On Target Newsletter

In this issue:

  • Brexit 2 in 2020 & Scotland
  • The new decade: what to expect
  • Japan: its shares look good
  • Dirty money in America
  • Century bonds

Britain to Leave the European Union: What Next?

It now seems almost certain that Brexit will happen on the last day of this month. What happens afterwards?

Britain will no longer be a member of the European Union, but in terms of the Brexit agreement it will remain within its customs union, temporarily, just as if it’s still a member of the EU. That’s to allow time to negotiate a new trade relationship between the UK and Europe.

Almost all those who are experts about how difficult it is to negotiate such international agreements say it can’t be done in such a short time. Several years will be needed. The Johnson government says they’re wrong. It could be right.

In the election campaign the prime minister made a commitment that a trade agreement will be concluded by the end of this year. That he won’t ask for an extension of the deadline. He’s even incorporated an extension-cannot-happen clause in the withdrawal agreement now going through parliament.

So what’s likely to happen? Will there be a trade agreement by the year’s end? Or will there be an extension asked for? (Boris Johnson has a ruthless capacity to scrap commitments if needs be, as he showed in resolving the “no Irish border” obstacle in the Brexit negotiations). Or will he allow negotiations to run out of time, if agreement cannot be reached, precipitating another no-deal-exit crisis at the end of this year?

I think the most likely outcome is that there WILL be an agreement without a time extension being necessary, for these reasons…

► Even Brexiteers admit that the UK’s departure from the EU will do at least some temporary damage to the British economy. Johnson knows that limiting that damage and promoting growth longer-term is going to be critically important to delivering his “one nation” promises. And in particular to entrenching the loyalty to the Conservatives of his new-found voters in the North and Midlands.

It will be essential to reach a deal quickly with the Continent because of its overwhelming importance to British business. It accounts for almost a half UK exports. And supply chains across the Channel such as those for major industries — automobiles and aircraft, for example — must be maintained. Even if that means delaying delivery on the Brexit vision of a new era of trade agreements with other countries such as the US. The “Singapore-on-Thames” ideal of a bonfire of regulations and aggressive tax cuts will have to wait. Maybe for ever.


► Johnson will be able to push through such a “Soft Brexit” agreement, making difficult concessions on issues such as fishing rights, because of his commanding control of parliament, even if that angers the 20 or so MPs who are Hard Brexiteers, and small batches of Conservative voters such as those of the fishing ports.

He’ll have overwhelming support from those inside his party and outside it who would favour a deal that underpins continuing strong trade relationships with the Continent.

► Europe’s negotiators will be much more flexible than in the past.

Although they took a hard line in dealing with the Theresa May government, getting their way on the important issues, they were so successful that the British parliament refused to approve the deal. It nearly produced a no-deal departure from the EU. And it did lead to election of a (relatively) hard-line Brexiteer prime minister. Brussels won’t take the risk of generating a no-deal exit this time around.

The EU itself is sailing into heavy seas of internal divisions.

Getting agreement over a new seven-year budget is going to be extraordinarily difficult, especially as there won’t be the UK to provide a substantial share of its income. There is growing angry disagreement over issues such as rule of law, immigration, and new issues such as who is to pay for fighting climate change (ambitious no-carbon targets, a new favourite of the European elite).

Europe wants to get the whole difficult, embarrassing business of Brexit resolved and out of the way.

What will happen to Scotland?

A final matter that arises out of the British election…

The Scottish National Party did well, gaining seats, and can be expected to put great public pressure for another referendum on independence for Scotland. The last one, in 2014, produced a substantial majority for those wanting to remain part of the United Kingdom. Now, it appears, public opinion is in favour of independence.

Johnson has made it clear that he won’t allow another referendum. The SNP will probably fight back by holding an unofficial one. But even if it produces a majority in favour of a Scottish exit, it cannot have any legal effect. Only put more pressure on the British government to give way. Which won’t work.

I reckon that in time the campaign will fade away. Opinion swung in favour of independence because Brexit, an issue that wasn’t a significant factor in the 2014 vote, seemingly influenced many Scots to prefer the idea of remaining in the European Union as a separate country rather than staying within the UK outside of it. Once Brexit has happened, irreversible at least for a long while, it will no longer be a major issue for Scots.

And with the passing of time, we’ll probably see another effect. It’s become clear that the SNP is making a shamble of governing Scotland. That will become an increasingly important issue swinging voters to support anti-independence parties such as the Conservatives, Liberal Democrats, even Labour.

