CC-BY-SA-2.0, FlickrFoto: Toy Dog Design. Corea levanta la voz por sus accionistas
Corporate governance practices in South Korea’s family-controlled conglomerates, known as chaebol, find their roots in a social contract that was implicit in the process of the country’s economic development under military dictatorship, which began in the early 1960s. Korea’s previously autocratic government initiated economic plans and wielded power in the private sector by assigning different areas of development to each of several chosen corporate families. These corporations were expected to create jobs and earn U.S. dollars through exports. In turn, they received the privilege of government subsidies and considerable freedoms. Finally, under such a social contract, ordinary citizens were forced to give up certain democratic values and endure harsh working conditions to pull themselves out of poverty. Under this system, little if any consideration was given to shareholder value, and a culture of good corporate governance was an afterthought.
But South Korea has become a successful model of economic development and its governance is also changing accordingly. The implementation of democracy and an expectation of shareholder capitalism are part of the country’s new social contract. As it happens, South Korean authorities have recently imposed more severe punishment on business executives found guilty of corruption. In the past, courts were fairly lenient with chaebol tycoons, often pardoning them with comments such as “in consideration of past contributions to the national economy.” In terms of public sentiment in recent years, the reputation of Korea’s chaebol has also changed from that of “an export powerhouse” that can benefit the overall economy to that of an independent interest group whose expansion into domestic businesses might threaten the prosperity of the average citizen. Reflecting this new attitude, recent government measures have imposed limits on the expansion of such chaebol-owned businesses as franchise discount stores, bakeries and restaurants.
From the perspective of ownership in the local market, we can also observe a change. The assets under management of the country’s 14-year-old National Pension Fund have grown at a brisk pace. It now commands a considerable 6% of total ownership in the country’s stock market, up from about 3.6% in 2009. Given the continuously growing stake of the National Pension Fund in numerous Korean companies, it is not surprising that there will be incremental demand for better corporate governance and shareholder value, which may be mirrored in dividend payouts. The dividend yield of the Korean Composite Stock Price (KOSPI) Index is a mere 1.14%, while that of the MSCI All Country Asia ex Japan Index is 2.47%. Lower dividend payouts may reflect lower efficiency of invested shareholder capital, and may indicate that a company is sitting on excess cash. This scenario has been key to the so-called “Korea Discount” among global equity markets.
Interestingly, demand for better corporate governance in Korea has been initiated by liberal-minded social activists rather than capitalists. The group of political activists, who have also contributed to the nation’s political democracy, have been more vocal than activist investors about corporate governance issues. The fact that Korea’s somewhat conservative legal system has begun to react in favor of shareholder returns and economic democracy is an encouraging indicator of the formation of a new social contract for Korean society, and one I am optimistic about.
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Chris Bullock, co-manager of the Henderson Horizon Euro High Yield Bond Fund. European High Yield Takes on Greater Prominence
Once the preserve of the US, the high yield bond market has followed the trend towards a more globalised world and this is evident in the increasing share of European high yield bonds within the global high yield market.
The chart below shows the market value of the US, European and emerging market high yield bond markets. From a standing start in the mid to late 1990s, the high yield bond market in Europe has grown to represent more than 20% of the global market.
Source: Bloomberg, August 1986 to September 2013. Market Value in USD using BofA ML regional indices (H0A0, HP00, EMHB).
Growth in the European high yield bond market has been particularly rapid since the eruption of the financial crisis. Starved of capital from the banks, which are shrinking their bloated balance sheets, companies are increasingly forced to look towards high yield bonds as a source of financing. The proceeds were deployed primarily to refinance and for general corporate purposes, rather than more aggressive activities such as merger and acquisitions, although there has been greater evidence of the latter this year as corporate executives regain confidence.
The fact that the European high yield market has grown so strongly since the financial crisis has had an interesting structural influence on the market. The last five years has been characterised by a more conservative atmosphere prevailing among ratings agencies. The general drop in sovereign and corporate ratings means that the European high yield market is very diverse in types of issuers and therefore more of a mainstream, liquid market. In addition, alongside companies that would ordinarily be classed as high yield are fallen angels (former investment grade companies), that are likely to recover their higher rating as their prospects improve. A good example would be Continental, the global tyre manufacturer, which recently regained its BBB rating.
