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Why oil still rules the world

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By Economic Strategist, Hottinger Investment Management  

When it comes to the importance of oil to the global economy, few have expressed it better than the Scottish novelist  James Buchan. In an article for The New Statesman in 2006, he wrote:

“A century ago, petroleum – what we call oil – was just an obscure commodity; today it is almost as vital to human existence as water. Oil transports us, powers our machines, warms us and lights us. It clothes us, wraps our food and encases our computers. It gives us medicines, cosmetics, CDs and car tyres. Even those things that are not made from oil are often made with oil, with the energy it gives. Life without oil, in fact, would be so different that it is frightening to contemplate.”

In the twelve years since, some of the technologies have changed but the triumph of oil has only advanced.  Since 2006, according to the International Energy Agency, global oil production from all sources – including shale, oil sands and natural gas liquids – has risen by over 12% from 82.5 million barrels a day to just under 93 million barrels a day. About half of that increase has come from China with other emerging economies driving the rest.

It’s no surprise, therefore, that analysts and economists still look to the oil price as a guide to the fortunes of the global system. Helen Thompson of the University of Cambridge is a specialist on the political economy of oil, and has built her thesis around an astonishing fact: All but one of the recessions in the United States have been preceded by a sharp rise in the price of oil, not just those that were specifically caused by OPEC in the 1970s and 1980s (see chart, recessionary periods in red), though that is not to say that all oil price spikes cause recessions.

In the eighteen months before the Great Recession, Brent Crude trebled in price, from around $50 per barrel at the start of 2017 to $150 per barrel in July 2008. It is not unreasonable to think that price pressures from oil caused the Federal Reserve then to tighten too quickly, seizing up credit markets at a time when banks were running amok.

This provides pause for thought for those wondering whether the global slowdown could become more severe. The current down trend in the price of oil could reflect weakened demand from emerging market economies that have been hammered by the combination of the rise in the price of crude from about $30 per barrel at the start of 2016 to $85 this May and the strengthening of the dollar.  A more sanguine view, however, would suggest that the introduction of new sources of supply has kept oil prices manageably low levels and reduced the risk of global recession in the immediate future.

While we now talk of demand for oil peaking sometime in the middle of this century due to the rise of alternative forms of energy and awareness of climate change, in the mid-2000s the fear was of peak oil supply. This was because discoveries of conventionally produced oil – that is, oil produced by drilling and pumping – had been falling (and continues to fall), and the many of the places where substantial reserves exist – such as Iran, Iraq and Venezuela – were not exactly conducive to the requirements of the global economy. That was the fundamental reason why oil prices spiked so much in the years up to the Great Recession. New sources of supply were yet to come on stream and global demand was soaring.

Oil prices have not returned to the heady heights of 2008, and indeed have broadly fallen since 2014, because the introduction of shale, tar sands and natural gas liquids onto the market has more than met the increase in demand from the emerging countries. In 1990, just over 90% of global oil was sourced from conventional processes; in 2013, that figure was just 80% and it has likely fallen further since (see chart). This increase in supply has been driven largely by the US, enabling that country to not just become energy independent but to exceed the volumes it achieved in the 1960s and 1970s when its conventional oil industry was at its peak and producing up to 10 million barrels a day.

When oil prices become too high, they put pressures on consumer spending and induce central banks to raise interest rates to keep inflation under control. This happened in 2008 and 2011, catching out the European Central Bank which responded to rising inflation by raising rates in an environment of weak demand, arguably deepening and lengthening what we call the ‘euro crisis’ of 2009-2015.

But the development of shale has, however, created a very different problem. Due to the rise of production from these high-cost alternative sources, oil prices can create problems for the economies that are dependent on these sources when prices become too low.  When prices become too low, analysts start worrying about the fortunes of highly leveraged shale producers which borrowed when QE made credit cheap, which have invested in expensive capital-intensive infrastructure at a time when oil prices were high, and which rely on high prices staying high to break even.  It is commonly thought that $40 a barrel is now the price below which shale producers start making losses, and there are concerns that the surpluses that are building up in the oil market could push the oil price down further towards those levels.

According to Thompson, the issuance of high yield bonds by US companies in the energy sector trebled between 2005 and 2015, and the value of syndicated loans to the oil and gas sector increased by 160% between 2006 and 2014. While oil prices don’t present the same direct risk to the global economy as they did in 2008 because they are relatively low, they do – precisely because they are low – to the US economy, whose central bank continues to raise interest rates at a pace that the market thinks is too fast for highly levered firms such as shale producers to handle.

Together with concerns around corporate credit more broadly in the US and the significant exposure to it of European banks, we should keep a close eye on the oil price if it continues to trend down.

What is going on with the UK economy?

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By Economic Strategist, Hottinger Investment Management  

According to the Office for National Statistics, the UK grew its economy by 0.6% in the period between July and September, the fastest pace of quarterly growth for two years and a rate that would correspond to 2.5% if applied across the calendar year. This announcement came a day after the European Commission produced its forecasts for 2019 economic growth, with the UK at the bottom of its European league table tied with Italy. An annual expansion of just 1.2% is expected in both countries. Meanwhile, Ireland sits near the top of the Commission’s league table, with 4.5% growth anticipated. Political posturing aside, what is going on?

During Q1 and Q2 this year, the British economy grew by 0.2% and 0.4% respectively. If we include the Q3 figures, that means the economy has expanded by 1.2% in the first three quarters of 2018. This compares with just 1% in the Eurozone, 0.8% in France and 1.1% in Germany (based on a +0.2% Q3 estimate). Third quarter growth itself in the UK exceeded that of France and Italy – and most likely Germany too. Part of that is because of the recovery of activity lost during the first three months of the year due to the exceptionally cold weather, with construction (+2.1% QoQ) and manufacturing (+0.6% QoQ) up during the summer months, the latter on the back of strong performance in the export of cars and machinery.

The UK has been gaining momentum over the year while the rest of Europe has been losing it after its stellar performance in 2017, yet pessimism over the future for the UK is proving so hard to shift. Brexit is part of the explanation, but only part. As long as there remains uncertainty over the UK’s trading status with the countries which constitute over 40% of its exports, businesses will hold off from making long-term investments, and we see this in the data. The chart shows that the UK is an outlier among G7 nations in investment spending both over the last quarter and over the last twelve months. British businesses haven’t felt confident enough to take part in the global growth story of 2017.

Trade complexity matters, and the complacency with which some Brexit-supporting politicians treat the issue presents a risk that is now materialising to the British economy. Global supply chains get more complex each year. We realise this from time to time, whether it was how the Fukushima nuclear disaster of 2011 in Japan created delays in the supply of components for car companies and smartphone manufacturers across the region, or – closer to home and nearer in time – the situation earlier this year in which KFC, the fast-food chicken franchise, ran out of chicken. The pressure for ultra-lean inventory and fast delivery creates conditions for dramatic stories like these. But it also potentially makes Brexit Britain a less attractive place for international businesses that want to sell into Europe competing with firms that benefit from lean supply chains elsewhere. That’s what matters, not tariffs (which can be mitigated to some extent by a currency devaluation and countervailing tax measures), but regulatory frictions that cause material delays, and the EU knows it. It’s not clear, however, that the people with whom they are negotiating with do.