The New Decade: What to Expect

Deutsche Bank has published its research analysts’ contrarian ideas for what the coming decade may hold. Here are some of the most interesting…

The end of fiat money? With money no longer backed by an asset such as gold, there is always the risk that governments will electronically “print” so much of the stuff that it inflates prices. “Politically it is always too tempting to create money when nothing is backing it.”

The forces that have held together the current “fiat” system together with generating excessive inflation now look fragile and could begin to unravel.

Policy may shift away from monetary constraint towards fiscal expansion to favour low-paid workers. This will boost labour costs as there will no longer be an abundance of additional cheap labour in and from developing economies to counter it. High debt levels will make it harder (riskier) to tighten monetary policy. The current global trend of low inflation could reverse.

Will fiat currencies survive the policy dilemma that authorities will experience as they try to balance the need for higher interest rates to combat inflation with record levels of debt?

As a backlash against “paper” money develops, “demand for alternative currencies such as gold or cryptocurrencies could soar.”

Europe to lag? There’s a risk of relative deterioration in its global standing, “that Europe falls permanently behind the US and China in adopting the next generation of technological advances.”

Europe has no technology companies on the scale of Microsoft and Apple in the US or Tencent and Alibaba in China. When it comes to educating the next generation of top students, Europe lags substantially behind the US, which dominates the field in elite higher education. There is a risk that the technological imbalance could become entrenched. Given the continent’s relatively low military spending, this deficit in technology could also develop into a security issue as well as an economic one.

There is a similar story in financial services. None of the ten largest financial groups globally is based in Europe. Negative interest rate policy has hurt European banks and, by extension, lending to Europe’s real economy.

Another adverse factor is demographic deterioration. Europe’s population is ageing faster than America’s. By 2030 more than a quarter of Germany’s will be older than 65.

The worry is not that the European economy will begin to emulate that of Japan, with very low growth, but that it won’t even be able to do as well. Japan has remained wealthy and cohesive in spite of economic challenges. Bold decisions are needed to ensure that Europe does not fall further behind.

China’s consumer decade. The nation’s economy has been driven by a key theme in each of the last two decades: exports, and then public investment. The next one is set to be consumption.

Consumer spending continues to grow at an average annual rate of 8 per cent, despite the fact that Chinese save – that is, do not spend – a third of their incomes. By 2030 China could be the world’s largest consumer market, overtaking those of America and Europe.

One sector likely to do particularly well is that of low-tier cities and rural areas, where incomes and living standards are growing rapidly. Another will be the “silver economy” as the post-war baby-boom generation go into retirement… “rich, healthy and full of time for leisure.”

There’s going to be particular growth potential in the market for leisure services and products – travel, hobbies, wellness, entertainment.

The end of high profit margins. The sky-high levels of profits in the US and Europe are ready for a fall. They’re going to be hit by the returning power of labour, greater competition and higher taxes.

The billion cheap workers introduced into the world economy by China, India and the Soviet Union over the past four decades have now been absorbed. Companies are finding it difficult to source new politically-stable low-wage countries to which they can outsource work. At home, lower-paid workers are becoming activist. Businesses will have to get used to paying higher wages.

There’s the threat of more and higher taxes fuelled by populism. Politicians are also becoming keener on enforcing greater competition, for example by dismantling megaliths. Corporate debt will become harder to finance and more expensive.

Revolution in food distribution. E-commerce is transforming retailing in products such as electronics and clothing, and in services such as entertainment. Now it’s coming in fresh foodstuffs.

The meal kits concept didn’t exist ten years ago. Now it’s spreading fast. A pioneering example is Berlin-based HelloFresh, which has 2½ million customers in 13 countries. They are asked what they want to eat next week from a list of 20 recipes. They’re sent right-sized packages of ingredients to cook themselves. No bother with shopping. And no waste.

The on-line market for fresh foodstuffs is now worth $250 billion. It’s expected to triple over the next five years.

Because of the abundant data being generated, businesses are able to give advanced notice to farmers and other suppliers around the world of what they will need and when. A just-in-time approach minimizes wastage.

The entire food value chain is being transformed. By 2030 most supermarkets won’t be as we know them now, but electronic interface stores where you place your order for next week and collect what you booked last week, if you don’t opt for home delivery.

The rise of the drones. At present there are issues that hobble widespread use of these unmanned aerial vehicles, mainly safety-related. But they are being resolved. In the US alone it’s reckoned that within three years there will be 700,000 commercial UAVs operating; by 2030, more than 6 million. With the cost of an average delivery forecast to plunge to $2 apiece there will be huge demand for cheap, fast last-mile delivery.

