The CEO’s case for rocketing equity markets

Middle East and Korean peace in the offing

A year after writing about the unsustainability of the French economy, I found myself this August once again amidst the glory-on-earth that is inland Provence. The economy is in worse shape, even more of the profit-making elite have left the country and President Francois Hollande is beyond a blancmange.

Demand for places in the South Kensington Lycée is such that a new one is being built near Wembley football stadium. London’s gain is France’s loss.

And yet I join a select group of forecasters who have to date been proved wrong. We continue to hammer away at our theme of the bankruptcy of the French state while enjoying the delights of long lunches with saucissons de sanglier, the local rosé and the dream of owning our own estate. The head and the heart do not always move in sync. Why France will fall next.

The time to invest in equities is now. Ignore the pundits who declare them overpriced. Dismiss the majority view which emphasises these five certainties: anaemic world growth is set to persist for the foreseeable future; China is set to become a superpower; the North-South Korea stand-off is unlikely to change anytime soon; US supremacy is at an end; the Israel-Arab conflict will endure.

Instead, read the fascinatingly contrarian world vision that a well-known, cerebral CEO recently shared with me.

“China will struggle more than many investors expect, particularly in the context of what could be the Asian strategic surprise of the next few years: Japan. Chinese growth well under double digits at 7-8% will not be enough to sustain the socio-political compact which has kept it as a unitary state with a quiescent population. The subversive power of the internet, growing income inequality devoid of the hope that a rising tide will lift all boats, local corruption, Muslim extremism in some provinces and regional separatism, will lead to domestic problems which the Communist Party will not be able to contain. It could lose power while the country messily breaks up into smaller areas of influence, although it is worth keeping in mind that “smaller” in Chinese terms is still large by any other.

The Koreas will unify as the Chinese reconsider the cost of supporting the existing North Korean regime. South Korea will pay for re-unification, just like the West Germans paid for the East. After a decade or two of domestic integration focus, Korea will be born as an even more powerful economic entity, playing a much larger role on the world stage.

The US looks set to continue as a superpower. With the Republican Party in a mess, Hilary Rodham Clinton could be elected on a landslide at the next election, bringing the House along with her. The US will continue its upward trajectory, based on cheap shale gas and its flexible, innovative economy, with no one country able to challenge it.

Peace is due to break out in the Middle East within the next 3-5 years as the Shia axis surely will be broken when Bashar is ousted. He may not be out of power yet, but the prospects of continued Alawite domination of Syria (12% of the population) grow dimmer by the day as Sunni support for the rebels continues to grow. Syria’s fall would effectively defang Hezbollah and creates much improved prospects for peace with Israel. The new military government in Egypt may transition into a civilian government over time, but likely will continue to curtail arms trafficking across their border into Gaza, further weakening Hezbollah. Shia Iran, the main backer of Hezbollah, would end up being further isolated and surrounded by Sunni powers.

The Arab Spring has brought to the surface the main threat to existing regimes in the Arab world: a lack of growth and diversification with its consequent unemployment, especially youth unemployment – under 25’s being the largest (and growing) segment of the population in the Arab world. The monarchies and dictatorships have used the conflict with Israel as an excuse for their lack of progress, but this is no longer enough.

Peace with Israel will allow the focus to shift to growth. Informal approaches to Israel from the Saudis have already been made. For Israel, which does not have the military capacity to fully disable Iran’s nuclear capabilities, a comprehensive peace settlement may have allure. Not least because Arab Israelis are set to be a majority of the population within a decade.

The confluence of these unexpected factors, including the enhanced power of the US and the shock of a Middle East and Korean settlement, means equity markets will take off on the back of the boost to world growth.”

Hopefully, this radical vision will more likely happen than this Column’s dire French predictions.

The Tyranny of Numbers

Criminal bankers, interest rate spikes & mythical holidays

I assume we will be seeing bankers in court, as UK Chancellor George Osborne is set to implement a reform suggested by the Parliamentary Commission on Banking Standards, namely introducing a new criminal offence: “reckless misconduct in the management of a bank”. Pandering to populism, it is aimed at capturing bank CEOs and directors.

But should not our new, state-of-the-art regulatory system be in the dock right now? The prosecuting lawyer would surely argue there was “reckless misconduct in the supervision of a bank” when the Co-operative Group’s bank was rescued last month. After all, there were plenty of warning signs when in 2012 the bank plunged to a £674m loss amidst almost £470m in write-downs due to commercial property loans acquired via a takeover in 2009.

And why restrict the accusation to financial services? I can envisage “reckless misconduct in the management of a nation’s health” which would apply to all junk food company CEOs.

The list of company directors accused of “reckless misconduct” could be as endless as it would be pointless.