The relatively young, but fast-growing European high yield market means there are lots of new names so it is a market that rewards intelligent research and good stock-picking. There remains considerable dispersion in spreads (yield premium over government bonds) across the different ratings in high yield, again creating opportunities for additional gains from astute stock selection.
We expect the European high yield market to follow the US experience, so the coming decades are likely to see significant growth ahead, not just in terms of the size and depth of the market, but also in terms of the experience and confidence of the participants on both the borrowing and lending sides. Market growth, therefore, becomes self-reinforcing as the European high yield bond market matures.
Chris Bullock, co-manager of the Henderson Horizon Euro High Yield Bond Fund
Photo: Umbdet. How to Manage your Finances during the University Years
These days, providing children with the best education possible may come with a hefty price tag but there are some simple lessons parents should teach their budding scholars before they start their university life. Not always do children get financial education in schools until it is mandated by the school systems, which is why they must be trained by their parents or learn about finance in the school of hard knocks which is an unforgiving teacher.
Students need to be aware of their financial responsibilities and more importantly, the adverse consequences poor financial habits can create. Therefore, taking the time to discuss financial matters can help students to initiate sound budgeting measures and prevent them from becoming overcome by debt which will stalk them long after graduation. Financial management skills are extremely valuable later in life and are necessary in order to have a good enjoyable life. Moreover, parents must teach their children how to defer the instant gratification that comes with consumption in order to save enough money to reach their long term financial goals.
Whether entering college or getting ready to graduate, it is key that parents and students keep some essential actions in mind when managing their budget:
Becoming a frugal freshman
Put limits on spending: Make sure students know what they need to survive and determine how much they are allowed to spend on every expense category. Building a budget that works will make it easier to keep spending at a sustainable level, avoiding the need for excessive borrowing.
Major in debt management
Manage debt during and after university: Students really need to understand what debt means for them and set out a plan to pay off their student loans, and any other debt. It is important to consolidate loans in a way that ensures you are paying the lowest interest rate possible. If managed incorrectly, loans can easily become an anchor weighing on future saving and investments. Moreover, accepting a credit card that comes with your new student account can also be a massive mistake; credit cards are not a good idea unless you can pay them off each month before the high interest rates kicks in. Remember that your credit limit is not a target you have to reach, but rather something you need to manage carefully.
Graduating from the University of Mom & Dad
Prepare for life outside of the family financial comfort zone: Mom and Dad have spent years providing comfort, security and financing to their children, often at the expense of their own financial needs. Now that your offspring have completed their education, it is time for them to move out of the family nest, and parents should establish some timelines that will help transition their children towards financial independence. This is an important step not only for young adults but for their parents also. Parents can use this opportunity to reassess their own financial situation and perhaps they can now afford to save more towards retirement or make higher payments on their mortgage.
As students become more financially independent, they should start building on their financial stability and trust their financial behavior. Only recognizing their own behavior, they will be able to best identify a financial advisor they can trust to manage their investments in the future.
The school years may be the best years in life but they can leave students with a burden of debt that persists long after their studies. The lessons above should be taken into account to best learn how to manage your finances during the university years and prepare for the years ahead.
Opinion column by Robert Stammers, CFA, director of Investor Education for CFA Institute
By Dolmang. Hangang Railway Bridge, Seoul, Korea. Environmental Awareness in Asia
I traveled to China in September, quite possibly one of the best times of the year to visit in terms of weather. The air quality in both Beijing and Shanghai was actually pleasant and was very different from how it seemed during my previous visits as well as from the typical accounts one usually hears of the notorious smog in China’s major cities. It made me think about growing up during the industrialization of my home country, South Korea.
In the 1980s, I lived in an industrialized city close to Seoul. The city then was filled with factories and its harbor was dirty. In school, we had to boil the tap water before we could drink it. Sometimes, during outdoor activity, students would walk around to pick garbage in neighborhood clean-up efforts. The fast economic development and rapidly growing population of Seoul in the late 1980s also polluted the Han River—hardly the place for family picnics. Fast forward a couple of decades, however, and now it is much cleaner and frequently enjoyed as a good spot for leisure and sports.