Other benefits are becoming apparent – for medical emergencies, for example. In Africa Zipline has launched a programme to deliver drugs and blood to 2,000 health centres in Ghana and Rwanda by drone. “Dark” kitchens are starting to use them to deliver hot meals to homes. Regulators are being asked to approve the use of drones for traffic monitoring and mosquito spraying.

Precision-targeted medicines. Personalized drugs designed to treat patients that are matched to his/her genome now account for one of every four new drugs approved by US regulators. Some experts say that it’s going to be the defining medical technology of the 2020s.

The problem is cost. One of the biggest success stories of genomic medicine is Gleevec, a precision cancer treatment that saves 2,000 lives a year in the US. But at an average cost of about $1 million per life saved. By comparison a relatively simple and inexpensive treatment for HPV, which causes cervical cancer, saves the lives of 300,000 American women a year.

It may be hard to reconcile the huge expense of personalized drugs compared to equivalent spending on wide-scale public health treatments, particularly in countries with publicly-funded healthcare systems.

The end of cash and plastic cards? Cash is losing ground. In advanced economies two-thirds of people now prefer to use dematerialized vehicles (neither cash nor cheques) to make payments. But it’s still well-ingrained in many. In the US, Western Europe and Japan one third of people still consider cash their favourite. They find their spending easier to monitor, transactions fast and convenient, they have no trouble with acceptance, and their purchases remain anonymous.

In emerging economies, however, the move away from cash is likely to accelerate as a large part of the unbanked population is transitioning directly to smartphone-based payments. By 2016 cash was only used for 11 per cent of payments in China. There the government has built a world-class infrastructure to support digitization. It’s the world’s largest market for smartphones and e-commerce.

In the US plastic cards are ingrained in the culture and remain a dominant force, underpinned by the spread of contactless payment technology (you just tap a card reader). In Europe mobile payment is not yet popular either. Only 8 per cent of people use smartphones to pay. But the mobile technology is primed to take off over the next five years.

“It is only a matter of time before smartphones make plastic cards an obsolete tool.”

How governments will respond to record debt. In the US federal debt has risen from 34 per cent of GDP in 2000 to 78 per cent now. The Congressional Budget Office says it’s heading to 93 per cent in 2030 and thereafter to 144 per cent after two more decades. As many major economies “look vulnerable to secular stagnation themes, it’s hard to see government debt being anything but higher in a decade’s time.”

Preventing that could seemingly only be done by large-scale money printing (in place of borrowing) and “very aggressive financial repression” (savers being forced to accept interest rates below the rate of inflation).

By their aggressive intervention in bond markets (“quantitative easing”), driving down interest rates, central banks have invited governments to experiment with even more unconventional policies. In the 2020s it seems inevitable that we’ll see “helicopter money” (direct handouts of cash to citizens to encourage them to spend). And central banks will finance governments directly.

In Europe internal and external pressures are mounting on governments to spend more – especially those of countries perceived to be in a position to do so, such as Germany. It could see a three to four percentage points to GDP swing from fiscal surplus to fiscal deficit.

Political tipping points. Last decade the biggest developments in politics have been the emergence of a backlash against globalization, against immigration, and a rise of nationalism. There are several issues that have the potential to gain sudden political traction in the coming decade.

One is the generation gap fuelled by housing affordability. In the US the proportion of adult children living in their parents’ homes has risen from 10 to 17 per cent; in the UK from 25 to 35 per cent. It’s forcing more young people to delay life-defining moments such as marriage and children. They are starting to rally behind politicians promising property and wealth taxes, and measures to ease supply of and access to their own homes.

A second under-appreciated theme is falling trust in the European Union. Eurosceptic parties are increasing their support and influence. There is a distinct possibility that rising scepticism will lead to greater divisions within countries, or even calls for secession, as we are already seeing in Britain (Scotland) and Spain (Catalonia).

Another issue is the precarious state of southern European economies. The youth unemployment rate is now 28 per cent in Italy, 33 per cent in Spain and 34 per cent in Greece. The consequence is “simmering discontent.” Today’s populism could be just the start of a much bigger wave.

A fourth political risk is ageing populations. As the proportion of retirees grows, so does their voting power. Governments will be tempted to shower them with more generous pensions and other age-related transfers. The younger generations could find themselves alienated from the political process and fight back… as they already seem to be doing over climate change.

A defining theme of the new decade could be the emergence of generation war.

As ageing pushes a higher proportion of retirees into the voting population, governments will be incentivized into showering the elderly with more generous pensions and other age-related transfers, but that will stimulate discontent among young voters. As recent climate-change protests have shown, they’re quite capable of ratcheting up their concerns on the political agenda.

Are generation wars to be a defining theme of the next generation?

