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http://billehrman.tumblr.com/post/146504385463/the-sky-is-not-fallingby: Bill Ehrman
The Brexit vote confirmed that the status quo just will not cut it anymore! The people spoke and want a more responsive government to their needs, aspirations and future.
Change is afoot—a good thing. Change, especially political change, takes time and we we must all be patient. There will be will be hiccups along the way, so keep your eye on the goal rather than each data point along the way.
Brexit is good not only for the Brits, but also for all of Europe and the rest of the world, as this vote will precipitate even more change everywhere. Watch out Hilary! Haven’t you noticed that Europe has been stuck in a rut for years despite monetary authorities first lowering rates to aggressive monetary ease, QE, and finally to negative rates all to no avail as economic growth, employment, incomes and global competitiveness continue to languish. Governments did virtually nothing despite the need for changes in fiscal, regulatory, tax and social policies. So why vote for continuing the status quo?
Brits call themselves Englishmen first, Europeans second and accordingly did not want to be subject to rules set by others. Herein was the reason why 52% of the voters, against all odds, chose to exit the Eurozone. The costs of being a member of the Eurozone just outweighed the benefits to the people.
The Brexit process will take at least two years to complete and probably many more than that unfortunately. It serves everyone’s interests to do it quickly, smartly and with dignity. It can truly be a win/win for both sides. It does not at all have to be subversive, nasty or punitive but cooperative with the intent of strengthening the overall alliance within Europe. It’s time that the key members of the Eurozone, especially Germany, recognize that the status quo does not work. It’s time for positive change!
Corporations will adjust much more quickly than governments to Brexit and make the necessary changes quickly to their strategic plans even without knowing all the details of the new rules, trade agreements and regulations. I don’t see Brexit impacting earnings for U.S multinationals longer term despite the fear that exists to the contrary.
My concern was and still is that the Brexit vote was the beginning of the end of the 23-year experiment called the Eurozone or European Union comprising 28 member states. There are at least 5 other countries contemplating a similar vote even before Brexit and more may follow. But will the end of the Eurozone really hurt the world economies? I doubt it, longer term, as it is a zero sum game. But it will be disruptive short term for sure.
The real losers will be members of the Eurozone itself as the one currency reverts to many once again and separate trade agreements will have to be agreed to and implemented. For instance, the fall in the British pound will actually help its economy as it may stimulate exports. But if the German mark returns, it will be a strong global currency and may impede its exports, which are at the foundation of German economic growth. Near term the dollar will rise hurting growth and earnings but longer term we are very likely one of the winners from the split up of the Eurozone.
The reactions of the financial markets were swift and exactly as anticipated: stock markets fell, led by financials groups; yields fell even lower everywhere, as risk was taken off even more; the Euro got punished while the dollar and yen rose, and finally, commodities prices, dollar dominated, got hit except gold and silver. The markets hate change and uncertainty!
Opportunities are being created for investors who kept their powder dry and maintained excess liquidity to profit as we said in prior blogs while others are forced to liquidate and/or are continuing to take risk off. If you dip your toes, always remember to maintain excess liquidity.
Our core beliefs that serve as our compass during these VUCA (volatility, uncertainty, complexity and ambiguity) times continue to serve us well.
I must acknowledge the pundits who have been bearish over the last few months. Interestingly, the stocks markets were advancing Thursday to new highs. None of these pundits really anticipated the Brexit vote correctly. Even George Soros, my esteemed former partner, bought gold for the wrong reason as he predicted that England would vote yes to stay. Gold was declining prior to the Brexit vote.
We moved aside and have had no exposure to Europe and Japan ever since negative rates were introduced in those markets, as you know.