Watching Quentin Tarantino’s classic Pulp Fiction the other night underlined how anaesthetised we have become to violence. Released in 1994, it was a byword for violence. Now, in 2013, it appears endearingly quaint when compared to the blood-spattered Call of Duty: Black Ops II and other ghastly video games played by teenagers.

In a similar fashion, we in the West have become inured to low interest rates and a negative return on savings. We are assuming a few years of them – witness the market panic when the Federal Reserve suggested mid-June it would soon taper off its stimulus programme of buying government securities.

New UK Governor Mark Carney is expected to give guidance next month to push UK rates lower. Interest rate markets currently estimate the first rate increase for 2015, not late 2016, which was their May forecast.

However, say the US economy accelerates faster than expected and the Fed eases off its quantitative easing in line with new circumstances. Sterling plummets. Might not Carney be forced to raise rates unexpectedly early in order to combat a sterling crisis?

Black Ops II would be nothing compared to the carnage unleashed then.

Leadership is about taking decisions without the evidence to back them up.

At a recent Pi Capital event, Lord John Browne, former Group Chief Executive of oil company BP, voiced concern about the current culture of “evidence-based decisions.” He noted that we live in an age of data overload, which leads to an unhealthy reliance – a decision appears to almost “make itself” based on the facts. Most great leaders have made judgements which appeared irrational at the time, with wartime hero Winston Churchill and steel magnate Andrew Carnegie among classic examples.

German philosopher Friedrich Nietzche was right to warn about the “continual falsification of the world by means of numbers.” His words two centuries ago are even more true today due to what Professor Christopher Coker calls “the unstoppable onwards march of mathematics.” Even when the limitation of numbers is shown up – viz risk systems and the financial crisis – the belief system continues.

Boardrooms are often populated by those who hold unconditional faith in numbers, a delusory substitute for religion, most of which at least admit that God’s plan is a mystery.

Two Prussian military commanders, Carl von Clausewitz and Helmut von Moltke, understood the self-contradictory absurdity of scheduling the movement of divisions and battalions in carefully calibrated master plans. The former admitted that the very nature of interaction is bound to make war unpredictable, while the latter put it in a rather more down to earth way by remarking that “no battle plan survives contact with the enemy”.*

The language of the Boardroom is increasingly financial. Yet the world does not operate according to a mathematical formula. In Non-Executive Searches too much emphasis is placed on all board members having deep financial skills, be this a career in finance or an accounting qualification. This is often at the expense of imaginative, creative thinkers, with careers that probably will not include the initials “CFO”. They are often women. There is no arguing that financial skills are crucial in a number of key roles, such as Chair of the Audit Committee; however a partner in a law firm in charge of Competition and Antitrust, or the head of marketing at a multinational may provide other relevant skills to the team.

Financiers formed the majority of the board of Royal Bank of Scotland in 2008. They were of little use in halting its downfall. Diversity is more than just a politically correct catchphrase.

Conventional wisdom in this country has it that southern Europeans are always on holiday. Discussing the topic recently with various Spanish and Italian compatriots who now live in London, we grasped that this was a myth.

In Spain, holidays consist of a week at Christmas, a week at Easter and a month in August, with a few days off in between for Saint’s days. In London – and even more so in the City – they consist of two weeks at Christmas, half term in February, three weeks at Easter, half term in May, half time over the month of June between all the social events like Glyndebourne, Wimbledon and Henley, a why-don’t- we-deal-with-this-in-September attitude in July followed by the month of August off, and capped by two weeks of half term in October.

Robinson Hambro, as an enterprising Anglo-Spanish boutique, is never on holiday.

*Warrior Geeks by Christopher Coker, a fascinating tour d’horizon on the changing face of war and its philosophical underpinnings.

Reputation loss: Rato, Mervyn and Dimon

The growth myth

If raw capitalism is about creative destruction, we have undoubtedly seen a lot of destruction. It is not yet clear how creative it will be.

On the back of the financial crisis there was a first wave of people such as Dick Fuld of Lehman Brothers and Sir Fred Goodwin of Royal Bank of Scotland.

We are now seeing the second wave. Mervyn King has lost his reputation as a competent governor, although he won’t lose his job. The Governor’s consistent refusal to commission a study of what went wrong at the Bank of England; a series of in-depth articles detailing his rejection of dissenting opinions; his antipathy towards the City; his obsession with monetary policy at a time when financial stability should have been high on the list; these have all massively eroded his credibility.

The much-criticised independent Court of Directors has now countenanced three separate studies on the issue, surely an embarasse de richesse. Those who argue the Governor ensured each study has a very limited brief are right, but the fact that they are taking place is itself a most vehement slap in the face.

The destruction of the stellar career of Rodrigo Rato, Spain’s much-lauded Finance Minister in better times and subsequently Managing Director of the International Monetary Fund, is further advanced. It has now imploded with Bankia’s effective bankruptcy. The third largest Spanish bank by deposits was effectively nationalised and its chairman fired. The bank spent many months without a ceo as no banker of note was willing to serve under a man who had never been a banker yet whose views reigned supreme.