India’s promise. Over the next decade India’s economy is likely to grow 2½ times to become the world’s third largest. Ongoing structural reforms have significantly boosted its potential. Introduction of a goods and services tax and currency reform, apart from reducing tax avoidance, will incentivize a faster pace of digitization.

An increased focus on urbanization means that India will become one of the world’s leading sources of middle-class demand – more than twice the size of America’s — as incomes in real terms per person grow at an average rate of 5½ per cent a year over the next decade. By 2030 it will account for 17 per cent of consumption by the world’s middle classes. (China’s is expected to be 22 per cent; the US for only 7 per cent).

This will open up huge investment opportunities, particularly in sectors such as infrastructure, banking, utilities and industrials.

The risk of rising corporate taxation. Politicians with higher corporate taxes in their sights are gaining in popularity. Some American cities have started levying their own additional taxes on businesses; in Europe similar pressure is building. In the UK the new government is rolling back planned tax cuts.

The OECD’s proposals for global tax co-ordination include calls for a minimum rate of tax for corporations and requiring them to pay tax in every country where they sell goods, not just those where they have a base.

On-demand life. Over the coming decade global technology companies will pour money into developing “super apps.” They want to expand from being just platforms offering goods and services into integrated groups able to provide unlimited free deliveries of anything on demand. They will use artificial intelligence to manage every aspect of our on-demand lives.

The Case for Investing in Japanese Shares

For the best part of three decades, international investors have tended to overlook Japan’s equities market as the well-trodden stories about deflation, population decline and arcane corporate governance pushed them to go elsewhere. Yet, the financial publishing house Nikkei, reports: “In the past few years a quiet and multi-faceted revolution has taken place” in what is the world’s third largest economy. “It has ended the long-running deflation, boosted economic growth and raised productivity.”

Return on equity, a key measure of how effectively companies employ shareholder funds, has doubled since 2012 to about 10 per cent. The Nikkei Stock Average, the leading index of listed shares, gained nearly 50 per cent in dollar terms in the five years to May. By comparison, equivalent growth in Europe was just 5 per cent.

A wave of corporate reforms have increased transparency. The complex web of shareholdings that discouraged management change has been dismantled. In 1990 city and regional banks owned about 16 per cent of listed stocks; that’s now down to just 3 per cent. The share owned by foreign investors has risen from 5 to 29 per cent.

There has even been progress in recent years with sweeping away “poison pills,” defensive tactics used by companies to ward off hostile takeover attempts. Recently as many as 75 firms scrapped their poison pills — a sign of greater transparency and openness.

While it’s true that Japan has the oldest population of any country, it is less well known that the number of foreign workers allowed in has been growing about 15 per cent a year. The five fastest-growing sources of foreign labour are Vietnam, Indonesia, Nepal, South Korea and the Philippines. There has been a huge change in the country’s approach towards immigration.

All American Politicians’ Scandalous Silence

America “is the largest dirty money haven in the world,” but its politicians ignore the fact, argues the FT’s Edward Luce. Even a campaigner such as Elizabeth Warren is silent “on links between US politics and global corruption.”

America’s largest law firms, real estate companies and lobbyists “thrive on dirty money.” It’s a problem that spans Democrats and Republicans, New York and Washington, the public and private sectors. It is a curse that dare not speak its name in the 2020 election.” According to the World Bank the US has ten times more shell companies than the next 41 jurisdictions combined.

Joe Biden helped to turn Delaware, his home state, into the most popular domicile for such anonymously-owned companies. Donald Trump made a great deal of money using them to sell condo units; in one of his organization’s towers in Florida more than 80 per cent of its units are owned by shell companies.

Even the US Treasury estimates that $300 billion a year is laundered through America, and that’s probably a fraction of the true number. The government has no idea who controls the companies that channel the money because America lacks a corporate central registry. There is no national law requiring disclosure of beneficial ownership.

Legally, banks must report suspicious activity… but law firms, real estate groups, art sellers, incorporated enterprises and non-bank financial institutions are exempt.

“There used to be a bright red line between America and the world’s kleptocracies. Now they are symbiotically linked,” Luce says.

Century Bonds to Pay for the Northern Strategy?

Britain’s new government will have no difficulty financing its plans to spend massively on infrastructure – bridges, hospitals, railways – in England’s North.

Its borrowing potential is arguably the greatest of any major nation. Domestically it has a substantial investor base of institutions who hoover up Gilts (government bonds) to meet their future pension and insurance liabilities. Internationally the UK is regarded as one of the safest places to invest for the long term – that’s why 30-year Gilts trade on lower yields than counterparts of other nations.

