Tatton Weekly: Remarkable market resilience; Article 50 triggered; Prospects for European banks

Remarkable market resilience;  Article 50 triggered – Quo Vadis UK?;   European banks – unloved perhaps, but welcome harbingers of economic growth;  Bankruptcy of Westinghouse and why companies should be allowed to fail;  It’s not Size that matters

Remarkable market resilience

While I would really like to interpret the recent resilience of market and business sentiment as the beginning of a more resilient growth phase, this is probably still premature. Yes, true, nothing is changing in the shorter term, but the potential and apparent willingness of Trump, China and the UK/EU to fundamentally change the terms of Global trade and with it the framework that has brought us growth and prosperity must be truly concerning.

With so much reason for markets to ‘throw a tantrum’ ahead, I continue to expect markets to experience a return to bouts of volatility in the near term. Our current neutral portfolio positioning should therefore continue to be the most suitable approach to navigate clients’ investments through whatever may lie ahead over the coming months.

Article 50 triggered – Quo Vadis UK?

We do note that from the perspective of rational assessment, a ‘hard Brexit’ – one in which the two parties part ways without a trade deal and the UK is forced to trade with the EU under WTO rules – seems the most likely outcome if neither side shows willingness to concede movement away from their ‘red lines’. At Tatton, we are unconvinced that ‘hard Brexit’ is inevitable, but acknowledge that treating it as a base case is perhaps the most sensible way forward. We are unconvinced because ‘where there is a will, there is a way’. This aspect may become particularly pertinent if US president Trump launches a full-frontal attack on free trade globally, and the cohesion of the remaining EU in particular. Nothing welds wavering partners back together more than a real external threat.

European banks – unloved perhaps, but welcome harbingers of economic growth

Admittedly, the ECB is not yet about to raise rates, and we think that the Euro is likely to strengthen in the face of stronger growth. This would contain inflationary pressures, potentially delaying the prospect of rate rises. However, a currency move would not stop markets anticipating rate rises – it would just be seen in rising longer bond yields first, rather than in short rates. Such a steepening in the yield curve would still be positive for bank profits and equity. Indeed, we also think a strengthening of the euro might well lead to a “Goldilocks” scenario of capital inflow, compression of savings rates and a prolonged bout of real growth – a very positive scenario for financials and non-financials alike, and for the prospects of their equity prices.

Bankruptcy of Westinghouse and why companies should be allowed to fail

In our piece on Kondratieff Cycles last week, we discussed how short-term business and confidence cycles interact with longer-term cycles of economic activity. The consequences of these interactions can lead to periods of expansion and contraction, during which businesses do better in up cycles and the stronger firms survive down cycles, while weaker ones go bankrupt.

Typically, this expansion and contraction action can account for a majority of business creation and failure, in what is termed ‘Creative Destruction’, popularised by Austrian economist Joseph Schumpeter in 1942. Essentially, old inefficient companies die and new ones take their place in a process of “industrial mutation”, or natural evolution of “spontaneous order”, as termed by the famous economist F.A. Hayek.

As Kondratieff noted, the capitalist or free market economic system is naturally self-regenerating. The implications for investors are that the optimal outcome over the long-term is to have a wider selection of investments, spread across multiple asset types, companies, sectors and regions, to help offset or even benefit from changes in business cycles and the natural process of Creative Destruction.

It’s not Size that matters

We would therefore point out that the size of a company does not matter as much as its future profitable growth prospects. Professional AIM investors will strive to quantify future earnings streams of each company through thorough research, ensuring diversified investments to control risk and produce favourable long term return on capital.

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