"Our peace will, like a broken limb united,
grow stronger for the breaking."
K. Henry IV Pt. 2.
Recent election results have not been happy ones for pollsters. Public verdicts on Brexit, Trump and May heaped embarrassment on most of them. Theirs is an industry used to dominating headlines at political crisis points. One wonders now whether pollsters have lost touch with reality. Reliable signals of voting intentions seem to belong to a different world, inaccessible to psephology.
A similar disconnect exists between the apprehensions of many investors and the upward march of equity prices. Granted, economic trends generally continue to improve in America and Europe, if less in the UK. Growth continues, and unemployment on both sides of the Atlantic is at a record low. Company profits have risen quite sharply, as have dividends. These benign trends have naturally assisted equity markets. Even so, the extent of the recent rise is hard to justify using standard investment analysis. Many investors, maybe most, remain anxious. Yet the markets’ rise implies that their worries are misconceived. And, so far, they have been. That is because the potency of another factor has been widely underestimated.
The effect of post-crisis efforts to re-liquefy the Western banking system is that factor. Financial asset prices have been inflated beyond any conventional reckoning as a result. As interest rates collapsed, so market prices have been pushed ever upwards. Rescue of the global financial system has rendered the usual yardsticks of investment value virtually meaningless. For some 10 years, investors have had to engage with a strange new world whose price levers are operated by central banks. Recently the US and UK authorities have begun to raise interest rates. But primary borrowing costs are still close to historic lows. Late in the day, the consensus has shifted. Many observers now conclude that so long as monetary policy remains relatively relaxed, equity markets may retain - even extend - their recent advance. However, consensus is no guide to the future. Just as the driving factor behind the markets’ rise was mistaken, so may be the cause of a possible relapse.
Among those without a stake in rising asset prices, trust in the workings of the enterprise system has collapsed. In both America and the UK, successive governments have estranged large sections of the electorate. Massive policy failures have bred popular mistrust. In the UK, immigration, health, education, Europe, environmental, and social support policies have all failed to meet expectations. For much of the UK population such failures coincide with an extended period of falling real incomes. These disappointments follow a span of 30 years over which privatisation, outsourcing, and anarchic globalisation detached the governing order from accountability. Over roughly the same period, business credibility has been shredded by rampant exploitation and greed. While executive pay has soared, and profits of the technology sector have skyrocketed, tax is exigible only, it seems, from those unable or unwilling to side-step it. Popular resentment is the new reality confronting authority.
The lesson of recent ballots in America, the UK and, perhaps, even Germany is that the worm has turned. Among a populace longing to rid itself of a failed establishment, the iconoclast reigns supreme. The ascent of Corbyn and Trump is no coincidence. History teaches that an economic system engendering resentment and mistrust on the current scale cannot long survive. Mr Corbyn’s manifesto proposed an alternative of radical socialism and the disaffected rejoiced. Any voice perceived as authentic can triumph when patience with rhetoric wears thin. No doubt equity markets can ignore, for a while, the intangible factors that are turning the tide of consent. But in the UK retreating eddies are already visible.
The Bank of England begins to frown at an asset inflation of its own making. Tax fugitives, especially tech leviathans, fall prey to the court of public opinion and the grasp of a cash-strapped Treasury. Digital data publishers are compelled to acknowledge a wider social responsibility. Unions begin to flex their muscles in resistance to further falls in members’ real income. Tensions between popular aspiration and fiscal capacity rise by the day. In the UK the strains are all too obvious in the NHS. So far these ghosts at the party have failed to dent the mood of the market. They are likely to take clearer shape before long.
The question for investors is how, if ever, the impact of public frustration will affect confidence; how social disquiet may result in consequences that matter to markets.
In the UK, government borrowing looks set to remain high indefinitely. Falling economic growth means tax revenue will shrink below previous expectations. Political response to competing claims may take various forms. Income pressure on consumers can be met by direct intervention. The government has already flagged an intention to cap gas prices. Regulators of privately owned utilities face pressures to toughen up control over companies’ permissible returns. Clamour for the renationalisation of essential services seems to be growing. Even bigger challenges arise from the claims of the health service, especially provision for mental disease and care for the elderly. Hammond’s recent budget paid lip service to many such demands. More funds will be demanded. The ultimate net impact of Brexit is yet imponderable. Meantime the transitional costs are almost certain to be considerable.
Presumably the government’s revenue base can be enlarged through tax increases. Short of faster economic growth, however, it is questionable whether any practicable tax adjustment can yield enough to quell insistent spending demands.
Spending ceilings are likely (again) to take the strain. Borrowing forecasts will tend to rise. In a year or two, when the pressures become apparent, the UK will be on its own. Access to the supportive structures of the EU will presumably be unavailable. At some point before then concern over the UK’s fiscal position will grow. Thereafter any clear prospects disappear in a cloud of variables. Exchange rate movements and the course of inflation are two critical ones.
Apprehensions about the future shape of the enterprise system have framed our own investment strategy. This reflects an expectation that the journey towards a less polarised public consensus may, for a while, be troubling. Reconciling the claims of a frustrated underclass with the means of satisfaction will take time. Even if Britain’s history supports confidence that common sense will ultimately see us through to the necessary compromise and balance, fiscal strains on the way will be uncomfortable. It is difficult to see how the equity market can remain unmoved.
These comments relate to Britain alone. Some are relevant to other countries too. America faces budgetary problems similar to those in the UK. While Britain is the site of a (significant) share of global investment activity, its market prospects cannot be assessed in isolation. Global investors’ preferences always rest on relative calculation.
Following the banking crisis 10 years ago, the community has become atomised at two extremes – one part carried to cosy warmth by rising asset values, the other abandoned to chilling stringency in an Arctic wasteland. Happily, some progress towards re-establishing our connectedness with each other and with the world outside is discernible.
Businesses are beginning to reshape mistakenly narrow priorities into a more sustainable model. Many acknowledge that survival depends on regaining the trust of all their stakeholders. Environmental impacts are being weighted much more heavily in national priorities. Protecting the planet is beginning to matter as the tipping point draws near. The internet invites abhorrence of institutional extravagance from a mass audience. Encouraging signs are evident in other fields. The Christian establishment is beginning to use a more popular idiom to reconnect itself with the millennial generation. Scientists are documenting connections between health and the social environment. Lovers of the natural world are discovering aspects of animal behaviour analogous to our own. Threads of connectivity are being drawn together in all sorts of areas.
Divergent experience has divided our nation. Countervailing forces of conciliation and mutual understanding are urgently required. Good sense, the voice of democracy and constructive use of digital media can provide them. Society may be fractured but its constituents remain interdependent. Recovery of a lost connectedness and better awareness of the requirements for sustainable co-existence can help close the divisions.
Sooner or later pollsters will discover the sentiments that matter in the new reality. At that point their forecasts will play out in results. If their reconnection with the mood of voters mirrors similar progress in wider society, equity investors will be able to view their future returns with more justifiable confidence. They would then belong to something like a united kingdom.
1st December 2017