While Korea can still do more to improve its environment, the country has done much to correct the adverse impacts of its earlier industrialization. Since systematic waste water collection and treatment systems were installed in the Han River, Korea has invested approximately 1.5% to 1.8% of its GDP each year in pollution abatement. Though overall spending in this area decreased just after the 1997 Asian Financial Crisis, it has continued to grow each year since then amid more stringent environmental rules.
Spending for environmental control in Korea is well balanced between the public and business sectors. Corporations do their share to help protect the environment and public awareness is high. In fact, many Seoul citizens seem to have the correct mindset, placing greater importance on their own actions and habits for environmental protection than relying on just infrastructure investment spending.
As a much bigger country, China’s efforts to restore its environmental health could take much longer. One of its biggest challenges may be to encourage local governments to balance economic growth with environmental health. There are many statistics to measure the costs of China’s environmental pollution to its economy. By some estimates, it could possibly cost tens of billions of dollars to install the basic infrastructure to combat China’s pollution.
But judging from Korea’s experience, environmental improvements for China should be about more than just infrastructure investment. Environmental infrastructure requires every citizen’s efforts as well as the long-term commitment of both the government and private sector. Exactly how the value of environmental improvements are measured in monetary terms concerns entrepreneurs as they develop business models accordingly. However, no doubt such improvements should benefit us in countless ways and provide for many positive opportunities going forward.
In-Bok Song, Senior Research Analyst at Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Many investors have expressed concerns over the quality and general integrity of financial reports filed by Asian companies. Often cited as a reason to be less trusting are less stringent regulatory laws that have created a historical culture of accepting transgressions in corporate governance. Complicating matters are the size and maturity of capital markets in the region, particularly when compared to more advanced economies. Also, there are challenges faced by minority shareholders from company executives unaccustomed to outside interests in the management of their company. All of these are real concerns for investors in the region, and in many cases, can only be addressed through experience in different countries, industries and cultures—and even the variety of families that run each business.
As fundamental investors, being able to understand the myriad of complex accounting practices used in Asia, and ultimately being comfortable with them in order to make investment decisions, is critical for firms like ours. In what will be a series of commentaries, we will aim to dissect in more detail the often esoteric approach taken by many Asian companies to financial reporting and the communications around earnings management. This first issue will focus on “the numbers” and begin by looking at how we evaluate the quality of financial reporting. It will also explain what the role of forensic accounting—the process of taking a deeper look into a company’s accounting practices—plays within our firm.
At Matthews, the consistency with which a management team applies sensible and responsible accounting rules during both good times and bad is something we constantly evaluate and this presents a useful starting point for our discussion. Areas we pay specific attention to include determining whether the accounting policies a company elects to use increases management’s influence in setting executive compensation. For example, a company that incentivizes management with 10% growth in earnings per share (EPS), might see a consistent 10% improvement in its EPS year after year. In this instance, less volatile patterns of EPS are suspicious and we would tend to take a closer look into this area of their books.
We also pay attention to free cash flow generated by a company. While free cash flow is a fairly simple concept (cash flow from operations less capital expenditures), we tend to focus on those instances in which a company boosts cash flow from operations. For example, securitizing account receivables gives an exaggerated picture of the sustainable cash flow generated.
Related party transactions are another key area of concern. We tend to closely monitor these disclosures and try to understand the economic rationale behind these transactions. Corporate balance sheets are another factor to consider. For instance, there are many times when investors focus solely on the income statement. However, management might bypass the income statement altogether, and this may pose another red flag if the firm has unrecognized losses on its balance sheet without a credible economic explanation.
Opinion column by Sudarshan Murthy, CFA; Research Analyst at Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Foto: Artyominc. La apuesta a contracorriente por Brasil
Brazilian equities have suddenly outperformed after trailing for a large part of the year. Since the end of August Brazil’s stock market has outperformed all other countries in the Latin America universe and has also widely outperformed the broader global and emerging market (EM) equity indices.