Business will continue to fight for a Brexit deal that keeps in place that all-important just-in-time (JIT) supply chain infrastructure. But without greater strategic awareness from the government, Brexit will look like an expensive and reckless experiment in de-globalisation.

But there is a wider problem with the British economy that means one cannot lay blame wholly at the door of Brexit. The UK has consistently lagged other G7 countries when it comes to productivity, defined as output per hour of labour, and growth in productivity (see table). An hour worked in the UK in 2017 yields 80% of an hour worked in Germany and France. We like to mock the French for their employment attitudes and general sense of joie de vivre but the fact is that if they worked as many hours each day as the British, they could afford to take Friday off and be just as well-off per capita.

The culprit is decades of underinvestment as the second chart shows; since 1979, with the exception of a brief period in the late 1980s, the UK has consistently had one of the lowest rates of investment as a share of its GDP in the G7. Business investment has remained low for decades as banks have diverted funds towards mortgage lending over productive enterprise.

The table shows that compared to its G7 peers the UK hasn’t done badly in terms of real GDP growth since the end of 2007, before the Great Recession; only the US, Canada and Germany have grown by more. The countries however are ranked according to growth in labour productivity in the first column, where the UK only marginally beats Italy in the fight to avoid the wooden spoon. If we accept that GDP is basically the sum of productivity and labour input, what this means is that the UK has relied disproportionately on labour input to deliver growth. The UK is the only country that has seen an increase in labour hours per employee since the Great Recession, and it shares a high rate of employment growth with Germany and Canada, two countries that have seen significant immigration in the last decade.

The UK has relied on three unsustainable sources for its recovery. The first is a rise in the employment rate above its pre-crisis trend, as a result of government policies that encourage work. The second is a rise in hours worked per employee, most likely in response to negative real earnings growth during much of the period of interest. The third, and most important, is immigration. The UK population has increased by almost 8% (or 4.7 millions) between 2008 and 2017; official net migration in that period was just under 2.5 million (or 53% of the total rise in population). Immigrants are significantly more likely to be of working age; EU migrants (but not non-EU migrants) are more likely to be employed than natives. But even assuming they are equally as likely in both categories means that a very substantial chunk of the 2.48m rise in employed persons between 2007 and 2017 consists of immigrants.

And this brings us back not so much to Brexit but instead to the causes of Brexit. If Brexit is about reducing immigration then the UK is going to need a new economic model and it has to revolve around raising the investment rate in order to replace the economic growth provided by recent immigrants. At some point the economic debate will have to turn to this and there are two clear models: the Conservatives favour a low tax and business-friendly approach, while the Labour Party wants to use the resources of the Bank of England and the Treasury to get things going. Without an investment strategy for after Brexit, the growth outlook for the UK is justifiably poor.

Investment Review: October 2018

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By Hottinger Investment Management

October saw US Treasury markets finally catch up with reality, in our opinion, and in doing so trigger significant global equity market volatility. The yield on the 10 year US Treasury moved sharply higher from 3.06% to touch 3.23% driven almost entirely by real yields rising because headline inflation fell slightly to 2.3 yoy in October. Financial markets seem to us to have been pricing in half the rate hikes that were currently being suggested by the Fed’s dot plot so it seemed a fair assumption to us at least that a market reaction to a hawkish speech by Governor Powell aimed at jolting markets followed up by reactionary rhetoric from President Trump would see markets react negatively to the potential end of an aging economic cycle. Furthermore, the increased tariff measures from the US administration aimed at China have also triggered a number of US companies to raise concerns over the increasing costs of protectionism. In Europe too trade tensions seem to have affected economic activity with new export orders falling significantly this year and in Germany, in particular, the new car emissions tests seem to have contributed to slowing manufacturing numbers during October in an industry already suffering in the crossfire of the US / China trade war.

As seen in February, a market looking to reduce risk in already extended equity market sectors also went through a significant rotation out of cyclical growth into defensive value. Indeed, despite the prospect of rising rates and bond yields many bond proxy equities showed their flight to quality credentials but another significant factor over late summer has been the value of cash at 2.3% moving above the yield of the S&P500 (1.9%), with investors seeing a modest real return in 2 year Treasuries at 2.9%. For long periods the argument that there is no alternative to equities has led to investors overpaying for growth and potential disruptive technologies that many investors have now become increasingly anxious about this late in the cycle.

However, 3rd quarter US GDP estimates came in stronger than expected at 3.5% qoq driven above consensus expectations by strong consumer spending assisted directly by the fiscal advantages introduced by President Trump. On the global growth front, the picture is clearly mixed. Growth has slowed at the world level from 3.8% over the 2017 calendar year to 3.5% annualized figure for Q3 2018 and has been a negative surprise for markets clearly contributing to the October sell-off. Behind the headline rate, the performance of the European Union and China, which account for about a third of global GDP, have contributed the most to the slowdown, with the central bank in China continuing their policy of monetary easing – going against the grain globally –  to support domestic and export activity.  On the other hand, the United States, the United Kingdom and Japan are all growing at faster rates than they achieved in 2017, with all countries expanding above 2.5% over the most recent quarter on an annualized basis. In emerging markets, India is strongest expanding by over 8% in Q2 2017 and facing tailwinds from demographics, urbanization and economically favourable policy reforms from the Modi government. Whether India becomes the new China, putting in year after year of 7%+ growth, remains to be seen but the signs suggest it might.

Furthermore, 3rd quarter earnings season has seen 85% of US companies beat EPS estimates so the back drop to the October sell-off was still broadly positive although investors did seem to be focusing more on company forward guidance for signs of possible future slowdown. The possibility that equity investors may have already seen peak earnings during the middle quarters of this year has increasingly caused an air of caution that spilled over in October. As calculated by JP Morgan A.M. the S&P500 moved by more than 1% on a daily basis ten times during October while only managing that feat 8 times in the whole of 2017. The index was down 6.9% on the month leaving it up only 1.4% on the year. The fact that the volatility trigger was an increase in real yields means that the normal negative correlation between bonds and equities also broke down with the Treasury market falling approx. 0.50% in aggregate over the month meaning that multi-asset investors also found it difficult to escape negative markets.

The nature of the correction was felt across all markets with Europe (-6.5%), Japan Nikkei index (-9.1%), UK FTSE All-Share index (-5.4%) and MSCI Emerging Markets (-8.8% in $ terms)all feeling the effects of the risk off sentiment. In fact many global markets found themselves in bear market territory down 20% on the year with only 20% of all asset class types yielding a positive return. The advent of QE brought with it a move away from market fundamentals towards political and central bank influence over investors and, arguably, the existence of a central bank back stop a reduction in volatility that favoured risk assets. As QE turns to QT (quantitative tightening) and economic strength is left to stand on its own feet a return to normal volatility in the latter stages of an economic cycle is to be expected especially if signs begin to show that the economic data is also turning. A return to fundamentals may also see the market signalling system become clearer increasing market opportunities for active investors.

A Tale of Two Americas

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By Economic Strategist, Hottinger Investment Management  

Last week, the U.S. Labour department issued its most important figures. Job creation surprised on the upside, with 250,000 new positions filled compared to the expectation of 195,000. Additionally average earnings broke through the three-percent barrier for the first time in nine years to 3.1% in a sign that inflationary pressures are increasing. Labour force participation rose slightly from 62.7% to 62.9% as the unemployment rate held steady at 3.7%.

