Market Thinking - a view from the equity market - commentary from Mark Tinker, AXA IM - Notes from the road. Globalisation is being “uber –ed”

27/06/2017

Monday 26th June 2017

  • The UK Election result should be compared to 2010 rather than 2015 which was distorted by the two referendum parties. On that basis May gained 11 more seats than Cameron and Corbyn 4 more seats than Brown. This is not a revolution; it is a return to 2010 minority government.
  • The so called populist uprising in the west is a rejection of one aspect of globalisation, the power of the supra-national institutions and their policies. Technology is offering new platforms to do what the elite used to control.
  • The trade aspects of globalisation remain intact and with China offering an alternative model of outbound capital, investment as well as consumption has an alternative model. Capital markets used to American rules are going to need to adapt.

 

At around the half year there always seems to be a flurry of conferences, as people try to cram everything in before the holidays. As such I appear to be spending almost the whole of June on the road, in London, Thailand, Melbourne and Singapore, doing presentations and sitting on speaker panels. The topics are varied, but all ultimately come back to our view of the world, looking past the short term noise but more focussed on the investable horizon than the real long term big picture. So as I sit on yet another plane, I thought it worth putting down some of the thoughts and discussions that we have been having.

First and briefly on the UK election. If the last year and a half has taught us anything, it is that nothing is certain in politics, but it has also taught investors of the need for calm and perspective. The internet and particularly social media has brought a lot more emotion into political discussion and while markets may briefly be emotional, ultimately they are rational and impartial. As I have said on many occasions, the market reaction after a political event does not imply approval or disapproval, simply an adjustment in risk premia. Thus investors and more particularly traders can decide if they agree with the movements in risk premia around the known unknowns of elections or they can sit them out. More important afterwards is to analyse the new environment (if any) from the fundamental perspective, acknowledging that much of the so called analysis continues to come from a particular political viewpoint and can often reflect the wishes and biases of the analyst or commentator.

So to a little perspective on the UK Election. As we said in the last note, Theresa May has undoubtedly been weakened by this and her inner circle have indeed resigned, but what this is not, despite the desire by some to portray it as such, is a vote for an ultra-left government. Nor is it a rejection of Brexit. In my opinion, we are all in danger of focussing on the wrong benchmark for success here; we should be looking at the result in 2010 as our base for comparison, not the one in 2015. Back in 2010, David Cameron was heavily criticised for failing to achieve a majority against the widely disliked Gordon Brown, who, like Mrs May had inherited rather than been elected to the post of Prime Minister. With 307 seats, Cameron was forced into a coalition with the Liberal Democrats, while Labour shrank to 258 seats.  It was said at the time that this 2010 result reflected the new era of coalition politics for the UK. The British public were not minded to give either party a dominant position and I think that this was not only true back then, but is true today. To think, when I left London for Hong Kong we had a coalition government. Since then, we have had a surprise majority for David Cameron, a Scottish Referendum, a European Referendum and a snap election turning an anticipated landslide back to a minority government. And I haven’t been gone four years yet!

My point is that it looks like 2015 was the anomaly. The Liberal Democrats, who had promised no tuition fees in 2010 lost heavily following a U-turn on this and the two referendum parties, the SNP and UKIP, hit Labour more than the Conservatives. In particular, the previous Labour stronghold of Scotland was all but wiped out by the SNP, where thanks to the nature of the UK voting system their 1.5million votes earned them 56 seats. By contrast, UKIP’s 4 million votes only earned them one seat, but arguably cost Labour a lot of marginals. This time around the referendum votes declined sharply – UKIP only got 600,000 votes for example, while the SNP lost to both Labour and Conservatives. Labour’s revisit to the notion of no tuition fees was even more attractive than the equally un-costed promise made by the Liberal Democrats in 2010, in that it offered to also wipe out the debts accumulated over the last seven years and that undoubtedly had an effect, especially given the ability to vote in university towns rather than at ‘home’. The net result was that the Conservatives ended up with 318 seats, 11 more than in 2010 and Labour with 262, four more than back then. Cameron wasn’t terrible in 2010, but nor was he a genius in 2015. Equally Ed Milliband wasn’t as bad as portrayed in 2015 and Jeremy Corbyn is not leading a new left wing revolution. The youth vote is important, but it is largely focussed on tuition fees. Sometimes it is more about systems than about people. In effect what we have seen is a return to two party politics, with the Conservatives the largest party, but without a commanding majority.