So what is next?Clearly the global monetary authorities will act as a buffer to excessive market volatility and add, if needed, even more liquidity into the system keeping interest rates ridiculously low and the dollar strong as the interest rate differential widens. The prior currency deal made over the winter amongst authorities to stabilize the dollar may fall apart and the dollar could easily move to 100 to the euro and less than 100 to the yen which will impact U.S. multinationals. I remember when a strong dollar had positive connotations and a weak one just the opposite. That still makes sense to me. A strong dollar will hurt exports but help the U.S consumer, still over 70% of the U.S economy, as prices stay down boosting disposable personal income. It also penalizes reported earnings of U.S. multinationals.
While there is uncertainty in the world leading many investors to take risk off near term, Brexit is clearly the clarion call to all governments and monetary authorities that the status quo is no longer viable and its time to act or you will be voted out of office. It’s time to walk the walk rather than talk the talk. Listen carefully to the comments from German officials who have maintained a hard line too long against fiscal, regulatory and tax reforms throughout the Eurozone so needed to promote employment and growth.
As the calls for change grow louder, hopefully the entrenched establishment will start listening, put politics aside and make the obvious policy changes sorely needed to stimulate growth. But change takes time. Listen closely to what is said over the next few weeks as to whether or not it makes sense.
The solution is that we need a pro-growth agenda that starts with government policies including fiscal, tax and regulatory changes. Also the monetary authorities need to let up on banks and all financials. Liquidity and capital ratios have risen far enough and its time to let banks do their job by providing the capital needed for growth. After all, the banks just passed the most stringent stress test to date and ironically many of them will be raising their dividends and increasing their share buy-backs in the coming weeks.
During these VUCA times, the U.S economy will stand out and growth will remain above 2% for this year led by the consumer. It is equally clear that the Fed is done for the year as we predicted back in January. It is just as clear that growth in Europe and Japan will fall short of prior projections despite all the monetary moves. Negative rates are a bad thing and have had the reverse impact on economic growth than anticipated. I still expect China to grow in excess of 6% and India by 7% this year.
I continue to favor U.S investments over the rest of the world. Each of our companies has recognized the need to make strategic shifts to create a winning proposition for themselves and their shareholders. In addition, we look for companies on the long side increasing volume, market share, revenues, increasing margins, cash flows, free cash flows and are yielding over 3% with dividends set to rise over the next few years. I don’t mind collecting 3% in a world of 0% short-term rates and 1.6% 10-year bond yields.
I want to comment on the core beliefs that guide our longer-term capital allocation, investment exposure and risk profile.
We continue to believe that we are in a slow growth world with lower highs and higher lows in economic activity; the creation of capital still exceeds the demand for capital which is good for risk assets; inflation will remain below 2% for some time; consumer and business psychology remains cautious leading to higher than normal savings rates and tight cost controls, less capital spending and strong balance sheets by corporations; the dollar will remain the currency of choice over time; M & A activity will continue at record levels as both the buyer and the seller are winners; speculation is non-existent and new issues will remain light; cash levels will remain higher than normal; refinancing at lower interest rates will accelerate improving individual and corporate balance sheets; and finally change is everywhere. Look to own companies increasing their returns and be short those with declining returns. The surprise will be that corporate profits and cash flows remain strong during this period despite negative currency translations.
While the stock market is statistically undervalued, it may remain that way for some time in these VUCA times. However, I would use this opportunity to buy companies that are the winners over time as they recognized and are implementing positive strategic changes, are selling beneath market multiples, are at a discount to real book and are yielding over 3%.
The sky is not falling, rather just cloudy at the moment.Take the time to review all the facts, step back and take a long pause to reflect, consider the proper asset allocation with risk controls, maintain excess liquidity at all times, understand mindset shifts at all levels, do first hand independent research on each investment and…
Invest Accordingly!
Bill Ehrman
About the author:
Bill served as Head of the Investment committee at Century Capital. He was Head of Investments for Worldwide and Private Equities at the Quantum Fund, where he was George Soros’ 1st partner. He was the Founding Partner and CEO at EGS. His new family of domestic and foreign hedge funds is called Paix et Prospérité.
