Taal selectie

Sell in may and go away

Not Out of the Woods

Pascal Blackburne & Luc Synaeghel 2019-06-01

The European elections have come and gone, without the feared populist victory but yielding a fragmented landscape – which promises intricate negotiations to form a majority in parliament and elect the EU Commission President. Meanwhile, financial markets have also been rattled by a new set of Trump missiles, targeting China and Mexico. Making investment decisions in such an unpredictable and geopolitically-driven context really is a delicate and difficult task.

In just a few weeks, US-China talks have moved from being near an agreement to slipping dangerously towards an outright trade war. By raising – with immediate effect – the tariff on USD 200 million worth of Chinese products from 10% to 25% and blacklisting Huawei on national security grounds, President Trump has considerably reduced the odds of a near-term trade deal. The white paper subsequently released by China suggests that, while leaving the door open to discussions, it is gearing up for a protracted conflict, and blaming the US for the current impasse.

The May 30 surprise announcement of a 5% US tariff on Mexican goods, scheduled to rise to 25% by monthly increments of 5% “unless and until Mexico substantially stops the illegal inflow of aliens coming through its territory”, must only have added to Chinese concerns about the reliability of President Trump as an interlocutor. If he can tweet such a decision even as his administration seemed about to ratify the revised NAFTA (North American Free Trade Agreement), what confidence can China have that any deal signed with the US would hold firm?

We have long felt that, contrary to what many in America believe, China holds the upper hand in the trade conflict, not only because of its position in electronics supply chains, but mainly owing to its longer-term perspective and the technological knowhow it has attained. Chinese companies today are a far cry from being just manufacturers of low-cost goods. As regards the electronics space more specifically, a ban of “rare earths” exports to the US is being mentioned as a potential retaliatory measure. Indeed, Premier Xi Jinping’s visit to a domestic producer of these minerals (the country accounts for some 80% of global supply) was enough for the sanctions on Huawei to be postponed by three months. That said, disrupting electronics supply chains would hurt China too. Also, despite their name, these 17 metals with specific electro-magnetic properties are actually not that rare on Earth’s crust. It is just that China has been their largest miner so far…

What stance should investors take in such an uncertain context? With interest rates near zero for the foreseeable future, moving out of equities and into cash is no real option. However frustrating the disconnect between fundamentals and stock price patterns may be, we continue to advocate diversified exposure to attractively valued and dividend-paying stocks, with a willingness to sit out shocks. Shale oil producers, for instance, are trading at half their 2016 value, a time when they were heavily indebted and the oil price was around USD 25. Now that most are generating positive cashflow and oil is back to levels that well support their business, why such a depressed valuation?

European Elections: What Next?

The European elections brought no major surprises, save perhaps the fact that German Chancellor Angela Merkel is not ready to step down. They resulted in a fragmented EU parliament, with the four mainstream parties claiming “only” two-thirds of the 751 seats and a (divided) extreme right showing of 175 seats.

As such, only two options appear available to form a governing majority: the centre right Christian Democrats (23.8% of votes) could ally with the Socialists (20.4%) and the Greens (9.2%), or they could ally with the Liberals (14.0%) and the Socialists.

The first option would probably only serve to strengthen the far-right parties in the next elections, five years down the road. It would also be at odds with the composition of the EU Commission, to which each member country government gets to nominate one representative – hence resulting in legislative stalemate.

We thus rather expect the second option to prevail, with the Liberals playing a pivotal role. In fact, we would not be surprised to see their Margrethe Vestager become President of the EU Commission. Importantly, the Christian Democrats’ Spitzenkandidat, Manfred Weber, does not have the support of French President Macron. Mrs Vestager would also be acceptable to most parties, thanks to her tough stance with respect to anti-competitive policies, imposing billions of euros in fines since becoming EU Commissioner for Competition in 2014. And she would be the first woman to head the EU.

In the wake of the European elections, our bigger concerns actually lie at the country level, in the UK of course as the path to Brexit has become murkier than ever, but even more so in Italy. Bolstered by his party’s success in the European elections, Italian Deputy Prime Minister Matteo Salvini is now eager to deploy his 15% flat tax rate. Needless to say, this would cause the Italian budget deficit to soar, from levels that already well exceed EU standards.

Italy’s position in the EU is very different to that of the UK, being tied not only by a customs union but also by a common currency (i.e. common central bank) and the Schengen agreement. It is also very different to that of Greece a few years ago, because of its much greater weight in the EU GDP and the sheer size of its industrial sector, second only to Germany. As Italy’s debt pile continues to mount, how would the EU withstand a potential downgrade of Italian government bonds by the rating agencies?

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