With the latest chapter in American democracy reaching its denouement tomorrow, it is worth considering a little trend that has wider import. Over the course of this year, the unemployment rate for Americans with less than a high school diploma actually rose. It increased from 5.2% last December to 6.0% last month. The monthly figures between those two dates are volatile but there is a clear upward movement. Meanwhile the unemployment rate for graduates has stayed flat at around 2%. It is worth noting that an unemployment rate of 2% is meaningless as it reflects mostly the proportion of people that are moving between jobs at any one time.

The high unemployment rate among those who are classed as ‘unskilled’ exists despite a record number of open vacancies (over 7 million) and firms saying it takes them over a month to fill the average role, such is the dearth of available labour.

Three features stand out from the chart below, which I have called “A Tale of Two Americas”. The first is that at no point in the last ten years has the graduate unemployment rate been higher than the lowest level that unemployment has been for those without high school diplomas. The second is that the rise in high school unemployment during the Great Recession was almost four times higher than the rise in graduate unemployment. The third point is that the chart exposes the structural inability of the US economy to produce jobs quickly for low-skilled people who want them, as there has not been a tendency for the two series to converge. This last point is underscored by the fact that the US labour force participation rate has not recovered from its high of 66% in the months before the financial crisis, meaning effectively that about 3% of the working age population have remained out of the labour force. (You could say, with some justification, that the real unemployment rate for the unskilled is as high as 9%.) It is often during recessions that firms take measures to automate and streamline their processes. And of course, lastly, these trends take no account of the rate of underemployment and precarious employment that exists to a greater extent within the lower echelons.

 

The point is that in the US if you’re a graduate you have almost no reason for economic anxiety and recessions are a mild inconvenience, although you might have the millstone of student debt around your neck. If you’re not, then you don’t. It’s a tale of two Americas because it is the people in the first camp who are likely to vote Democrat in the upcoming mid-terms and the people in the second camp who will back Donald Trump’s Republican Party; US counties that are more exposed to trade with China and Mexico, and which have more jobs at risk from automation, were significantly more likely to back Trump in 2016. There are enough people in Donald Trump’s camp to keep him from losing both chambers of Congress.

When you don’t have to worry about material matters, you can afford to build your political values around post-materialist issues such as gender, sexual and racial equality – important though they are. The Democratic Party has become a party of social-justice for post-materialist voters while developing a blind-spot towards the issues facing blue-collar workers, once a core part of their support, in the flyover states and in the Mid-West. For these, the material still matters, or as Bill Clinton eloquently put it: “It’s [still] the economy, stupid!”

It’s not that simple, however, as Republicans are still on average wealthier than Democrats, which attract a huge number of votes from poorer minorities as well as graduates. But the voters who pushed Trump over the winning line in 2016 belong to a specific, sizeable and important demographic, the white working class that once was solidly Democratic but now forms that heart of Trump’s base.

Core Trump voters, particularly male ones, can sense that the jobs that in their view gave them dignity – typically in agriculture, mining and manufacturing – are giving way to those that, again in their view, don’t. The US economy will need more care workers, nurses and office workers (jobs perceived to be feminine) in the future and fewer truck drivers, farmers and machinists (jobs perceived to be masculine), and many of Trump’s voters still think he is the one to bring them back. He’s failing.

Leaving aside whether Trump has actually done anything to advance this group’s interests in the last two years (he hasn’t), it remains the case that the US President’s targeted assault on various institutions, politicians and minorities is a sort of displacement technique that soothes the anxieties of his voters and permits blame for their plight to be shifted, not entirely unjustly, to the metropolitan and coastal view of things that has dominated since the 1980s. Sending thousands of troops to a 2000-mile US border to defend against refugees who have yet to complete the small task of walking through Mexico is the latest move to this effect.

While it is very likely that the Democrats will win the House of Representatives next week, the Republicans will probably keep control of the Senate, only a third of whose seats are being contested and most of those already held by Democrats, compared to every seat in the House of Representatives. Donald Trump’s popularity (at around the low 40s) has remained high enough for his party not to lose both chambers. But if recent presidential history is anything to go by, the return of a split Congress will make it harder for the President to push through his agenda, and that includes the tax cuts and deregulatory acts that have been helping US firms boost their earnings and increase their degree of freedom over the last 12 months.

 

Investment Review: September 2018

Posted on by admin@hottinger.co.uk

By Hottinger Investment Management

A booming economy has left the US equity markets well ahead of the other regions over the summer months and September has proved to be a month of retrospection with the first signs of a possible rotation from cyclicals into more defensive sectors. However, whenever this has happened previously it has proven to be short lived, but it is probably true to say that US markets have become a little more anxious as we head into October, which has always been a difficult month historically.

Economically, in September, JP Morgan report that US consumer confidence hit its highest level since 2000; initial jobless claims fell to the lowest monthly average level since 1969 while wage growth rose to the highest level since 2009 and retail sales grew more than 7% year-on-year. The level of fiscal stimulus announced by the Trump presidency is unprecedented this late in the cycle and when combined with the move from quantitative easing to quantitative and monetary tightening the threat of the US economy overheating has definitely increased as a risk. The US yield curve remains very flat with the 2 – 10yr curve only positive by 40 basis points, although the economic signals emanating from the bond market have been severely dulled by central bank intervention.

The Federal Open Market Committee’s meeting in September delivered a well-choreographed 25 basis points hike for the third time  this year and a removal of the last of the QE wording that policy remains “accommodative” in the official statement paving the way for another 25bps in December. Indeed US Treasuries lost 1% over the month and 10yr Yields finished at 3.06% following this latest tightening round. So far the Fed has managed the expectations of financial markets very well with the gradual monetary tightening not shocking the market; every time the US 10yr Treasury breaks above 3% it fails to consolidate its positon to move towards 3.5% decisively despite the expectation that we may have passed peak growth. While core inflation risks remain under control, financial markets are unprepared for a more aggressive Fed approach and risk assets remain in favour.

During September the S&P500 printed another all-time high of 2940.91 but failed to hold that level into month-end finishing still positive +0.43% at 2913.98. The headline numbers do not tell the full story though as the fact that the NASDAQ fell 0.78% in September might suggest. The high valuations surrounding some cyclical stocks saw investors implement a certain level of rotation during the month as the FAANG+ index fell 4.19% and the S&P Banks Index fell 4.37% while defensive sectors such as Healthcare gained 2.80%. The narrowness of sector returns over the third quarter has seen many equity investors ride the IT wave (FAANG+ is still up 22% YTD vs. 9% S&P500) while the outperformance continues creating a lot of “froth” that is reliant upon earnings growth surprising on the upside into year end. Many market analysts including Absolute Strategy Research believe that earnings will fall significantly in Q4 bringing into question equity valuations. This rotation into value stocks is the most significant since the February hiccup but it could face headwinds if inflation fails to materialise and unemployment continues to fall.

In the UK, financial markets remain under pressure as fears of a no deal Brexit gain momentum as well as latest round of political party conferences got underway. The FTSE All-share gained +0.53% while Gilts fell 1.62% and sterling was flat. In theory a no-deal Brexit would be good for the equity market due to the expected fall in sterling depending on your opinion of what is already priced in. However, many are now more anxious of a pending Corbyn government than they are of the type of Brexit deal that is achievable leaving the outlook for UK financial markets cloudy at best. Elsewhere in Europe the banking system has been called into question twice over the summer due to exposure to Turkey and Italy which has added to wider market fears following last year’s significant outperformance. European equities fell 0.31% over the month as trade war rhetoric between the US and China continued to add to the forecasts of an already slowing Chinese economy, which will have a knock on effect to European exporters.

