Friday, 4th of October 2019
“There are so many different kinds of stupidity, and cleverness is one of the worst.”
– Thomas Mann
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Equities continued to sell-off this week as miserable economic data seemed to confirm fears that slower global growth would soon spark a rout for investors. Of particular concern was the September PMI print for US Manufacturing, which came in at 47.8 as the sector contracted for the second consecutive month amid flagging export orders. This was well below expectations and is the lowest level recorded since the depths of the recession in 2009. It shows that US manufacturing is not immune to the travails of Mr Trump and that US exporters have finally joined their European and Asian counterparts in the doldrums. Nevertheless, it was the European indices that suffered disproportionately this week, with some falling by more than 4% by the Friday open. The continent’s largest economies, and Germany in particular, are heavily dependent on a favourable external environment for their continued success. As such, they have been hardest hit by turbulence in US-China trade relations, the de-leveraging-induced slowdown of Chinese growth, and the trend towards deglobalisation spearheaded by the US President. To make matters worse, one of the cherished institutional pillars of the ‘rules-based international order’, the WTO, has ruled in favour of Uncle Sam and Boeing in a long-running dispute over illegal French subsidies for Airbus. The US has responded by slapping $7.5bn of WTO-sanctioned tariffs on a range of EU goods, from aircraft to olives. This is the largest penalty ever handed out by the organisation. For its part, the EU has threatened to retaliate with $20bn of its own tariffs. But with no legal basis for this response can the bloc hold itself up as a defender of liberal institutionalism if they go ahead? To be sure, the WTO is likely to find that Boeing has also been receiving illegal subsidies from the US government, but that decision is not expected until sometime next year. In the meantime, any EU countermeasures could spark a cycle of recriminations and unleash a trade war with the US at a moment of global economic vulnerability. The EU should wait… or lose the moral high ground as well as the jobs and other economic linkages that depend on a robust Atlantic relationship, one that is already under threat. We are glad to have our portfolios well-protected with puts and gold in case mercantilism takes charge in Europe too.
In Asia this week, the People’s Republic of China has been celebrating 70 years of Communist Party rule with an ostentatious parade of new military hardware and complete with DPRK-style mass dancing. The rolling ICBMs, tanks and marching infantrymen were interspersed with colourful authoritarian-kitsch floats bedecked with grinning pandas, fluorescent dragons, and folksy depictions of China’s few Party-approved ethnic minorities. Meanwhile, Hong Kong exploded in one of the most violent protests against creeping Chinese Mainland influence that we have seen in recent months. The twin spectacles were profoundly jarring at times, and yet also strangely complementary; two narratives, tightly woven – that is, the developmental state and the surveillance state – both on display, in what appears to be inherent conflict as well as mutual support… but now we are rambling.
On Brexit, there was a modicum of progress this week as the UK government published its proposals for ‘alternative arrangements’ to the so-called Irish backstop. Under the previous agreement, the UK as a whole would have remained within the EU customs union while Northern Ireland mirrored EU single market regulation indefinitely unless future negotiations secured a deep enough partnership to eliminate the need for border infrastructure in Ireland. Many MPs assumed that in those future talks the EU would tell UK negotiators that the only solution to avoid the backstop would be a permanent customs union with the bloc. Given that this was also the legal default under the backstop, the UK would have to agree to it or be forced into the relationship anyway with the collapse of talks. This was unacceptable to many Brexiteer MPs and was the principal reason why ex-PM Theresa May was ousted so unceremoniously. Johnson’s alternative plan envisages different backstop arrangements: (1) the EU and UK would exist within separate customs territories, but electronic customs declarations and a limited number of physical checks would take place away from the border in Ireland (e.g., at points of origin or in warehouses along the supply chain); (2) Northern Ireland would stay within the EU single market for goods, so there are no product standards and safety checks needed at the Irish border (these would take place in the Irish sea instead); and (3) the Northern Ireland Assembly would have to approve their membership of the EU single market for goods every four years if the backstop came into effect. According to the President of the European Council, Donald Tusk, the EU is “open but not convinced”. The EU objects to points (1) and (3) in particular, arguing that (1) is untested and ‘unworkable’ and (3) makes the application of the backstop contingent on the support of the government of Northern Ireland (god forbid!) which is dominated by the majority Unionist community and has not been sitting in recent months due to an ongoing dispute between Sinn Fein and the DUP. Proposal (2) is a technical breach of single market rules, but it is not likely to cause a stink given that it is basically a UK concession.
Johnson’s Brexit plan looks to have the backing of the UK Parliament and came not a moment too soon with just 10 working days before the crucial EU Council Summit on 17 October. UK negotiators had not presented the new backstop proposals before now in an effort to force the EU to engage with them constructively rather than reject them out of hand and demand further concessions from a PM who they know faces a hostile Parliament. Unfortunately for Johnson, a law demanding that he request another Article 50 extension if a deal has not been reached by 19 October (something he has pledged that he will never do) has left him backed up against the wall – and the EU knows it. The UK Attorney General has suggested that there is a legally sound way for the UK to exit the EU on 31 October without a deal and without having to ask for an extension. However, unless the EU believes him then, in their view, the alternative to Johnson’s plan is not ‘no deal’, but another three months of UK financial contributions, an election or second referendum, and perhaps a change of government, instead. They can afford to roll the dice one more time and we expect that this is what they will do unless the UK can prove that ‘no deal’ will result. We therefore continue to avoid sterling and dedicated exposure to UK assets, despite their relative value on most multiples. Once the Brexit fog lifts, the UK could be a gold mine for investors. But the clouds are thick – and the smart money can find plenty opportunities elsewhere. We are also cautious on Europe in the Brexit context, particularly with the dire economic data published on an almost daily basis and the WTO ruling against Airbus, both of which we discussed above. Happy hedging!
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