Its government debt is only 40 per cent of GDP; even Germany’s is 50 per cent. And its government bonds are the most trusted for the long term. Their average duration – number of years before they mature and their capital is due for repayment – is about 14, compared to nearly nine years for German bonds and less than seven for US Treasuries.

Given such strong fundamentals and current ultra-low yields generally for interest-paying securities regarded as the most secure, it would make sense, Bloomberg analysts suggest, for Britain to offer 100-year “Boris Bonds.”


Coal: One country has escaped the anger of eco-activist Greta Thunberg – China. Which is extraordinary, as it’s not only the world’s biggest polluter, but also it has the biggest programme to build more coal-fired power plants. Last year China boosted its electricity generated by coal by more than 25 gigawatts; the rest of the world actually cut its total by 3 gigawatts.

China is currently constructing enough coal-fuelled stations to generate as much power as all those already operating in the European Union. It’s also the biggest force behind building of new coal-fired plants elsewhere in the world. In 2018 China’s official development banks invested more than $25 billion in them in countries such as Indonesia, Vietnam and Malaysia.

Gold: The world’s rich are hoarding it, according to data in a recent Goldman Sachs note to clients. Owning the physical metal appears to be their preferred method to “hedge against tail events.” (A reference to very unusual but extreme events impacting on investors). The bank says the wealthy are fleeing to gold because of political uncertainties, recession fears, worries about wealth tax, increasing interest in Modern Monetary Theory (which is essentially money-printing to pay for aggressive government spending) and loose monetary policies by central banks.

Climate change: The European Union seems set to make fighting it the top priority, with a relatively soon zero-emissions target. Eoin Treacy says this is because “the EU’s political elite view the climate argument as a vote winner, a source of revenue for their constrained social services, and an additional control on the economy.” It is also a response to the fact that “the region is a major energy consumer and has long had to deal with regimes it is politically at odds with” because of dependence on imports of their oil and natural gas.

Giants underperform: Many American universities follow Yale’s so-called “endowment model” for investing their capital, giving a large role for private equity managers and hedge funds in their portfolios. Wasting their money, it seems.

Over the past decade, reports consultant Charles Skorina, none of the eight elite Ivy League universities and 52 other institutions using the endowment approach has outperformed a simple minimal-cost stock-market tracker fund.

A revolutionary car: India’s Tata Motors is planning to market one that runs on air, not petrol, diesel or electricity. The tiny Air Car is driven by compressed air loaded at home or specially-adapted filling stations. It’s expected to sell for the equivalent of little more than $8,000, with a top speed of 105 kms/hour, a range of about 300 kilometres, and requiring very little maintenance because of simple design.

Oil stocks: Christopher Wood of Jefferies suggests they could well be a good place to invest. The mounting campaign against fossil fuels seems to be condemning the oil giants to pariah status. When that happened to the tobacco sector its companies turned out to be the top performers over 20 years. The oil majors will be paying out “more and more cash as their investment budgets decline,” while demand for their product “will probably be maintained for far longer than current estimates.”

Zombies: A major criticism of bloated central-bank policies of easy credit is that they keep alive bad businesses competing against sound ones that ought to be allowed to fail. The number of these “zombie companies,” as they’re called, has reached a level not seen since the financial crisis. They’re categorized as such if their interest costs on borrowed money are greater than their annual earnings. In OECD countries there are 548 such firms.

Lithium: This key element of the batteries used in mobile phones and electric vehicles is another of the natural resources where Australia has become a major source of supply. Talison Lithium, now controlled by the Chinese company Tianqi, owns and mines the world’s largest and highest-grade reserves of the source mineral spodumene at Greenbushes, near Perth. It now meets 40 per cent of the world’s lithium needs, 75 per cent of China’s.

Worrywart investing: If you’re not worried about something as an investor, it’s really time to take a close look at your portfolio, advises Eoin Treacy of FullerTreacyMoney. “The best definition of bravery I have heard is: ‘feel the fear… and do it anyway.’ When we worry about nothing, and are supremely confident in our convictions, it is usually when we are most at risk.”

Automation: Earlier research suggested that the main effects of robotics, software and artificial intelligence will be to take away jobs in the middle of the skill and wage spectrum such as factory workers and office clerks. But new evidence from Brookings’ Michael Webb suggests that artificial intelligence will impact on whole new classes of higher-paid white-collar workers.

The Chinese: One indication that they could be heading for global dominance is, according to the latest Program for International Student Assessment, that in mathematics, 15-year-olds in China are on average almost four full grade levels ahead of those in the US.

Sectors to be in: The best for the next ten to 15 years will be emerging-market equities, reckons investment bank JPMorgan, followed by private equity and US real estate.

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