The highlight of the month was Japan which saw the Nikkei 225 rise 5.49% and $/Yen weaken 2.4% meaning that Japanese equities were stronger in dollar terms as well. The economic background of the strongest jobs market since 1974 and expanding bank lending have been equity supportive, but also the beginning of bi-lateral trade talks with the US and discussions in the Diet regarding a new fiscal package following Prime Minister Abe winning a third term has also helped create a positive backdrop.

From an asset allocation perspective, the favouring of US equities probably relates to their historical outperformance in poor market conditions due to the depth of diversification and liquidity while emerging markets as a bloc remain challenged by a strong dollar environment particularly those countries with large current account deficits that have increased their dollar-denominated debt. With regards to Europe, we think the end of ECB stimulus and limited fiscal support coupled with concerns over growing levels of household and corporate leverage heighten risk in investing in the region.

The value of a reserve currency

Posted on by admin@hottinger.co.uk

By Economic Strategist, Hottinger Investment Management  

What’s the value in a reserve currency?

Being in possession of a global reserve currency is often seen as a privilege for a country and its citizens. In times of growth, the use of a reserve currency to grease the wheels of international trade can reduce the borrowing costs for that country. In times of panic, investors pile in to buy the currency, pushing its value up and making imports cheaper.

Reserve currencies are an essential feature of a global economy that relies on a basket of national currencies, and are an important asset for investors to manage the risks from their investments.

The best reserve currencies are those that perform the three essential functions of money best. A currency is strong when it acts as not just a medium of exchange and a unit of account, but also as a store of value. When investors choose to store some of their wealth in a foreign currency, they trust the government in charge to keep inflation low and public debts within manageable limits.

Reserve currencies can fall out of favour

Since the end of the Second World War, the United States has managed the world’s dominant reserve currency, the dollar. But today, that status may be under threat as the US government under Donald Trump abuses its privileged status by running large budget deficits and putting trading sanctions on other countries in a way that runs against international agreements.

Are we therefore seeing the beginning of a shift away from the dollar to other global currencies? One way we can begin to form an answer is to look to history. During much of the 19th century and the first part of the 20th century, the British pound was the world’s reserve currency. Many of Britain’s colonies and trading partners pegged their currencies to gold sterling; the City of London was the world’s banker, with the Bank of England its line of last defence. In 1914, according to Barry Eichengreen of the University of California, sterling accounted for almost 90% of global foreign-denominated debt. By the end of WWII, still up to 60% of foreign-denominated debt was in sterling as the US dollar came to ascendancy. Many countries, however, maintained sterling pegs well into the 1950s.

The rise of the United States to prominence in the global economy throughout the 20th century naturally made it both able and willing to provide the reserve currency, and it was essential that it did. Eichengreen claims that the dollar overtook sterling in the 1920s if one excludes Commonwealth countries but well after WWII if one does not.

The political arrangements of Bretton-Woods that followed WWII and paved the way for US dominance as well as the high debts that burdened the UK after the war provided the death knell for sterling. This, alongside the decline of the British Empire, weakened sterling’s grip within the Commonwealth and made it infeasible for the UK to remain the head of a global fixed-exchange rate system, as it required a tight monetary policy at a time when domestically the opposite was called for and demanded.

The chart below shows the effects of the sterling-dollar transition that took place in the 1940s. Since that period, the real value of the British pound has been around 20% lower than what it was during the first half of the 20th century. The nominal value has fallen further. One pound bought five dollars at the start of the 20th century; today it buys less than $1.30, a 70% devaluation that is due both to the loss of sterling’s status as the global currency but importantly also the UK’s higher long-term inflation rate compared to the US.

Dollar reserves rose from 30% of global reserves in 1950 to just under 70% by the mid 1960s. Peak dollar came just after the end of the Bretton-Woods system in 1973, at which 80% of reserves were held in dollars.

Which currency dominates today?

Today, the dollar is still considered dominant part of a basket of global reserve currencies, some of which could grow in prominence in coming decades.  Over 60% of reserves are still held in dollars, with the rest shared across the euro (20%), the yen (5%), sterling (5%), the renminbi (1%) and swiss franc (0.2%).

It’s a diversified mix that suggests that in an age in which most exchange rates float against each other rather than remaining fixed against that of a global leader, there is more scope for competition for leadership as investors can choose which nation offers the most stable currency.

Over the last thirty years, the Japanese Yen and the Swiss Franc have been popular choices, as attested by the real strength (see chart). Sterling did well between 2009 and 2016 as the UK built a reputation for fiscal restraint. However, none of these currencies can serve as the dominant reserve currency as the economies that back them are too small, which means that investors come up against valuation and liquidity issues when these currencies essentially become too popular.

Competition for reserve currency status will ultimately be between the world’s big three economies: the US, the EU and China.

Despite greater competition, the dollar has held its value through most of the post-Bretton Woods period, as the chart above shows. Fluctuations aside, a dollar today buys more or less in real terms what it did in 1980. Indeed, all of the major global currencies have fluctuated around parity over the period, which can be expected for currencies that float against each other – the so called Law of One Price ensures that nominal exchange rates move in opposition to differences in inflation across countries.

The exception is the Chinese renminbi, which has weakened by up to 60% in real terms since 1980, as a result of a conscious decision by the Chinese authorities to peg its currency against others at a weak rate to boost the country’s export sector.

Many consider the Chinese renminbi to be the natural successor to the dollar as China grows to become the world’s largest economy later this century. It’s possible, but it would require China to either open up its financial markets to global capital, providing a safe asset, or impose itself as the new figurehead of a fixed rate currency system. Neither of these looks likely for some time, so the dollar is likely to keep its preferred status over the renminbi.

The fate of the euro is potentially more interesting. With the Trump administration using the dollar’s important role in facilitating international business to impose crippling sanction on adversaries such as Iran, Europe is beginning to consider ways to circumvent the dollar payment system for its businesses.

There is nothing theoretically stopping the euro rivalling the dollar as a reserve currency, especially between those countries that have a close trading relationship with the Eurozone. Emerging market economies may also find a more diversified global reserve system to their advantage, as it would reduce the sensitivity of their economies to US interest rates.

However, until reforms are made to put the single currency on a more sustainable footing, allaying fears that the Eurozone could one day break up, that prospect looks unlikely for some time.

It looks therefore as if the US will continue to benefit from having the most popular global currency. It is in US interests to maintain dollar primacy, keeping funding costs and import prices low, and having what amounts to the best defence against the vicissitudes of the global economy.  One group that does badly from this deal is US exporters and manufacturers, as a strong dollar undermines their competitiveness. This group has the sympathy of the US President, who has a preference for a weak dollar.

Investing in currencies

Having access to a range of currencies with safe-haven status is extremely valuable to investors. While first and foremost, any investor should consider her personal requirements – such as her preferred home currency, the balance of her international investments, her liquidity needs and the nature of her liabilities – there is value in considering which currencies are emerging as safe havens. For example, holding Yen between 1980 up until any time before the financial crisis would have yielded an average real return of over 40% (see chart), excluding any return on the investments held in those currencies. Holding the Swiss Franc between the financial crisis and 2015 would have yielded an average return of close to 40% on the currency alone.

