair, currently under arrest in Canada, to face charges in a US court, could have both short and long term consequences for us all. By the way, the CFO is the daughter of the founder and so this is getting personal. Now for the numbers, which for investment markets do matter. If the trade war continues beyond the G20 meeting at the end of June then this will have a negative impact on global economic growth. The issue is by how much. Numerically challenged commentators confuse probability, a mathematical term, with possibility, and go to the extreme with predictions that in 2019 growth will be 1% less than expected. Bearing in mind that at the moment the run rate is 3%, the implication is that a few tariffs will stop everything in its tracks for the rest of the year which is highly unlikely. Those who analyse these things in a more rigorous way estimate a 0.1-0.2% reduction this year and more of the same in 2020. However, beyond the numbers come the intangible, but even more important, issue of confidence. Just as quantitative easing was dwarfed by the ebb and flow of demand for credit, economic activity is dominated by sentiment. The dangerous part of a trade war, just as in the Gulf, is that careful calculation can be overwhelmed by the law of unintended consequences. There are many ways in which confidence can be tracked which is why, for the moment, keeping a close eye on the daily ration of economic indicators matters a bit more than usual. A less time consuming barometer of trade deal/no deal is the US dollar which tends to strengthen as tensions rise. Strategic plans are important, but at the moment the horizon is particularly murky and so tactics are important.

Back in the UK, political change seems to be getting closer. It’s always fun to watch the bookies and the signal is clear. A new leader of the Conservative party soon, but no General Election until 2022. As they say, there’s many a slip twixt cup and lip. British Steel, now owned privately by Greybull Capital, has asked the government for an emergency loan on top of the £100 million received not that long ago. Several thousand jobs would be at risk if British Steel became insolvent. Thomas Cook also seems to be in trouble because of a lack of cash. Brexit uncertainty has become the catch-all excuse for troubled businesses. Overall, it is important to note that the UK economy is growing, employment levels are high and inflation is low. A very different environment to the 1970s when state bail-outs of failing companies were part of the way in which governments attempted to manage the economy.

I am often asked about the impact of Brexit on the stock market and so back to the numbers, courtesy of a non-UK strategist looking in from afar. Since the referendum sterling has fallen against the US dollar by about 15% and the price earnings multiple of the FTSE 100 Index, which was at a slight premium to global average, is now at a substantial discount. With a bit more certainty, the gap might start to close which is why those who don’t live here are interested in the ‘state of our nation’.

All of this and more were the subjects of robust debate at a series of internal investment meetings which peppered my week. At times of difficulty it is good to have colleagues with informed opinions. Aggregation, synthesis and judgement are all part of successful implementation. Machines help, but in the end decisions are made by people. The same goes for governments, companies and consumers. The engine of change, is driven by 7.6 billion of us. As I mentioned last week, demographic change is a huge influence, as is better health care from cradle to grave. An unintended consequence of increasing life spans is that apparently minor issues grow in importance. Medical problems caused by obesity is much more of an issue in the 21st century than in the 20th as is mental health. It is estimated that globally there are 10 million new cases of dementia diagnosed each year. In the UK over 1% of the population is suffering including 70% of care home residents. It is Dementia Action Week and so you may hear more than usual about this subject over the next few days.            

Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

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