Three main drivers have contributed to the strong performance of emerging market assets and Brazilian equities. First, the US Federal Reserve’s (Fed) decision to postpone their planned ‘tapering’ of quantitative easing has ended speculation about a stronger US dollar and weaker EM currencies and bonds. This has led to strong rallies in local currencies and the stock markets of emerging market countries such as Brazil, India and Turkey that had suffered during the market sell-off earlier this year. The Brazilian Real was further supported by the central bank stepping in and intervening in the currency market. Second, Chinese economic data started to improve and countries with good export links to China have performed well. Finally, the Brazilian economy has started to show early signs of stabilisation – recent retail sales numbers have shown improvement and higher iron ore prices have boosted commodity-related industries.
The headwinds for this Latin American country are all well-known by investors – the economy has been growing below trend in recent years and the government remains stubbornly interventionist. It should be highlighted, however, that two of the three factors supporting Brazil in recent months are likely to remain in the near future i.e. the Fed further delaying tapering and stronger Chinese data. Furthermore, investor positioning in Brazil remains light and any marginal improvement in market sentiment is likely to lead to strong movements in equity prices. We believe that the contrarian case for Brazil remains based on its comparatively low equity valuations and sensitivity to any cyclical upturn in the fortunes of its main trading partners such as China and the US.
Opinion column by Christopher Palmer, Director of Global Emerging Markets at Henderson Global Investors.
Photo: IntelFreePress . Active Safety – the Next Car Industry Revolution
It used to be the case that investors turned to automobile manufacturers as a secure, long-term option for growth. But those days have passed. The world might still run on cars, but in terms of being a sector in which to invest, it requires selectivity. In Europe, weak consumer spending and saturation of the market has sapped demand for such big-ticket items. This has left the car industry in Europe in a category we term as ‘euro grunge’ – the value end of the market.
However, times are changing once again. Following years of economic uncertainty and industry restructuring, strong Chinese sales and pent-up demand for replacement cars in the US has provided some reasons for optimism. But the automotiveindustry remains at a crossroads. Its future is bound closely to the growth of technology, with consumers increasingly focused on fuel efficiency (in response to stricter governmental regulations on emissions), hybrid and electric vehicles, and safety. Those firms that can meet those needs are those that will be able to sell more vehicles and raise their market share.
The safety trend is one that looks particularly interesting. Passive safety is something we all know about, such as that provided by airbags and seatbelts. But active safety, technology that helps to prevent accidents from happening, is seeing more and more growth. Active safety started out with technologies such as anti-lock braking systems (ABS) and Electronic Stabilisation Programs (ESP), but has now extended to driver assistance systems that can prevent the driver from moving into the wrong lane on a motorway, alert the driver to pedestrians, assist with parking, or even apply the brakes early to avoid an accident.
Technology is unpredictable, but the line between driver assistance and automatic driving will continue to blur the further we go. Germany-based automotiveindustry supplier Continental believes that vehicles will be driven motorway distances on a fully automated basis by 2025 utilising vehicle-to-vehicle communication, while car manufacturer Renault believes that this could be a reality by 2020.
A lot of the growth we see in safety is being driven by regulation. Safety assistance is one of four areas in which the European New Car Assessment Programme (NCAP) regulations judge cars. NCAP rewards and recognises car manufacturers that develop new safety technologies, from blind spot monitoring to systems that detect drowsiness. From a regulatory perspective, from 2014 it will not be possible for cars to receive a 5* rating without an active safety component. This creates an element of embedded structural growth that should help to partly offset the cyclical nature of the broader automobiles sector.
We remain very cautious about the prospects for big car manufacturers, away from the premium brand market (where we continue to favour BMW). Firms that specialise in developing technology and components seem well positioned to meet the demand for active safety technology and therefore offer great investment opportunity. Continental, French vehicle components provider Valeo or Swedish-American automotivesafety systems producer Autoliv are amongst the names that we like at present. A key benefit of these component suppliers is that not only are they at the forefront of these heavily-demanded technologies but in having partnerships with several automakers around the world, their revenues are spread across numerous car brands and geographies, helping to spread risk.
Opinion column by John Bennet, Portfolio Manager at Henderson Global Investors
Photo: Rock Cohen- rockcohen. Europe, On the Road to Recovery
The potential breakup of the European Union and the demise of the Euro now seem to be a threat of the past. Just twelve months ago, the old continent seemed to be in a freefall situation. Four peripheral countries were virtually intervened, and there were considerable doubts concerning Spain and Italy. The European Central Bank’s intervention, cutting interest rates, coupled with a large injection of public money, has managed to stop the bleeding.