With the global situation more volatile than it has been since the end of the Cold War, and with so many things that we once thought of certainties now in doubt, now is a good time to reconsider where the best places are to hold and preserve capital.  Those places will have strong, responsible governments with open and liquid capital markets, low and stable public debt, and a willingness to accept a strong currency. And in today’s world, all of those things are contingent.

Hottinger Hike or Bike Charity Challenge

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By Emily Woolard, General Manager of Hottinger Capital Partners

Colleagues from Hottinger’s London and Dublin offices spent Saturday 8th September on the beautiful South Downs, hiking or biking their way to Devil’s Dyke to raise money for well respected charity Macmillan Cancer Support.

Thankfully, the weather was kind and the far-reaching views provided ample reward for their exertions.

The team split into two groups, with six cyclists setting off from Hampton Court Palace in the early morning and covering over 60 miles in total including some challenging climbs. They battled through pain and fatigue (some more than others!) and finally reached Devil’s Dyke around 5:15pm, where they were treated to some excellent views and a welcome drink.

Meanwhile, an intrepid collection of seven hikers set out from the Sussex town of Lewes and covered 13 miles, eventually reaching the top of Devil’s Dyke and meeting up with the team of cyclists.

After recovering at Devil’s Dyke, the team headed into Brighton to complete their journey and celebrate as a group.

As well as spending time together and tackling a sporting challenge, the teams were raising money for Macmillan Cancer Support. Macmillan is an excellent charity which provides advice and practical help to those suffering from cancer. The cause is close to many of the team’s hearts as a number of colleagues, friends and family have benefited from Macmillan’s services.

There is still time to sponsor the teams if you wish to do so: https://uk.virginmoneygiving.com/fundraiser-display/showROFundraiserPage?userUrl=Hottinger&pageUrl=3

Watch this space for information on next year’s team charity challenge!

Investment Review: August 2018

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By Hottinger Investment Management

August tends to be a quiet month due to the holiday season with problems only arising when major events combine with low volumes and reduced liquidity. In recent history, this has meant that the month has become one of the more turbulent of the year; however, the anticipated increase in volatility particularly in the US stock market largely failed to materialise.  The major earnings figures released in July showed equities performing well in the US, Europe and Asia, most likely reflecting the strong economic tailwinds that have seen most global regions performing well. However, the rather benign 1% increase in the MSCI World Index masked quite different performances at regional level.

The US stock markets continued to play a significant, positive part with the S&P500 finally surpassing the January high to print a new all-time high of 2,916.50, and, the current equity bull-run became the longest in history on August, 22 2018 at 3,453 days beating the rally of the 1990s that ended with the dot-com crash in 2000. The S&P500 rose 3.03% during August but continues to be surpassed by the NASDAQ (+5.70%), driven by the small selection of consumer technology companies as represented of the FAANG+ Index.

US Treasury yields having momentarily hit 3% in 10 year maturities at the beginning of the month recovered to closer to 2.82% during the month, as fears of an overshoot by the Fed in raising rates or an inflation surprise failed to weigh on investors’ worries. Interestingly, as Morgan Stanley point out, the yield spread for US investment grade corporate bonds has failed to fully re-tighten after they widened out during the equity weakness in March, even though equities have recovered all their lost ground. Such divergences do not tend to last for long, and if they do they tend to signal the end of an economic cycle. This situation underlines our cautious equity stance at present.

Europe was again the main region to see investor outflows over the month as European equities weakened 2.7% and the trials and tribulations in Italy also caused Eurozone Government Bond yields to edge higher. The European banking sector has a significant exposure to Turkey, which provided the month’s emerging market shock by announcing the fastest pace of inflation since 2003, causing the Turkish Lira to collapse 40% vs. the USD. The US Dollar Index gained 3.79% over the month and other vulnerable EM currencies such as Argentina Peso, Brazilian Real and South African Rand suffered contagion while Emerging Market equities lost 2.9% over the month. The on-going trade dispute between the US and China continues to undermine the Chinese Yuan but the more robust Asian markets only gave up 1.25% over the month.

During the UK House of Commons summer recess the frailties of both Conservative and Labour parties managed to dominate domestic headlines while sterling lost ground against the Euro (-.51%) and the USD (-1.28%). Brexit headlines continue to exploit deep divisions within the ruling Conservative Party, and many industries are becoming noticeably anxious about maintaining trade with the Eurozone after March 2019 when the UK is supposed to leave the EU. UK domestic orientated stocks have tended to lag the large cap global exporters this year so there are possible opportunities for UK investors amongst depressed valuations; however, the UK FTSE All-Share index fell 3.46% over August.

The macroeconomic focus was largely on the thinking of the Federal Reserve and the proceedings of the Jackson Hole summit. There, we learned that while Fed Governor Jay Powell believes that the ‘gradual process of normalization remains appropriate’, he also said that ‘there does not seem to be a risk of inflation acceleration’. He expressed the view that monetary policy should respond not to academic models of where interest rates should be but instead to conditions in the actual economy. This was an important statement because many models such as the Taylor Rule point to much higher interest rates than the market expects over the next 18 months. The median FOMC member, often using these models as a guide, expects the Fed Funds Rate to be 3.5% by the end of 2019, which would mean a 25bp rise each quarter (or another 6 rate rises). Markets think that two or three are more likely. Fed overshooting provides the greatest risk to the US economy in the near- and medium-term.

If the Fed is moving in a more flexible direction, and they see signs that productivity is picking up (which would subdue inflation), then it is possible that the long recovery will not be choked off by monetary policy. However, we have yet to see enough evidence that this is indeed the dominant Fed view; combined with the tightening bias in other regions and concerns over debt and the easiness of financial conditions, we still think that monetary headwinds will strengthen in 2019, creating less favourable and more volatile conditions for risk assets.

England beat the United States in the Westchester Cup

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By Alastair Hunter, Hottinger Capital Partners

On Saturday 28th July England took on the United States in the prestigious Westchester Cup. The event, also known as the International Day, was hosted by the Hurlingham Polo Association, the UK’s governing body for polo, at the Royal County of Berkshire Polo Club. The day was very well supported, with Hottinger guests joining Ally Hunter. They and the assembled spectators saw England, whose line-up included three of the winners of the 2018 Gold Cup El Remanso, retain the cup with a 12-6 win over the United States.

The game pitted evenly matched teams in a contest that was bound to be a close encounter, but in the end a stellar performance from Ollie Cudmore, who scored seven goals, proved the difference in what was a game of ebbs and flows, but England prevailed.

“I’d like to congratulate the English team on an amazing win today,” said Robert Puetz, CEO of the United States Polo Association, the body responsible for the game in the United States. “They played solid polo, were strategic, well-organized and well prepared. Additionally, I would like to thank the Hurlingham Polo Association, who provided amazing and welcoming hospitality to our team.” The Hottinger Group was delighted to represent the England team as an official shirt sponsor along with Flannels; other event partners include De Vere, Globe-Trotter and the Financial Times’ How to Spend It.

Plans are already in place for the next match to take place in the United States during 2019, the first time that the Westchester Cup will be played in consecutive years since the outbreak of the First World War.  It’s interesting to consider the parallels with golf and the Ryder Cup in the late 70’s. We see the opportunity for the Westchester Cup to develop and become a fixture in the polo calendar.

