Monthly Archives: November 2012

Financial Reader Part 2 Demographics and Finance

Financial Reader Part 2. Demographics & Finance
The second excellent piece from the FT is an, admittedly poorly edited, piece about demographics and finance (The population conundrum). I’m going to challenge the very essence of the piece, but in doing so I do not detract from its substantial contribution.
Japan – the first major developed economy to experience population shrinkage through ageing – was the economy that first introduced the idea that economics and finance are positively correlated to demographic trend. One might think that obvious, but, as the FT article points out, high returns have coincidentally been accredited to almost any other driver:
Such high returns were frequently attributed at the time to factors such as globalisation, deregulation, rising productivity through the widespread use of technology and the taming of inflation.

For me, the first major contribution to the topic was perhaps The Pinch, a detailed pre-crisis review of post industrialist Britain. Now the FT is taking the concept global, and mainstream. Yet is it automatically true that financial markets are prisoners of demographics, and that for this reason we are doomed to suffer a protracted slump?
The idea is both scary and intuitively alluring. But whilst the empirical correlation is clear, it is wrong to assume that our future is bleak simply because populations are ageing. Perhaps the best reflection of this comes from my own MBA programme, which took place in Spain. By coincidence Spain has some of the worst demographic dynamics of the Western hemisphere, putting the topic firmly on our study screens.
My challenge to the thesis that the demographics and economics are structurally cointegrated was perfectly underscored by my MBA class. As a group we produced a stream of ideas of business strategies to profit from ageing markets. Large retired populations switch to saving and spending, rather than working. But in essence this means they still consume, and invest. Their consumption patterns change of course, and so we can look for new businesses, products and services to benefit.
Stretching a degree further, I would highlight that the global population trend remains upward, hence there also remains potential for labour markets to remain stable, if sentiment toward immigration evolves suitably. Remember at the same time that we are automating ever more and have the potential to eliminate many low-skilled jobs altogether. Absent that, we will of course see continued off-shoring and an even more productive, self-sustaining globalisation process.
For me then, there is an empirical, but not obviously fixed relationship between demographics and economics. More pertinently, we live in a world of deleveraging and painfully excessive debt-loads, like it or not, we need to dramatically reform our welfare states, and to stimulate growth to get out of this fix. Until we complete these two monumental challenges, the danger is that financial markets will struggle to move against shifting demographic trends, regardless of the creativity of the capitalist system.

The Financial Reader Part 1

The FT came good this week, after a rather protracted period of below par commentary, it ran three excellent pieces, which can help us to pinpoint our current status in this prolonged chapter of post-industrialist adjustment.
Part 1: Ethics of Finance
The awesomely named Lex van Dam, who – unbeknown to me – has become something of a post-crisis media star, beautifully summed up the persistent problem of big-bank capitalism (Adoboli should not take all the blame).
His defence of Kweku Adoboli is a stretch (“Adoboli comes across as a decent, hard-working person”), whether his superiors new or not, Adoboli drifted from ambitious to outright criminal.
But his own old-school motives in finance “Money did not interest me as much as the daily fight to be smarter than the market,” are too rare and would even spark incredulity from many in the city. Until such drivers return, finance will continue to walk the wrong side of the ethical line.
Sadly, as much as I desire it, I also doubt Lex’s conclusion: “(Adoboli‘s) actions could produce a positive side-effect that the credit crisis did not, and that is to force investment banks to become serious about how they risk their capital – or, perhaps I should say, their shareholders’ capital.”
For now, banks are staffed by survivors. It is wrong to assume that large capitalist entities are efficient meritocracies. All too often the survivors are the players, skilled at manoeuvring carefully, driven by self-interest and disdainful of honest value creation unless it directly (and excessively) lines their own pockets.
Whilst the regulatory framework is still in flux, banks can alternately blame the environment for their failings and disguise beta as alpha when it goes right. Once the regulatory environment has settled, assuming that the global debt overhang doesn’t pull us into depression, then we might get a shot at really cleaning up finance. 

Notes on the EU Budget

The European Union budget discussion underway today is of no less importance than was the Treaty of Versailles back in 1919. Then as now, Europe was economically broken and lacking unity amid a cacophony of competing demands that ended with the pie shrinking for all.

The Treaty set Europe’s (catastrophic) economic and political course for the ensuing 20 years. Likewise, today’s debate will determine the chances of the European Union coping with the fall out of what has the potential to be an even worse economic period, if badly handled.

The Treaty caused turmoil by requiring Germany to go through a completely impossible economic trial. Likewise, increasing spending at the “federal” level today is a completely unrealistic challenge for the continent that is home to the world’s highest national tax rates, already going through a painful, forced downward spending adjustment.

The EU is a vitally important project, but it was designed to bring unity and common purpose, healing the scars of war and conflict. It has grown beyond that, and it seemed laudable to pursue convergence through inter-European structural funding as waves of less developed entrants joined the core. But, the sad and unavoidable conclusion of the financial crisis is that structural funds haven’t solved the problems they targeted. In the meanwhile, the net contributors have entered difficulties of their own.

To stand strong through this period of difficulty, Europe needs to remain cohesive and united. But, it is time for countries to assume responsibility for their own economic conditions. Increasing the union budget at a time when nations can’t finance themselves is absurd. Building a union on debt likewise.

Fiscal Cliff is a Window of Opportunity

Last night the market fell again, reaching new lows after President Obama gave his first post-election press conference, and repeated that he wants to raise taxes on wealthy Americans. The obvious conclusion here is that the two US political parties are on the same collision course they were on last year, and that for this reason equities are are the wrong place to be invested. In my opinion, this is a mistake interpretation.
The first speeches about the fiscal cliff after the election were very gentle, but it should be openly accepted that a hardening of public posture is essential before moving toward agreement. It is a great shame that the market seems unwilling to project more confidence in political process.
Both the Democrats and the Republicans have move since the election. Particularly the latter who are now conceding that de facto tax hikes are possible. Today Obama hinted that those tax hikes should be explicit, not simply closed loopholes. The truth is that such a step is now on the table, but only in the case of a “grand bargain” resolving the whole issue for the longer term.
In short, the negotiating process is proceeding well, and arguably quicker than might be expected. Of course there are many possible missteps, but we should not doubt that there is a negotiated solution ahead. In this vein, it remains my conviction that the sell-off is an opportunity to get into an accelerating global cycle, rather than a last chance to get out of risky assets before a cataclysmic crash (as any crash at this stage presumably would be).
We stand ready to present carefully selected conviction investment ideas targeted to your risk profile and personal preferences.
Best regards,
James