Can the Gallagher Brothers help the Chancellor?

Can the Gallagher Brothers help the Chancellor?

After the quite intense focus last week from both the press – and this newsletter – on Gilts and bond yields, Ms Reeves seems to have got lucky and of the 2 and a half options that I suggested were the ways out of this problem, it seems lady luck is shining on the Chancellor and the half option – do nothing and wait until global yields retreat – is coming to pass.

A benign inflation figure on Tuesday in the UK of 2.5%, reinforced by a similarly docile US inflation figure later in the day, caused global yields to retreat, stocks to rally and No. 11 Downing Street to breathe a big sigh of relief. However, one swallow a summer does not make, and with a low GDP figure of 0.1% on Wednesday and Retail Sales figure of -0.3%, the UK economy is officially going nowhere at present. Pressure remains on the Chancellor to “fix” this, however her options remained limited, but can I suggest a left-field option?which may sound ridiculous but hear me out?

Think back to the early 2000s.

New Labour was in full swing -?Oasis and the Spice Girls dominated the global charts and Cool Brittania was a real thing. I remember waiting in transit in Beijing airport, looking at union jacks on massive Burberry billboards, ads for the new James Bond movie with all?it’s?connected marketing and sipping a Village Cricket iced tea from Costa Coffee. The UK was cool as it had opened the doors to inwards international investment, but at the same time sent very British cultural icons back out to the rest of the world.

The unique values of British cultural heritage along with a modern, dynamic economy was (and still is) very attractive to international consumers and businesses. So why can’t we do that again? Can the Gallagher brothers be convinced to stay together long enough to go on a Taylor Swift-style marathon global tour and remind the world of Cool Brittania? Or a more realistic option, can public spending prioritise funding of music and the arts to help find and launch the next Oasis, Damien Hirst, Tracey Emin, Christoper Nolan, Dua Lipa or Ed Sheeran. This is soft power. It is real and it works.

This is a confident Britian on the global stage, reminding the world that post-Brexit we are not an inward looking nation. That feels a long way off from where we are today, but Governments can and should promote this. The Royal family have understood soft power for decades and used it very wisely. Incoming US President Trump does not bow to many, but he did bow to a diminutive, quick-witted 90-year old woman when he visited Buckingham Palace in 2016.

Maybe Ms Reeves should take all her Treasury team to an Oasis concert in the summer and see if they can get this party, and the economy, started?

Trump and China can start off on the right foot with a joint focus on currency.

One of the most interesting, and perhaps scariest, prospects over the next 4 years is how the relationship between the Chinese authorities and President Trump develops. A key aspect of this is trade, and given in 2019 the Trump administration officially declared (correctly) China as a currency manipulator, it’s fair to say things can’t get much worse.

However, the respective economies are now in very different positions from 2016 and this provides an interesting opportunity to develop a shared goal – to allow the Chinese Renminbi to strengthen against the US Dollar. We need to go back a step to understand why this is an issue and why now is the time it can be solved. This can get complicated so to any FX/economic specialists please bear with me as I’m going to be massively oversimplifying this, but otherwise I will lose 99% of my other readers!

Since global trade first began and currencies have floated freely, economic history is littered with emerging market currency crises. In short, fast-growing economies would borrow dollars because they were cheaper than their local currencies and invest this in the growing economy. When the local currency is going up or flat, this works fine.

However if/when growth falters, the local currency falls and all of a sudden this dollar debt gets bigger in local currency terms and they can’t pay it – then comes crisis and default. In 1997 the Chinese were determined not to let this happen so it pegged the Renminbi (RMB) to the US Dollar. This is done through the Central Bank going into the currency market and literally buying or selling the currency to get it to the level it wants.

Fast-forward to December 2001 and China joined the World Trade Organisation (WTO) which was it’s entry onto the world stage. Global trade took off as now virtually any company around the world could access easily China’s low-cost manufacturing. Chinese growth also took off. If the RMB was free-floating, we would have expected to see a sharp rise in the RMB to reflect this big increase in growth, but because the currency was pegged this didn’t happen. Like most economic interventions against free markets, this created massive distortions.

On the plus side, the world continued to enjoy super low-cost manufacturing and deflation as the price of many goods actually fell (remember our TV example), but this was at the cost of local economies, manufacturing jobs and other industries that could be outsourced – something which politicians that appealed to the “heartland” voters rallied against. This was the rise of Trump 1.0 and laid the foundations of Make America Great Again.

But 2025 is a different story. The US Dollar reigns supreme as global growth is underpinned by the US economy whilst virtually every other region deals with it’s own struggles. China is a case in point. Growth still has not started post the self-inflicted misery of lockdowns with the cause being many structural issues. The impact of a flat 15% tariff on all Chinese exports to the US would be potentially catastrophic. However, from the Chinese perspective, exports are it’s one shining light of the economy, with the total amount exported making new record highs – see the charts below. Internal growth is the Chinese problem.

So,?potentially allowing the RMB to appreciate against the US Dollar?not only helps in negotiations with President Trump – because everything is a negotiation for him – but it can also potentially help the domestic Chinese economy?by improving purchasing power. There is a lot of ifs, buts and maybes here, but at least starting with a shared joint aim gets everyone talking about solving problems.

The Bond/Stock relationship gets more analysis

For those of you invested with us through our PWP model portfolios, we hope you’ve been very pleased with the performance. We certainly have.

One of the main features of the portfolios are for the non-equity parts of the portfolio to NOT just rely on bonds to hedge out stock market risk – like many of our competitor funds -?because our view is that bonds have more of a positive correlation (ie. they move in the same direction at the same time) than the theoretical negative correlation the textbooks say they have. This is why we include many other assets like gold, commodities, infrastructure and even cash. The chart below provides more analysis of this:

The recent years since 1998 of negative correlation seem to be coming to an end. In a positive correlated relationship, the idea of “bonds as a hedge” falls apart. We continue to see this playing out, but it’s always nice to see new supporting evidence back up our research.

A headline that may scare some, but was always coming...

More on this next week with my view...

Have a great weekend,

Adam Walkom

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*My personal views only. Please remember the value of investments, and any income from them, can fall as well as rise so you could get back less than you invest.*