Institutional players have been starting to invest in Europe waiting for a slow but sustainable recovery
During the past 24 months, financial markets focused in the U.S. stock market, taking advantage of the sharp rise in fixed- income prices. The latter has already concluded, and unless a disaster occurs, the future will bring higher interest rates. However, European stock markets as well as many Asian ones, lag far behind their American counterparts.
Investors typically buy based on expectations of change and on future valuations. Currently, and for the last few weeks, institutional players have been starting to invest in Europe waiting for a slow but sustainable recovery, which would help to reduce the valuation difference with other markets. The important thing is to find good managers who invest in companies which are fundamentally sound and which can also benefit from a very hard hit domestic market.
At this stage we see three different types of opportunities in Europe. The first is the market for assets in liquidation. These can be high-quality companies which are facing a lack of liquidity due to the lending restrictions practiced by the majority of the continent’s financial institutions. They would be companies with solid bases, but which are currently in need of support in order to progress. Normally, these companies are not listed on the stock exchange, and in many cases either still belong to family groups, or are non-strategic assets of some of the multinationals. The best way to find these investment options is through venture capital funds (“private equity”), with local presence and access to groups needing support.
The second area where we see opportunities is in those countries that have had sharp declines in their real estate prices. In some cases, we are seeing their valuations bottoming out, while in others there may still be some further drops. The regulators’ new capital requirements are causing many financial institutions to package those assets on which their loans are not being paid or which they have received as guarantees, and are selling them in bulk to large funds. This move has been seen in recent weeks in Spain, Portugal and Ireland. Other operations are the purchase of corporate buildings with tenants (in many cases the vendors themselves sell it with a long-term lease and even with a repurchase agreement in time). This helps them to obtain the liquidity they need by removing an asset which may be substantial from their balance sheet, while being able to continue to occupy it. What is important in these cases is that the tenant is reliable, as the last thing we want is to be stuck with an unproductive asset. We are now seeing several cases of international HNWIs entering directly into this type of investment.
Finally, we are currently seeing an inflow of direct capital into the European stock markets, which in some cases have seen their indexes increase by more than 20% from their June lows. Despite these large increases, they still remain cheap, historically, in relation to other markets, as well as in relation to their price / earnings ratios. There are two ways to invest in this area, the easiest, fastest and cheapest is through a passive vehicle like ETFs; however, there is also an opportunity through active managers who can add value by taking advantage of specific growth opportunities of some sectors or of specific companies.
It seems, or I would like to think, that we have already seen the worst of the financial crisis, and that the old continent is beginning to enter into the growth path, and to be once again targeted by investors.
Opinion column by Santiago Ulloa, founder and managing partner at WE Family Offices.
A few weeks ago, my curiosity over Macau’s transformation since my last visit led me to hop a ferry there from Hong Kong during a hard rain. In particular, I wanted to see firsthand all the new casino developments underway in Macau’s Cotai neighborhood.
The last time I toured Cotai in 2010, I recall being overwhelmed by the sheer powerful presence of its big-time, VIP game players. Steve Wynn was in town that day for a grand opening and serious, hard-core gamblers were all there were. VIPs would spend millions overnight at the baccarat table. Back then, insiders would tell me that in Macau, unlike in Las Vegas, people came strictly for the gambling and non-casino entertainment facilities were not needed. Indeed, Macau’s casino revenue has grown from US$10 billion in 2007 to US$38 billion in 2012, and revenues from the beginning of 2013 to August were up 16%.
But while the casino business may be showing healthy returns, Macau’s newest growth area has been in related, non-gaming hospitality businesses. Massive hotel construction projects are underway to accommodate the region’s ever-growing number of visitors—not only VIPs, but also a rising number of family tourists. Visitors to Macau reached 28 million in 2012, up from about 23 million in 2009. Several factors seem to be driving tourism flows, including Macau’s improved infrastructure, its more affordable and family-friendly hotel rooms and increasing entertainment events. Pop musician Justin Bieber is scheduled to perform at the Cotai Arena this month, and November brings one of the year’s biggest professional boxing matches to the Arena.