As to Brexit, Tim Hartford, who writes the Undercover Economist column for the FT made a sound point when he pointed out that those, including himself, who had started saying that this result meant a so called soft Brexit was more likely had also been saying that a large majority for Theresa May would also make a soft Brexit more likely, something he refers to as expectation bias. Saying the vote was a rejection of Brexit, like saying it is a demand for more Marxist policies is thus largely a projection by the analyst. We need to focus on what is more likely to happen rather than what we would like to happen. For what it is worth, I think we need to focus on the points made that leaving the EU (which was the vote) means leaving the customs union and the single market. So far I can see there is as yet no evidence that the Brexit team are changing that view. More important perhaps is to recognise that the talks that began this week are the start of a process rather than a big ‘event’ to fit the 24 hour rolling news cycle. Britain has, in effect, decided to take itself on a journey away from political union with the rest of the EU. Trade (the focus of much discussion) can continue without a trade deal and whatever happens next there will be winners and losers, some more obvious than others. The ones who can see themselves as losers are lobbying hardest at the moment to retain their ‘privileges’ while the potential winners have not yet identified themselves.

This leads to a rather broader discussion about globalisation, something discussed at length at two of the conference panels that I spoke at. As the title of this note suggests, it is my contention that Globalisation is not dead, rather it has been ‘Uber-ed’, by which I mean an alternative system has appeared to offset or undermine the existing one and, to misappropriate the Labour party campaign slogan, it is for the many outside the political class rather than the few inside. This, I believe, is what the recent political ‘shocks’ are all about. Global capital flows are not going to slow, countries are not going to become isolationist. What is going to happen is that the institutions of globalisation are going to change and with it, the rules of the ‘system’. Financial markets will adapt to the new system and as investors we have to try and understand the new mechanisms, the new rules.

If we look at the history of what is generally perceived as globalisation, we see three waves. The first wave, from the turn of the last century to just after the end of the First World War was about agriculture and manufactured goods, as particularly America, with its huge natural resources and powerful internal market brought economies of scale to international trade. This was hit hard by the First World War and its aftermath and globalisation was seen to have died between the wars as America retreated. This is what some believe is going to happen now, although I disagree. The second wave began after the Second World War and was dominated by the US, with the Marshall Plan rebuilding Germany and Japan and the establishment of what became known as the Washington Consensus. Thanks to American capital and other institutional advantages Germany and Japan became the second and third largest economies in the world, their trade surpluses creating ever higher quality and efficiency of manufacturing as capital replaced increasingly expensive labour.  It was at this point that the world was convinced that the future was Japanese and that America was doomed. But it didn’t turn out that way because the system was shaken up by the fall of the Berlin wall and the sudden collapse of the Soviet Union.

This was followed by what one of my fellow panellists referred to as the third wave, or “hyper-globalisation” as the World Trade Organisation (WTO) meant that emerging markets and China in particular drove the substitution of labour in the west with cheap labour in the East through cheap imports and multi nationals created global supply chains to maximise profits. Thus labour in the US mid-west was not simply competing with cheaper labour in Mexico, but with a near unbeatable combination of US capital and Mexican labour. So if wave one was globalisation of land (agriculture and resources), wave two was a globalisation of labour (outsourcing and cheap imports) then wave three was a powerful combination of the two, a globalisation of both capital and labour. Land, labour and capita. The three factors of production. In an emerging economy, growth comes from using more of each factor. Later on, it becomes important to make each factor more productive. The early 1990s brought cheap Chinese labour to combine with western or developed market capital, much of it Japanese, but it also brought most of Eastern Europe as a source of higher educated but cheap labour to combine with, mostly German, capital. The US meanwhile, although not having a savings surplus, had the dollar and thus effectively an unlimited pool of capital such that while on the one hand the US multi nationals continued to create global supply chains, on the other they drove the giant strides in technology that not only retained US dominance of the globalisation narrative, but turned it into a globalisation of services. The platform company became the new model and US companies dominated as the Japanese equity market collapsed and the US soared.

