There is an old (and valuable) piece of advice that says never send an angry email at night and many is the time that a ‘rant’ about something has sat on the ‘draft’ pages of wordpress until the following morning, whereupon it is usually deleted. It was interesting to see therefore that in breaking my own rules with the last blog post (The Full Melchett), written in both anger and haste, I caught the attention of the mighty Lockdownsceptics.org and a few other blogs besides and, as a result, led to a small flurry in subscriptions. Welcome. Any new visitors might therefore also like to check out the previous post on General Melchett as well as the ones on Dad’s Army and (my favourite word of 2020, Kakistocracy). Or even the Christmas Murder Mystery. However, this blog is not solely about the madness of Covid and the official response to it. It is really aimed at understanding markets, particularly, but not exclusively, financial markets, by analyzing the behaviours of individuals within those markets. Moreover it is also aimed at analysing Systems, for it is the interaction of natural Human behaviours with the System that drives the outcomes.
Common Law – Everything is allowed, unless it is forbidden. Napoleonic/Justinian Law – Everything is forbidden, unless it is allowed.
One clear difference in Systems is revealed by the four year long fight over Brexit, which came finally to an end last week with a last minute ‘deal’. The reality is that the UK operates under Common Law system, whereas the EU (and much of the world including Russia, Japan and China) operate under Justinian or Napoleonic law. The best way of comparing the two is the age old quip that under Common Law, everything is allowed unless it is banned, whereas under Justinian or Napoleonic Law, everything is banned unless it is allowed.
In fact this does not so much describe a system, as a set of common cultural behaviours. British tend to prefer the notion that it is better to apologise than to ask permission, whereas many continentals (especially the Germans) prefer the opposite approach. Having worked for a variety of continental financial institutions – Swiss, German and French – over the last thirty years, as well as British ones, I can confirm that the cliché exists for a reason and (again anecdotally) would note that the most entrepreneurial of my colleagues may well have been European, but they all came to work in London precisely because of the apologise rather than ask permission culture. At the same time, some of the most obstructive members of what we used to refer to as “The Revenue Prevention Team’ were British nationals, imposing an ‘ask permission culture’ on would-be creative ideas. Thus we would stress, it is not the people, it is the system.
As regards trade, we don’t need permission to trade. We never did. If we can design a system that makes it easier, then even better, but we have never been as worried about the prospect of ‘No Deal’ as many in the Commentariat have been, since we recognise that ‘the System’ of trade does not require the permission of a trade deal for trade to happen. Indeed, trade deals are often designed to favour a small group of large and influential businesses with close ties to government over the interests of small businesses and consumers – the EU customs union being a prime example of this, designed to protect inefficient ‘home’ producers from cheaper foreign competition, particularly in areas such as food, clothing and textiles.
This then is the medium term opportunity for the UK, allowing new competition and new players to maximise on the relative growth opportunities that come from this culture rather than the over-regulated red tape of the EU. Note, this is not an anti EU point, rather it is looking at the best environment within which markets can work to deliver goods and services to consumers of the best possible quality at the best possible price. The ability of companies to prosper (and for us to invest in) is inherently dependent on the system they operate under. A change to the system therefore can be regarded as an exogenous shock to our corporate models. The flip side of course to this potential reassertion of Common Law is that, thanks to Covid, it is exactly the newly empowered Health Taliban, Town Hall Bureaucrats and ‘Warden Hodges’ of this world who are currently doing their best to impose an ‘everything is banned unless we grant permission’ culture in the name of Health and Safety and in doing so to strangle the entrepreneurial Gig economy that has grown up as a result of the Common law culture (which is ultimately where the Full-Melchett rant came from).
However, these are largely what we refer to as Medium Term Risks and the purpose of the Monday Morning Musings is to focus a little more on the Short Term Uncertainties. Here we would obviously point to the Georgia Senate Elections this week, which technically get to set the balance of power in the US. The markets bounced following the Presidential election, not, we would argue, because they favoured Biden over Trump, but because there was no Blue Wall – the notion promoted within the Democrat Media bubble that the Democrats would sweep all three branches of the legislature. Markets don’t like governments to have too much power – after all that could change ‘the system’. Should the Democrats win this week then the CNNs and New York Times of this world may find themselves ‘shocked’ that the market might not like it.
The obvious markets for short term uncertainty are the FX and to a lesser extent commodity markets, as we discussed in our January Market Thinking and thus it is worth noting that today the US$ trade-weighted index has broken 90 for the first time since 2018.
Short Term Uncertainties will focus on the US$
Currency trading is heavily technical and, if the previous low fails to hold, then we would expect the narrative to shift to one of a ‘deliberate $ devaluation’ and predictions of Euro and Sterling at 1.50, Yen at below 100, AUD at 90 and (most painful of all perhaps) the CNY below the 6.2 ‘floor’. This is not to say that any of this will actually happen, the whole point of FX noise trading is to predict a large move in order to trade a smaller one, but the noise from FX does tend to have a spill over into other markets – not least in driving diversification. Look for example at a snapshot of one-year returns for a US $ based investor returning to work this morning. Note in particular the difference between the two most right-hand columns, the local currency and $ based return for China, Japan and even Sweden.
A case for International Diversification?
As we noted in the January Market Thinking, the first quarter tends to be a period when (largely risk-averse) Asset Allocators try and set out their ‘Year Ahead’ and the first step is usually to go neutral to the Index, which can mean allocating not so much to things they ‘like’ as to things they are underweight. This means rotation. As a second step they are likely to revisit diversification and with many crowded into a narrow group of US Tech trades there already looks to be some rotation into so-called ‘Cyclicals’ and, increasingly we suspect overseas markets, most obviously where locally traded Tech stands to do better than the US equivalents on the basis of access to the faster growing markets. Some are seeing this as a strategic ‘bet’ on ‘risk’ and high beta, but our analysis of the people (risk averse asset allocators) and the system (one obsessed with benchmarks and volatility) actually suggests otherwise.