In terms of infrastructure, border checkpoint areas to Macau such as the Gongbei Border Gate have recently been expanded, and new facilities may soon increase daily capacity to 350,000 visitors, up from approximately 270,000 today. Other projects include a new Macau light rail system and a 26-mile bridge and tunnel project, due for completion by 2016. This bridge-tunnel will connect Hong Kong International Airport to Macau, and is expected to cut car travel time between both sides of the Pearl River delta from four hours to just 45 minutes.
With seven more casinos slated to open by 2017, the number of hotel rooms should increase to 41,000, up from approximately 25,000 currently. New development projects are also planned on nearby Hengqin Island, which is just one bridge away from Macau. These include golf courses, theme parks and aquariums.
What is most impressive about Macau today is the strong sense of collaboration and commitment from all involved parties: both Macau and mainland Chinese government officials and casino operators. While Asia’s other gambling centers (Singapore, Malaysia, Cambodia and the Philippines) have also seen waves of notable development in recent years, Macau, in my opinion, should be recognized as the gold standard of the gaming space in Asia.
Opinion column by Taizo Ishida, Portfolio Manager at Matthews Asia.
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Foto cedidaTim Stevenson, Head of European Equity at Henderson Global Investors. Don’t let politics get in the way of the economy
It was Mark Twain, in Pudd’nhead Wilson, who originally suggested that October is a dangerous month to speculate in stocks. He, of course, went on to suggest that every month of the year is ‘peculiarly dangerous’, in effect. This October seems to follow the phenomenon: there is a rather nervous feel to European markets, but almost solely due to political uncertainty rather than the imminent results season.
Politics has loomed its head across markets, with Italy in particular hit by concerns over recent attempts by the despicable Mr Berlusconi to avoid imprisonment. In the Netherlands, politics is an increasingly volatile game, while in Austria the populist ‘Team Stronach’ party, which campaigned on a mandate to split the euro by national borders, has won seats in parliament. In France, President Hollande continues to plumb new depths of unpopularity, and in the UK politics remains a threat to stability. Even Germany’s Chancellor Merkel is being forced to compromise with the left-leaning SPD in order to form a coalition, despite a very strong showing for her party in the recent elections.
Just in case all this is not enough to make markets nervous, party-political infighting over where to apply spending cuts has forced the US government to shut up shop for an indeterminate period.
If this all sounds familiar; it should. It was the same last year.
The result this time around is a sharp increase in short-term uncertainty, which throws a cloud over recent economic data and companies’ statements, which indicate that conditions are improving. Suddenly, the obvious inflow of funds to European markets could be checked by concerns that we might be close to launching into another Euro crisis.
My view is that the next few months may be tense, but the benefits of taking tough decisions on austerity are beginning to show. The only party in Germany that wants to exit the Euro, the AfD, failed to reach the 5% threshold needed to enter the Bundestag, and generally there is optimism that the eurozone has already passed through the worst. That some parts of the electorate want to return to previous failed policies seems a contradiction, given that economies in the region look to have finally turned the corner.
Part of the market thrives on uncertainty and changes of direction provide renewed opportunities to trade on conflicting investor sentiment, at least for a while. Certainly, after the strong share price gains we have seen so far in 2013, a period of consolidation is both healthy and quite likely. There is also evidence that a significant part of the funds flowing to European Equities has been by way of the ETF market, which has been shown to be a flaky, somewhat artificial means of ‘investing’. These investor flows might just as quickly run in the opposite direction, reversing a trend that has been in place for several months.
So prepare for a nervous few months and watch developments carefully. It may be difficult to filter out reality from the noise. My suspicion is that Italy will have a working coalition in the not too-distant future, which will get to grips with some of the many pressing issues that need addressing. Germany is likely to see a Merkel-led coalition, which will continue to press on with measures to reform and reflate the German economy, while also preparing for more debt write-downs in some of the peripheral countries of Europe. In the UK, we may still be wrestling over whether or not we want to be part of Europe, or part of some fantasy world.
In the meantime, the US government might reopen for business, after settling on a compromise agreement that allows difficult decisions to be postponed another year.
In this period, I recommend that investors look at where quality companies are trading and what returns they may be able to offer to patient investors over the next few years.