Despite the Global Financial Crisis (GFC) (of which more in a minute) this has remained the case but for the emergence of China as an economic force. However, it is this third wave of hyper globalisation that many regard as a ‘bad thing’, especially as it now appears to be hollowing out the middle class white collar workers who write about such things. In particular the recent political shocks are being portrayed as a ‘reaction to globalisation’ leading a number of people to become very gloomy about the future (not an unusual condition for many economists I admit) and to predict a retreat away from the good things of globalisation. I beg to differ a little and in our various panel discussions sought to offer a different, more market based perspective, one which might perhaps give an alternative prediction of what might happen next.

The potted history of globalisation outlined above is, of course, also a potted recent history of the development of international capital markets.  Prior to the ‘big bang’ in financial markets in the mid-1908s, most global capital came in the form of government loans, either directly or via the western banking system. This led to its problems of course – my first job involved writing country risk reports for a bank, a market and regulatory requirement in the wake of various bank lending crises in the 1970s, notably in Latin America. Walter Writson of Citicorp famously said “countries don’t go bust” shortly before several did and many Latin American countries had to be bailed out by the US government or its institutions. Indeed Britain in the mid-1970s had been forced to go to the International Monetary Fund (IMF) for emergency loans and the whole era of the second wave of globalisation was essentially run by the big US multilateral organisations, notionally multi-lateral but effectively US controlled. My money, my rules meant that the second wave of globalisation was dominated by the US created agencies. The IMF, the World Bank, the OECD, the G7, GATT (later the WTO), NATO, even the EU, were part of a system built by the US for the post war era and the rules were known as the Washington Consensus. Markets adapted to those rules, countries borrowing US dollar needed to run current account surpluses, avoid large government deficits and maintain a stable currency. When that, almost inevitably, didn’t work they needed to aggressively devalue their currency, privatise key state assets and start again. Market participants began to trade the other side of these official flows, speculating on the currencies, trading the foreign debt markets and participating in both the privatisations and emerging equity markets as at least some of the countries escaped the reliance on foreign direct investment and began to develop their own savings pools. It meant of course that trading these emerging markets was very volatile and risky; something that still affects investors’ attitudes today. However, they were on occasion also potentially very profitable and, I would argue, one of a number of sources of potential value opportunities for investors. Emerging markets under wave 3 have been very different from wave 2 and will continue to become more like developed markets. The end of phase 3 will not be followed by a reversion to phase 2. This approach was very much behind the mis-reading in my view of China over the last two years. For those used to phase 2 emerging markets, the size of China’s debts and its fixed currency peg meant that it looked like Thailand in 1997 and that a 40% depreciation was “inevitable’. Well it wasn’t and nor does tighter US monetary policy or a strong dollar spell catastrophe for emerging markets generally – as was thought by many at the start of this year. Econometric or correlation models that take in wave 2 globalisation miss a structural change and thus deliver a false certainty about the future. As I said at a different seminar, we must be wary of the false certainty of financial modelling, for just as the economies are undergoing structural change, so are the capital markets that serve them.

So too are the institutions that created wave 2 and it is here that I come to my title. The fall of the Soviet Union and the emergence of wave 3 left most of the Washington Consensus  institutions without a role, but institutions have a momentum of their own and almost inevitably in looking for a role to replace that for which they were originally created they risk over-reach or mis-appropriation by other agencies. They also become subject to what is known as producer capture, being run for the benefit of their employees rather than their customers. This is a particular risk when the funding is from diverse governments and is largely unaccountable. Moreover, when, as is largely the case, the employees of these organisations are not subject to the same economic consequences of their policies as others - principally they pay little or no tax themselves while promoting policies that increase taxes on others – friction builds up and tensions rise. This problem extends to most western governments, where the revolving door between global institutions, governments and a huge proliferation of non-governmental organisations (NGOs) and charities that are effectively almost entirely government funded has led to a globalist government class. The constant calendar of meetings and conferences were interrupted for a while by ‘anti-globalisation’ protests in the 1990s (which mainly seemed to involve smashing up McDonalds) and drove further separation from the public, exemplified by the annual globalist meeting in Davos, leading Charles gave of Gavekal to dub them “The Davoisie”.

