17 Sep 2024
Jonathan Platt, Head of Fixed Income
Having returned from a short cycling holiday in Dorset I can confirm that the countryside is beautiful and lush – probably due to the high incidence of rain in September, if my experience is typical.
A neglected feature of our de-industrialisation is the array of cycle paths, established on disused rail lines. The commercial drive to build lines in the Victorian period was partly to capture passenger traffic but was often associated with industrial requirements, particularly the shipment of coal. Indeed, the importance of coal helped drive an earlier development – canal building. In today’s fast evolving world, we lose sight of the tremendous technological change that has shaped our history in the last three centuries. The entrepreneurial spirit that saw private capital attracted to canals and then railways was not always rewarded, with many failures along the way. But that spirit was the bedrock of Britain’s economic success. Failure was an accepted part of life.
Risk and return calculations are basic human instincts. Individuals make choices that reflect their preferences: some tolerate more risk; others favour a more cautious approach. This is not done in a vacuum but is shaped by societal factors. This brings me to a report published last week on the Future of European Competitiveness. Whilst this is an EU report the conclusions are applicable to the UK.
In the paper Mario Draghi sets out the challenge. Whilst the EU boasts strong education and health systems, backed by solid welfare states, there is a struggle to turn these assets into globally competitive industries. As a consequence, a significant GDP gap between the EU and the US has arisen, primarily due to slow productivity growth. On a per capita basis, real disposable income has grown almost twice as much in the US as in the EU since 2000. To make matters worse, the demographic shifts underway, implying a shrinking workforce, increases the importance of productivity growth.
The report highlights three areas for change. First, to close the innovation gap with the US and China. To illustrate this point Draghi notes that there is no EU company with a market capitalisation over EUR100 billion that has been set up from scratch in the last fifty years, while all six US companies with a valuation above EUR1 trillion have been created in this period. The solution offered is to improve financing options for unicorns, to make entrepreneurs less dependent on US venture capital. But this misses the point. Europe is caught between two models. A state sponsored system, as seen in China, and a freer market approach in the US. There may be a third way but the regulatory mindset, often the friend of the incumbent, is a greater impediment. The conundrum is how to inject more competition, and accept more disruption whilst keeping a social model, based upon welfare systems.
The second solution is to position for decarbonisation and to eliminate the energy cost advantage that has aided the US. This shift to low-cost clean energy may work but the transition will be problematic and costly. Third, Draghi wants an EU foreign economic policy, to reduce dependencies on China through securing preferential trade agreements and direct investment with resource-rich nations (“closing stable doors” comes to mind). A more coordinated defence regime will also be required to channel government spending to European champion companies, reducing reliance on US technology. What is not spelt out is that all this will require much greater political integration at a time when disillusionment with the EU is on the rise. The UK faces the same issues. There is an increasing inclination to regulate all facets of life, driven by the belief that markets are unreliable. It seems probable that both the EU and the UK will have to learn that despite some imperfections, markets remain the most efficient way to allocate resources and foster growth.
Government bond markets continued the recent downward trend in yields. Ten-year US rates finished below 3.7% whilst the UK equivalent moved 12 basis points lower to close below 3.8%. The 25bps cut in official euro rates was widely anticipated and there was only a small fall in ten-year euro yields. On the data front, the UK GDP release for July was disappointing, showing no growth in the month. Services were a bit stronger, after weather and strikes dragged on output in June but there were falls in both construction and manufacturing production. Overall, the GDP release is supportive of the interest rate cut profile priced into markets but upcoming labour market and inflation-related data will weigh more on Bank of England thinking. Credit market spreads were broadly unchanged. In sterling higher issuance pushed investment grade spreads a touch wider whilst high yield was generally stable.
Ending back on politics. I love the Rest is Politics US version. What is apparent from these podcasts is that the hunting ground for votes is the US middle class; over half of the electorate put themselves in this category. This contrasts with the UK where the percentage is nearer 30% and more Brits now identify as being working class than in 1997. According to a New Stateman survey a year ago this increase in working class identification is associated with more left of centre economic policies and may explain our growing preference for regulation over competition.
This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.