Jamie Dimon, the embattled head of JP Morgan Chase, is still in his post following $2bn of declared trading losses at the chief investment office. Market and press estimates put the loss at a probable $7bn. More importantly, this raises doubts about the bank’s risk assessment. Dimon’s fate has yet to be decided, but calling the trades “an isolated event” is surely tempting fate.

Is there a common theme linking these three personalities? None of them have been felled by personal scandals. They are all intelligent and all acted and are acting with the best intentions. They have been justifiably acclaimed for years. But we are living in exceptional times. What they perhaps all lack is the capability to allow strong characters around them, the capacity to accept criticism and the flexibility to change behavior accordingly.

At least what happens to those who fall from grace these days is less violent than in ancient times. Julius Caesar, whose dictatorial tendencies were upsetting his peers in the Roman Republic, was assassinated by Brutus and others. He needed a jester, much beloved of later European monarchs, who was armed with permission to mock and thus keep the ego and ambitions of royalty and others within bounds.

According to Roman historian Suetonius, Caesar’s final words were not the famous “Et tu, Brute?” (And you, Brutus?); rather, he spoke his last words in Greek, the language he used for family and intimates: “Kai su, teknon?”(Even you, my son?).

Caesar was rumoured to be Brutus’s father as his long affair with Brutus’s mother was well-known.

The Financial Services Authority will exist for only a bit longer in its current form. It is now a source of destruction, liberally doling out fines and reputational damage as it seeks to cover its former laissez-faire sins with a tsunami of action.

At Robinson Hambro we quacked with fear at the return address on the envelope that came through the office door: “Unauthorised Business Department, Financial Services Authority”.

Our Board Search boutique looked set to bite the dust. All the hard work – be it finding Chairmen for companies, to hosting high-powered dinner parties, to dealing with Ambassadors and family offices – was to be in vain.

We quacked as we opened the letter. Had we mistakenly told a retailing Chairman that a few more women on his board would be a good thing? Had our Ambassador turned out to be a much-married fraudster with children scattered all over the world? Had the blue of our corporate logo infringed a new regulation?

Once the shaking of the hand that held the letter stopped, it turned out to be a warning that we were being targeted by fraudsters. As the FSA warned, in bold, “Remember: if it sounds too good to be true, it probably is!”

The new conventional wisdom, that growth can be easily combined with austerity is just that: too good to be true. There is worthy growth, based on structural reforms and investment and moderate spending, and bad growth.

Far be it from me to question the wisdom of the International Monetary Fund, which in this week’s report on the UK suggested a further lowering of interest rates from the base rate’s 0.5%. Nevertheless, when you are bumping along the bottom, shaving off half a percentage point makes little difference. Take a look at Japan.

As for its suggestion of infrastructure spending, anyone who has tried to move around London, where traffic is paralysed by road and building works, would think enough is being done. For future spending, with no money in state coffers, it will be tempting to finance increased infrastructure investment via private finance initiatives (PFI) or public private partnerships (PPP). These are often accounting gimmicks to keep government liabilities off-balance sheet. The UK has merrily exported these to the rest of the world.

Additionally, infrastructure spending takes quite a bit of time to make its way through the system.

There is, of course, a more radical solution. As proposed by the Institute of Directors and the Taxpayers’ Alliance, a single income tax rate of 30% would put money in consumer’s pockets. It would lead to a surge of spending. Combine that with another radical measure, the raising of interest rates, and savers would be rewarded after years of being the losers compared to borrowers. This would create enough confidence at a micro level for increased spending.

Simplistic, you say, gentle reader, with no thought for the other implications of such policies? Right you may be, but the IMF prescriptions are no less so. Pushing a cut in interest rates and more quantitative easing, when there is no evidence of what the medium term effects are, leaves a lot to be desired.

Perhaps, though, a new “growth” strategy from the government will be enough to boost confidence, just as perceived austerity took it away. Headlines on new spending are perfectly timed for mid-term. The coalition government’s management of public relations is looking good.I have my own jester, keeping my feet on the ground. My son’s Norfolk terrier, Sasha, a small golden bundle of fun, pines to be a source of destruction – with no creativity thrown in. He has now taken to dementedly barking at all and sundry, especially larger dogs who could eat him in two easy gulps.

Having tried everything from rolled up newspapers to shouting, it was suggested I try spraying his nose. Armed with a spray bought in Avignon a few summers ago, we set off on our walk. Encountering a German Shepherd, I maniacally spritzed Sasha’s button nose with lavender spray. The smell of many a Provencal summer wafted tranquillity onto me. The little dog continued his snarling and baying for blood. The German Shepherd disdainfully walked on by.