The separation has widened even more over the last decade, prompted mainly, but not exclusively by the GFC and the reaction by the members of these global institutions. As one of my fellow panellists put it, the Committee to Save the World following the Asian Financial Crisis managed to blow it up instead. The subsequent failure to fix things while continuing to dodge even partial responsibility for the problems in the first place are driving a growing rejection of the wave 2 institutions. Moreover as my old pal Albert Edwards pointed out this week, the central banks are part of the global institutional framework and they too are being rejected.

These are the ‘experts’ that are being rejected by the wider public and technology is providing a different platform. They are being ‘uber-ed’. As I discussed in the last note, Uber in London offers the same quality or better but for literally half the price, while Uber in Hong Kong offers significantly higher quality for only a modest premium. Both offer wider consumer choice and both are under threat from vested interests trying to use legislation to preserve their monopoly. They may, perhaps, stop Uber, but the model is now forever changed, they will have to adapt. The same is true of these global institutions. President Trump has made it clear that perhaps we don’t need NATO, he has also suggested that the plans on climate change under the Paris agreement driven by the UN are not in the interests of the United States and in both cases is suggesting that he is not willing to pay the bills. He has made it clear that he does not believe in a ‘global community’, provoking shock and horror, particularly for all those working in the multilateral (but largely US funded) organisations  that comprise that community. They are like London Cab drivers, convinced they are providing a great service (which in many cases they are), using legislation to try and preserve their privileges while trying to deny the existence of competition. The people (the customers) are voting for ‘change”, they want more for their money. This is not just about Donald Trump however, part of Obama’s appeal was the prospect of hope and change and so was for many people the vote for Brexit. Not as the globalists would have it a rejection of Europe or European people, but a desire to change from the globalist institution that is the EU. In this sense it is more like a Hong Kong taxi compared to Uber – despite being told it might cost more, the consumer voted for a different and hopefully better product.

The agencies for change are of course technology, but also China - in particular its now vast pool of savings capital which has now become independent. Instead of simply being recycled into US treasuries, allowing the US to continue to run global markets under US rules, it has taken to playing by its own rules. Hence the creation of new institutions like the Asia Infrastructure Investment Bank (AIIB) which will be a key feature of the One Belt One Road (OBOR) infrastructure initiative. This capital is not playing by World Bank or IMF rules, nor is it beholden to the Washington Consensus or any other western rules based system. It is like a Marshall Plan without a war and is more pragmatic than the west (has become). China is developing the Pakistan Economic Corridor for example without conditions on human rights or carbon emissions.

Technology is facilitating the recycling of this capital in multiple ways. While social media obviously plays an important role in the messaging of opposition to existing institutions, it is just part of the landscape, like the Uber App. FinTech is everywhere, undermining traditional capital platforms with crowd sourcing, shadow banking systems and, with block chain, even currencies. Central bankers can control the economy only in so far as they can control the banks. Regulators are forcing banks to hold ever more capital and performing stress tests to try and ensure confidence in the banking system without recognising that is was essentially the non-bank system that causes the problems when the traditional banks withdraw liquidity. The biggest risks to markets in my mind are the ETF products that are leading retail investors to be (largely unwitting) sellers of market volatility. As with the notorious CDS squared type products, leverage, especially hidden leverage, is always the issue.

The overall thesis then is that what we are seeing is not a rejection or even an end to the third wave of globalisation but a clearing out of the institutions that came with the second wave. They are being Uber-ed, by China and by Donald Trump. This is not a rejection of trade or the ability of value added to be transferred across boundaries, if anything it is a rejection of the attempts by various vested interests to prevent more of that form of globalisation. Tariff barriers and customs unions prevent consumers from benefiting from dis-inflationary growth elsewhere. The real benefit from free trade, is the same or better for less money. Just like Uber. And just like Uber, you can try and change the messenger, but you can’t change the message.

As investors we recognise that the old rules no longer apply. Capital is coming from different places, with different aims and intentions. We need to think and invest more thematically. Where a company is quoted, or what sector an index provider has put it in is much less important than what factors and future trends it is exposed to. Demographics, shifting consumptions, longevity and healthcare, technology innovations, industrial automation, the whole digital economy. These investment themes are truly global.

But this is already (way) too long. http://content.time.com/time/covers/0,16641,19990215,00.html More next week.

Regards,

Mark

 

Mark Tinker

Head of AXA IM Framlington Equities Asia

-ENDS-

 

Notes to Editors

All data sourced by AXA IM as at Monday 26th June 2017.

 

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