Our core view continues to be that the backdrop remains more constructive than it has been in the past two years and consequently we retain an overweight equity position in our asset allocation.
Be positive
The primary reason for choosing optimism over despair is that policymakers in the US and UK have made it clear that any signs of weakening momentum will see more monetary stimulus.
The Bank of Japan is considering more easing; even though the European Central Bank (ECB) is not actively supporting economic activity, its balance sheet is 25% larger than the Federal Reserve’s; China, Brazil, India and a number of other emerging economies are easing policy and recent weak data flow will have done nothing to discourage more easing.
“Don’t fight the Fed and its friends” remains a useful mantra to remember.
This is very different from the situation 12 months ago when the ECB was raising interest rates, which it did in April and July 2011, and the emerging world was fighting inflationary pressures with tight monetary policy.
Indeed, today we would go so far as to say that chairman Bernanke is effectively targeting the stock market. There is no greater bellwether of Americans’ sense of their prosperity than the Dow Jones Industrial Average. It is universally known and remains the most followed benchmark for politicians as well as the general public. If it can get to a record high (14,199 would do the trick), consumer and corporate confidence would increase.
And before you raise an eyebrow, or two, at the heresy of the thought, remember that ECB President Draghi told The Wall Street Journal in February that the first statistic he looks at in the morning is the stock market. Now that was eyebrow raising. After all, the ECB is based in Frankfurt. An internal Merrill Lynch investor survey I was privy to 15 years ago found that more Germans believed in the existence of UFOs than agreed with the statement that “equities are a sensible long-term investment”.
But look out for landmines
The great risk to the constructive scenario is that the inherent strains within the eurozone come to the fore again. No-one doubts that the lack of competitiveness afflicting the periphery of Europe most seriously, but that also characterises countries such as France, needs to be addressed with domestic deflationary policies. But imposing austerity on economies already in recession could stretch to breaking point the popular support that all democratic governments depend on. This is why the upcoming elections in Greece, the referendum in Ireland and even the presidential election in France are all potential landmines for the eurozone.
What is needed is a genuinely stimulatory monetary policy, a consequently weaker currency and an improvement in the external accounts of the euro constituent countries and therefore a boost to their growth rates.
The euro area as a whole had a current account deficit of €32bn last year. Large deficits in Italy (€51bn), France (€45bn), Spain (€40bn), Greece (€22bn) and Portugal (€12bn), to name just a few, more than offset the €136bn German surplus, and the €43bn Dutch one.
Monetary policy can only act as a short-term offset to the effects of the necessary austerity. The only long-term solution for the euro is a move toward fiscal union, involving the abrogation of national sovereignty to a pan-euro entity – in other words, the creation of a sovereign European state.
To most commentators this seems a pipe dream. Yet there is a historical precedent that could be a roadmap with a (relatively) happy ending.
There is a precedent, Mr President
The 1707 Union of Parliaments between England and Scotland, or, in modern parlance, fiscal union, is arguably more relevant to today’s Europe than it is to the debate about reasserting Scottish independence. England and Scotland had shared a monarch since 1603, but had remained two independent countries. This isn’t that different from today’s Europe. After all, President Herman Van Rompuy presides over multiple sovereign nations just as Queen Anne presided over England and Scotland in the run-up to union.
Nominally, the union meant both England and Scotland gave up sovereignty to the newly created state, Great Britain. In practice, Scotland gave up sovereignty and the English Parliament continued as it had done with 45 new Scottish members (England had 513 despite having only five times the Scottish population) and a new name.
The immediate trigger for the events that led to union was the English need for Scotland to accept the Act of Succession wherein Queen Anne would be succeeded by the House of Hanover to retain protestant control of the monarchy. The Scots had asserted independence by refusing to accede to that Act on the basis that they had not been consulted. This led to threats and counter-threats across the border, but eventually to the move toward union as the solution.
That assertion of independence in the dying days of it may have a modern parallel in the brinkmanship by Greek Prime Minister Papandreou when he called for a referendum to be held on the EU bailout. This was greeted with absolute horror by the European establishment and his removal from office at the insistence of Germany and France.
Was that the first assertion of eurozone sovereignty? Will it be looked back upon as the beginning of the move toward fiscal union?
The other driver for union was that by the early 18th century Scotland was effectively broke, having embarked on a disastrous attempt to empire build in Panama in the 1690s. Many Scottish nobles had lost fortunes and were susceptible to bribery when it came to the push for Union. Indeed, the supposed leader of the opposition to union was himself in the pay of the English.
Still questions to answer
Not only were the ruling class paid directly. At union, £398,085.50 was given to Scotland, partly to offset future liability towards the English national debt and as a compensation for losses incurred through the Darien venture.
Today we would call bribing the electorate and debt forgiveness “easing monetary policy” and/or “monetising deficits”. It can be done.
History rhymes rather than repeats. And taking complex events such as those in 1707 and comparing them to today is clearly not meant to be taken literally.
But it is interesting to me at least that Great Britain was created from putting together countries that would have preferred to stay apart, but which ultimately decided that union was the least bad way to keep peace and create prosperity. The union was unpopular on both sides of the border. Contemporary estimates suggest nearly unanimous dismay and aversion to it in north Britain. The English went into this begrudgingly, unsure what the benefits were.
As investors, the question for us is how bad will things have to get to make European policymakers see sense and take similar decisive steps, beginning with monetary ease?
Since it may not happen for a little while our core view remains constructive in the near term. But there will be a time when across Europe sovereignty will have to be abrogated, even at the risk of those doing so being condemned by many as “such a parcel of rogues in [every] nation”.