It’s worth dwelling for a second on the trophy itself which is well over 100 years old and is a magnificent prize for such a great fixture. Tiffany & Co were entrusted with the production and as you can see from the picture below it is a beautiful trophy which has a few stories to tell!

We expect the match will be just our first major involvement with the game of polo. At the time of writing, we are preparing a deal for new investments that will support the launch of a range of branded sports apparel products for sale in the UK and abroad. The company plans to license the Hurlingham Polo Association brand as its standard bearer for a new range of products.

With incomes and wealth rising around the world, there has been a rise in interest in elite sports and luxury consumer goods, a trend first exploited by Ralph Lauren in the 1970s. The Hurlingham Polo Association is the oldest such body in the game with an illustrious history and an esteemed reputation. The business case is compelling and we look forward to inviting interested parties to take part in what promises to be an exciting venture.

The Hurlingham Polo Association is a natural partner for the Hottinger Group. Both organisations share a culture that promotes sustainable activities and relationships that provide enduring value to a range of stakeholders in society. Soon after British tea planters discovered the game of polo on the Indian-Myanmar border in the 1850s, Hurlingham began to shape all aspects of the game, from the rule book to the handicap system. Today it boasts close to 3,000 members, and is involved with coaching and development, as well as providing scholarships to promising young players. That shared belief in nurturing a legacy is what makes Hurlingham and Hottinger a natural fit.

We hope that this is just the start and we look forward to updating you with further developments in the coming months as the relationship evolves.

Investment Review: July 2018

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By Hottinger Investment Management

World Cup fever and trade wars made for an exciting July within the financial sector just before the usually quiet days of August as the majority of the industry goes on vacation. This can lead to much lower volumes causing higher volatility should important events ignore the summer recess. For those left behind, investment opportunities can become apparent from unwarranted price volatility, but more often than not this is over-played.

The phenomenal strength of corporate earnings reported during quarterly earnings season was enough to push equity markets higher across the developed world. Over the course of the month, the S&P 500 gained 3.6% and European equities rose 3.5% and are now up on the year. Good economic news also pushed the 10-year US Treasury yield back towards 3% as the markets anticipated an August rate hike.

It is very difficult not to be impressed by corporate America with year-on-year earnings growth of 23.3% and growth in earnings of 8.7%; 91% of S&P 500 companies beat earnings-per-share (EPS) estimates and with regards to overall sales 74% of companies beat estimates. Despite the narrowness of stock returns that we have been discussing, especially the dominance of the FAANG stocks, there is nothing narrow about these statistics with all major sectors bar utilities seeing analysts raise forward guidance. As John Authers pointed out in the Financial Times, the FAANG’s have accounted for approximately 50% of the US stock market returns over the last 6 months, but it is still the fact that the number of stock price winners and losers overall is very similar.

European earnings have also impressed with 56% of the Euro Stoxx 600 Index beating EPS estimates and economic surveys in July suggest activity is stabilising at a level that is still consistent with growth of around 2%, which is above trend. Trade tensions eased between the US and EU after EU President Jean-Claude Juncker visited Washington adding to the good news surrounding equity markets. They agreed to work together and plans for new tariffs on other EU goods are on hold while talks take place. It is true to say that the bulk of the European recovery in financial markets was a 2017 story and European markets have been struggling this year with higher oil prices – Europe is a net importer of energy – and weakness in its chief exporting markets in Asia.

Brexit continues to dominate the UK headlines as the deadline for an agreement approaches. The market clearly remains nervous about the prime minister’s ability to strike a deal with Europe that will be sufficient to win a parliamentary vote. The continuing uncertainty is clearly affecting corporate investment and the cost of a weaker pound is also hitting the pockets of consumers. The FTSE All-Share gained 1.2% during July while the pound lost ground against major currencies over the course of the month down 0.5% vs the dollar and -0.67% vs the Euro. Despite general media marvelling at the strength of UK equities since the referendum the fact is that investment in foreign equities far outweighs the return in domestic markets. In sterling terms the S&P500 gained 4.1% in July to be up 8.5% YTD while European stocks returned 3.9% in sterling terms in July although YTD figures are very similar to UK stocks, up less than 1%. We note that a significant Brexit discount remains in the price of risk assets; we stand ready to respond should the outcome of the Brexit negotiations be favourable for risk markets.

Meanwhile Japanese equities only managed a 1% gain in July leaving the Nikkei 225 still down 0.7% YTD. While a case can be made for Japanese equities on a fundamentals basis, we believe that the currency risk remains too strong. The Yen’s safe haven status leaves it exposed to a deterioration of the trade skirmishes between the United States, Europe and Asia and until hostilities settle down, Japanese risk assets look unattractive. Trade relations between the US and China deteriorated further in July as the US government upped the rhetoric despite industry becoming more vocal about the impact of tariffs on trade. Having put the brakes on since the beginning of the year causing a noticeable slowdown in the Chinese economy the PBC cut the reserve requirement in July to encourage bank lending and the government announced a new package of fiscal policies that will affect many different Chinese companies. Ironically the 3% fall in the Yuan will help Chinese exporters overcome the effects of US tariffs which will do little to mollify Mr Trump.

India has become the single country globally to show the strongest economic growth (+7.7%) amongst large developing countries but, while emerging markets continue to provide a large part of global growth, financial markets will remain under pressure for as long as the dollar stays strong. The 6% correction in MSCI EM Index year to date is an indication of the effect of the dollar and the sharp slowdown in China this year but there are signs that equities markets are stabilising at current levels assuming there is no further deterioration in global conditions.

We entered the summer months feeling a little cautious regarding valuations and the ability of the global economy to continue at its current strength in the light of the extent of monetary tightening being undertaken and as such expect equities to be challenged in the second half of the year. We will, therefore, look to take some risk off the table in the medium term and increase cash balances in the expectation of more attractive valuations to come.

Volatility returns to emerging markets

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By Economic Strategist, Hottinger Investment Management  

A few years ago, the management consulting firm McKinsey produced a striking graphic. It showed how the economic centre of gravity has shifted over the millennia. In AD 1, the place to be was Asia. China and India produced about 70% of world GDP, with the rest shared by the Ancient world (Greece, Egypt, Turkey and Iran), Europe and Africa. That centre of gravity only really started to move in the 1500s, after the Black Death had transformed Europe’s social and economic institutions. By WW2 it was at its most westerly point, between Western Europe and the United States, as those two places accounted for 70% of world GDP. By 2025, McKinsey expects the world to be back to where it was in AD 1.

China and India will soon again account for the lion’s share of the world economy as the trend for countries with large, well-educated populations with strong governance systems to dominate takes hold. The French essayist Paul Valery was probably the first to notice this trend, writing in the aftermath of the first world war:

“So, the classification of the habitable regions of the world is becoming one in which gross material size, mere statistics and figures (e.g., population, area, raw materials) finally and alone determine the rating of the various sections of the globe.”

In the coming decades, it will make sense from an investment point of view to have an Asia-first focus, with the deliberations of the Central Bank of India and the People’s Bank of China carrying the weight that the decisions of the Federal Reserve and the European Central Bank have today. The International Monetary Fund predicts that in the next few years at least the continent of Asia will grow at 5.5% per year and account for two-thirds of all the world’s growth. By contrast, the U.S and Europe will struggle to grow faster than 2.5% per year.

