End of monetary violence in sight?

Interest rates and inflation

One of the difficult aspects of investing is that sometimes one would want to be happy with price declines and still be disappointed with price rises. They are, of course, weird emotions, but they do fit with the defensive investor, which we have been for a while. At the same time, we are somewhat delighted with the increase in interest rates, because we are also carefully positioned here. In the past, you would be worried about an increase in interest rates. But now 10-year interest rates in The Netherlands went from -0.6% to-0.3% and that already feels a bit better. What is it all about, I hear you think? Maybe you are right. We hope for an interest rate of 1-2% in the long term, but maybe that will take quite a while. Will there once again be a ‘normal’ interest rate? So, one, which is 1-2% higher than the inflation rate (currently 2.6%)? I would not count on it for the time being.

The crazy thing is that central banks are obsessed with inflation, which would be too low, but that has already come to a very normal level in many countries: in northern Europe, for example, inflation fluctuates around 2%, only in Southern Europe and countries like Japan it is still below 1%. Wage increases are beginning to translate into price rises, however, especially now that globalization seems to be taking place for isolationism and the cross-border price competition may be declining. Perhaps we will come up with a higher inflation as a matter of course, while central banks still use heavy guns to stimulate that inflation. And just before his departure, Draghi soon entered into a monetary bazooka, with the task of buying up billions of debt paper again.

The fact that such a monetary gun has still not been silenced is partly due to the further weakening industrial activity, even in the US. The consumer also starts to show some hesitations, but it is mainly the business community, which does not dare to take investment decisions. And here we come back to the trade war and to Brexit and the division between the financial world and the real economic world.

Financial world versus economic world

The financial world says in fact: “don’t fight the Fed”. If the Fed lowers interest rates, such as again at the end of October, it will be good, then the business cycle and thus operating profits will be maintained. However, the business community looks at Boris and Donald and knows that these gentlemen do not quite trace. Even though there may be a mini-trade deal between the US and China, this geo-political competition is going to take a long time. China has already informally announced that there will be no ‘big’ trade deal for the time being. Not only are the differences of opinion too great, but they don’t really trust Trump and fear that he can come back at any time on the agreements made. Companies also see this and therefore dare not make investment decisions, which can easily have a scope of 5-10-15 years.

Something similar is playing in Brexit. Suppose that the most recent deal will be ratified in England after the coming elections, is there a clear trade relationship with the EU? No, on the contrary, that will probably take another 4-6 years. Remember that our trade talks with Japan and Canada lasted much longer. Michel Barnier, the Brexit negotiator on behalf of the EU, has already been asked to take on new trade talks with the UK for the coming years. Therefore, there will be no certainty on the profitability of trade flows to and from England.

Industrial downturn

And with that I come back to the recent industrial downturn: it is too large to be attributed to the changes in auto production or just as a temporary cyclical downturn. It can only be explained by the enormous uncertainty for managers in the business world. We may still hope that consumers continue to spend, partly thanks to rising wages, but without new investment, healthy economic growth is difficult to achieve. And so interest rate measures do not help, because at the already super low interest rate it was not when building a new plant (where then? In the US, in China or in Germany?) was postponed.

The world, which was of us and everyone, seems to make place for regional blocks, which want to lead their own political, strategic and commercial life. China has just commissioned its business to set up its own chip production, in order to no longer be dependent on US chip suppliers. America is exerting considerable pressure on European countries to exclude Huawei as a supplier of the new 5G network. At the same time, companies take the uncertainty and build local factories to supply local markets. So a Tesla factory in Shanghai and soon fixed new BMW and VW factories in the US to spawn Trump and avoid any import tariffs for European cars. This way the business community becomes fragmented: by doubling up plants for similar models, economies of scale are lost. Globalisation seems to have been brought up and costs will rise. Not to mention those cost-boosting import tariffs of course. Perhaps Donald and Boris are doing more for inflation than the central banks are hoping to achieve with their monetary guns.

Impact financial markets

In the meantime, equity investors seem undeterred. I guess we are hoping for worse times, so that our illiquid investments with their steady Eddy coupon or dividend for relative rest can (continue to) flourish. They do, of course, already: our Swiss Mixed Pool achieved more than 7% up to September this year and our Infrastructure Pool has so far raked around 1.9% dividend every quarter. Only that is not so when fairs remain cheerful, they do not start to lag as fairs.

With this questionable desire, we will gradually go to the dark days before Christmas and with that I greet you wholeheartedly, on behalf of the entire team,

 

BY: WOUTER WEIJAND, Chief Investment Officer

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