It is in this context that we should see the rise in volatility in emerging markets in the last few months (see chart below). Over the last five years, there has been remarkable convergence between market volatility in the G7 and that in the emerging markets. Usually, emerging markets are attractive for investors who have long time horizons and a preference for growth over income in their portfolios, but in 2016 and 2017, according to the JP Morgan indices for volatility, emerging markets had as much average risk as that in G7 countries.

This year, emerging market volatility has risen sharply. Some of it is on the back of concerns over the fiscal sustainability of particular countries such as Turkey and Argentina; both of these countries have low levels of foreign reserves to support public debt in the event that tax revenues come up short. Similar to the situation in the United States, there is concern about over-leverage in corporate debt in some developing countries.

But much of the explanation lies with what developed-market central banks are doing with their monetary policies. The Federal Reserve has raised rates significantly in the last year, and have the intention to continue increasing rates until 2020. It is also selling Treasury bonds that it holds on its balance sheet at the time when the Trump Administration is planning to run $1trn annual budget deficits, funded by sales of new bonds to the public. With US interest rates still seen as a benchmark for the global economy, all these developments mean that global yields are rising on government and corporate bonds; additionally, the supply of dollars is more limited, strengthening the dollar exchange rate and making it harder for emerging markets to service their dollar debts.

This latter explanation reflects emerging markets’ vulnerability to external factors more than fundamental unsoundness with the direction of economic policy and development. It is why in the medium-run we should still expect relatively higher volatility to be the price to pay for exposure to developing countries, and why–although we should be concerned with the big uptick in EM volatility–we should place it in its proper perspective. As emerging economies grow, they will develop policy independence and less sensitivity to global events.

Political risk returns to Europe as the ECB tightens

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It has been an eventful few weeks in Europe. Markets have been actively following the unfolding situation in Italy, as the new 5 Star-Lega coalition of populist parties took office. Things have quietened down as the members of the new government have reassured investors that it has no intention of leaving the euro, or breaking EU-mandated public spending limits that might have led to the same event.

But this is not the end of the story because there are a range of possible events stemming from Italy that could unnerve markets in the coming months and test the political foundations of the eurozone.

The bold macroeconomic policies of the new Italian government are the central issue, and will create headaches in Europe. The recently agreed 5 Star-Lega populist administration has plans to sharply increase benefits to the unemployed, radically cut taxes, reduce the retirement age, and increase infrastructure spending. Independent estimates put the increase in spending at over €100bn per year, or 6% of GDP.

Italy is not a profligate country. It has run a primary budget surplus since 1992 and only has overall budget deficits due to the interest charges on its extremely large public debts – currently around 130% of GDP. Much of that debt accrued in the 1970s and 1980s as Italy raised funds to develop its welfare state and to invest in the country’s poorer and more agricultural south through the Cassa per il Mezzogiorno programme. Interest rates also rose sharply in the 1980s as the Bank of Italy clamped down on high inflation, raising the debt burden further.

Italy's debt overhang goes back to the 1970s

There are two short-to-medium term problems with the new government’s fiscal plans, the first exists irrespective of whether one believes bigger deficits would lead to the growth and additional tax revenues that would make the new debt sustainable. But both problems potentially lead to conflict between Italy and Europe’s creditor nations such as Germany and the Netherlands.

The first issue is both legal and political. Under the EU’s Fiscal Compact, countries cannot run a budget deficit greater than 3% of GDP, and if they insist on doing so they forfeit the right to assistance from the European Stability Mechanism in times of crisis. Being told by Europe that Italy cannot implement its economic policies is unlikely to reduce populist feeling in the country. Lega’s Matteo Salvini recently said that Italy will not be “slaves of Brussels or Berlin”, while 5-Star’s leader Luigi Di Maio suggested that he will go to “European tables” to fund his spending plans. That means either ignoring or revoking the Fiscal Compact.

The second issue is practical. Running large deficits means issuing quantities of bonds into the market at a time when the central bank is not an active player on the demand side and when interest rates are rising. Italy then would become exposed to significant political risk that could sharply push up yields further and thus the cost of borrowing. That in turn makes servicing Italy’s enormous debt pile even harder and could create centrifugal forces that make the state’s position in the euro area unsustainable. It is the feared ‘debt-crisis’ scenario.

This second issue assumes that markets believe that more state spending would not boost growth, and thus cut the debt-to-GDP ratio in the long-term; that is open for debate. But it also assumes that there are no meaningful political reforms in the euro area. Meaningful reforms include either significant moves to share risk across the region, such as introducing a Eurobond or a “safe European asset” that is backed by all euro area states; or agreeing to a banking union that consists of universal deposit insurance and a fiscal backstop for failed banks. In short, it assumes that Germany and other creditor states in Northern Europe do not agree to any form of risk sharing that ranges from debt guarantees to fully-fledged fiscal transfers.

Northern Europe and particularly Germany remain resistant. Last month, over 150 ordo-liberal German economists warned in a public letter against what they called a “debt union,” which would mean German taxpayers implicitly supporting other states. Chancellor Angela Merkel wants only limited reforms, including a European Monetary Fund that restructures debt and gives loaned assistance only if there are Eurozone-wide systemic risks and recipient countries implement structural reforms. This means exposing investors in troubled states’ bonds to haircuts and lengthened maturities during times of stress.

Unfortunately the German proposals, supported by the Netherlands and Austria, as they stand serve only to crystallise all of the problems that arose from the euro crisis of 2011-15. Merkel’s debt restructuring plan would weaken private sector confidence in peripheral sovereign bonds and reopen the possibility of self-fulfilling fiscal crises. It enacts punishing and self-defeating austerity regimes on troubled debtors, and strengthens the position of German Bunds as a safe asset. Italy will want a bolder approach, and they are likely to push for that ahead of the next EU summit on June 19th. France too will expect bigger concessions after implementing domestic reforms in labour markets and public spending as a quid-pro-quo for more economic integration.

The risk of a future Italian debt crisis also assumes that the ECB will not continue to backstop Italy’s sovereign bonds. This happens by default if the bank eventually moves into a phase of shrinking its balance sheet, but if the next governor of the bank, who takes office in October 2019, takes a more hawkish point of view, as is the preference of the German government, support for Southern European sovereign bonds in a future crisis scenario may not be there. Considering that it was Mario Draghi’s commitment in 2012 to do “whatever it takes” to contain the last crisis, a reversal of that commitment would create clear dangers.

We therefore face the possibility that the political ambitions of Italy’s new government could be thwarted by other countries and the European institutions. The question then becomes whether the populist government could credibly threaten to leave the euro and throw Europe into turmoil to extract concessions from the other countries. The answer is probably ‘no’ as euro-exit would decimate the Italian middle class. However, the systemic importance of Italy in the euro area and the recent shock of Brexit should focus policymakers.

Events in Europe in the last month show that there are still significant tensions between member states that cannot be solved by a short-term burst in economic growth across the region. Yet as that growth starts to slow and the ECB tightens policy, conditions will not be more favourable than they are today to agree the necessary reforms.

What is needed is a greater sense of pan-European solidarity in which your typical German Bavarian thinks of the concerns of the Italian Neapolitan with the same empathy with which she considers the problems of her immediate compatriots. That’s a multi-generational project.  In the absence of that, Europe will continue to evolve through crisis, yet always carrying with it the tail risk of breakup. Political risk in the region has clearly not gone away.

How will Brexit affect family offices?

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There has been much concern about the effect of Brexit on the UK’s financial services industry and the position of the City of London. Both Paris and Frankfurt have been seeking to attract people and business from London post-Brexit. European regulators have warned of restricted access to the EU if Britain leaves the single market, as it is likely to do.

One would expect that the dire warnings about the City’s future would cause a fall in business activity ahead of the UK’s exit, but that does not appear to be happening. Last year, cross-border lending by UK-based banks significantly increased for the first time since 2014. Foreign claims by the UK banking sector rose by $300bn last year to $5.1trillion, the biggest one-year increase since 2007 (see chart). The UK’s foreign banking exposure is about the same size as France and Germany’s combined. The upswing in global activity has played a part, but that only serves to underpin a broader point about London’s resilience as a venue for finance beyond Europe.

Since the Brexit referendum in 2016, London has maintained its position as the world’s premier centre for financial services, ahead of New York, Hong Kong and Singapore. It remains the case that London provides not just very deep capital markets, but a trusted legal structure; a whole range of ancillary services, covering insurance, tax and business consultancy; and world-beating cultural amenities.

There are strategic threats to the financial services industry of many large cities. An incompetently arranged Brexit is of course one only for London, but the rise of FinTech and the trend of large institutions spreading out their operations beyond the big cities also provide challenges.

What does this all mean for family offices?  Whilst genuine family offices provide a broad range of financial and non-financial services, the impact of Brexit would only have the potential to affect cross-border financial services such as investment management, capital raising and private equity transactions. Many of these services in the UK operate outside the scope of European regulation and will remain so after Brexit. The UK will be an attractive place for European families who wish to base some or all of their operations outside of Europe and benefit from any regulatory divergence that the UK makes post-Brexit.

There have been worries over whether the lack of so-called passporting rights for UK firms to operate in Europe post-Brexit and restrictions on the delegation of European business to the UK could harm business with EU citizens. However, in recent weeks, Brussels has begun to recognise that any serious trade restrictions would hit both sides if they were effective, or could be nullified by new UK regulatory and tax laws that create strong incentives for European firms and clients to relocate.

One particular area of the industry which is booming is private equity. The total amount spent by private equity firms on new buyouts in Europe hit €90.2bn last year, a rise of 50%. Much of this was driven by the UK, where total deal value almost doubled from €14.7bn last year to €27.1bn this year.

Aspects of the UK private equity industry fall under the regulatory auspices of the FCA and with international investors frequently participating in such investments it is important to consider the impact any change in passporting rights might bring.

Interestingly, however, the vast majority of countries where investors reside exempt either the sophisticated, professional and High Net-Worth investor or the private equity industry from regulatory oversight. Single family offices are exempt for regulations from both the UK and EU. UK-based family offices are therefore well placed to facilitate deals, benefitting from high deal flow, deep capital markets and decades of institutional experience.

We cannot be sure yet what the specific outcomes from the Brexit negotiations will be, but whatever they are, the UK will continue to be an attractive place to do business. London has been at the heart of the global economy for three hundred years and has survived all manner of events including the US War of Independence, the French and Russian Revolutions, and the cataclysms of the 20th century. Brexit cannot really be compared to events of this magnitude. Modern family offices, which have been around since the 5th century, will adapt too, always to the benefit of the clients they serve.

Britain can lead the world in green finance

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“I care nothing about the line or what is done with the money. If the East India Company choose to throw the money away, it is nothing to us.” This was how a British investor described the opportunity to fund a railway connecting the lush cotton fields of Gujarat to the port-city of Dholera, reported in an edition of Herapath’s Railway Journal in 1851.

Investors in London almost exclusively financed India’s first railways, but knowledge of the opportunities was scarce. All that mattered was that the British Raj guaranteed a 5% return, and if that meant taxing the Indian people when real returns fell short, then so be it.

It’s been some time since London could rely on the hard power of the British Empire to maintain its position as a dominant financial centre. The City today offers a deep pool of capital precisely because it depends on people who have an intimate knowledge of foreign markets and boasts decades of institutional experience. This makes capital cheaper and attracts worldwide business.

That is why last year, the Indian Railways came back to London Stock Exchange to raise $500m in green bonds to fund the electrification of their network and the replacement of their diesel trains.

That the state-backed company issued green bonds is significant. Britain’s trailblazing approach to climate change and London’s role as a financial hub present a golden opportunity for the UK to be a world-leader in financing the transition to low-carbon economies.

Financial instruments that are ‘green’ are those that fund projects that are defined as environmentally sustainable. As states implement the COP21 Paris Agreement to limit global warming to below 2°C, including regulatory actions that restrict high-carbon activities, the demand from governments and corporates for finance to support sustainable investment will grow.

Savers also increasingly care about how their money is used beyond its financial return. According to State Street Global Advisors, a quarter of all professionally managed assets (or $23trn) has an ESG mandate, growing by over 10% last year.

The OECD estimates that $44trn is needed in additional investments until 2050 to put the world on a sustainable footing. The investment opportunities are huge, from funding low-carbon infrastructure in booming African cities such as Lagos, to supporting China’s plans to build a vast renewable electricity grid across Eurasia, powering its Belt and Road project.

Low carbon investment more than pays for itself in the long-run through fuel savings but the infrastructure requires more up-front capital than dirty alternatives. Providing capital efficiently therefore matters.

London’s opportunity is to arrange and structure global green investments, and to manage assets with green mandates. The world needs deep, liquid, information-rich and well-regulated capital markets for green investments. Global investors want green financial products they can trust.

While Brexit threatens to weaken London’s lucrative role in underwriting European debt, it is unlikely to preclude steps to make the City attractive for emerging markets.

The Government’s Green Finance Taskforce recently presented a range of proposals that would advance London’s position. These include leading on regulatory standards in sustainable finance and on the corporate disclosure of climate risks and opportunities, as well as supporting research into the new field of green finance.

By providing these services, London can attract new business while keeping capital costs low for issuers, quickening the green transition.

The UK also needs to promote green finance at home. Britain has led the world in cutting emissions, down 43% on 1990, but it needs to go further. The next steps in decarbonisation, which include improvements in electricity storage and the development of hydrogen fuels for industry, will be harder to achieve and require more concerted support from the state.

The Green Finance Taskforce recommends that the government issue its own sovereign green bond, but it could go further.

In support of its Industrial Strategy, the government should set up a national development bank to allocate the proceeds of multiple green bond issuances, supporting research, the development of early-stage technologies, and emerging companies. It would create further opportunities for private capital to support.

Bank of England Governor Mark Carney last week spoke about the risks to financial stability posed by a delayed transition to sustainable economies. There is a case for reviewing the Bank’s mandate to allow it to favour green bonds in its asset purchasing programme. Boosting the availability of green finance through the central bank looks prudent.

The government through its Brexit strategy wants a Global Britain. Its 25-Year Environmental Plan aims for a green Britain, too. Green finance connects the two. It offers a new role for the nation that introduced the world to the industrial method and whose imperial legacy still touches billions of people.

Green finance presents an opportunity for the London and the wider UK to lead, at home and abroad, on the biggest issue facing our shared home. It’s time to seize it.