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.

Of heroes and superheroes

Foreigners and the City

As soon as I find it, I shall briskly dust off my Canadian passport and claim kinship with Mark Carney, the next Governor of the Bank of England. It is now fashionable to come from the frozen north, while interlocutors express condolences at an admittance of warm Spanish blood. Yet this hero worship of the Goldman Sachs alumnus will not last.

A couple of years ago Sir Howard Davies, former chairman of the FSA and deputy governor of the Bank of England, co-authored Banking on the Future. His book called for the end of the central bank and central bank governors as we know them.

“The past model – a secretive institution little inclined to explain itself and maintaining an air of mystery, cloaked in constructive ambiguity, and led by a philosopher king – has run its course… The new model central bank will be led by an individual who is skilled in chairmanship and communication and one who has a deep understanding of the financial sector and the wider economy, on a global scale. Taciturn autocrats need no longer apply (my italics).”

Mr Carney fulfils these conditions and is the antithesis of outgoing Governor Mervyn King. Yet before we elevate him to superhero level, it is worth remembering that he has been in charge of the straightforward Canadian financial system. He will soon be overseeing the most international financial system in the world.

Having said that, his work as Chairman of the Financial Stability Board, which attempts to coordinate disparate financial sector regulatory reforms, will have given him a taste of the global complications involved, while his appetite and awareness of the scale of the task is evident.

“I’m going to where the challenges are greatest,” he said.

Another difference in scale is that Canada’s financial sector employs 274,000 people. The UK employs around a million.

Many of them are foreign, proof of the City’s meritocratic nature and of openness. At a couple of Robinson Hambro dinners, I looked around the 10-seater table at what others might call the Financial Establishment. At least half were not English. We had a French Chairman running a major part of the global financial system, an Indian economist working as the head of an important unit within the regulator, an Israeli founder of a financial boutique, the South African CEO of a natural resource company, the American Chairman of a UK-based hotel group and the Anglo-Danish Chairman of a number of companies. The wine came from the vineyards of the Group CEO of the London Stock Exchange, Xavier Rolet, a Frenchman (Chenebleu).

Yet UK immigration policy is a shambles.

At a 2010 gathering for FTSE-350 chairmen soon after the UK government took power, the consensus was that the Coalition had already made two major mistakes that would harm business. One was its stance on immigration, which continues to be a rampant sore. The government needs to stand up to those who believe that kicking out foreign employees at Pret-a-Manger and the like will result in a rise in UK employment. Too many CEOS of both local and larger businesses swap tales of bending over backwards to employ British low-skilled labour and of the sorry consequences.

The government also needs to sort out its cap on visas for qualified professionals. Lastly, it must allow students who come to the UK for degree studies to work in this country. Many will go back to their countries of origin after a few years, attracted by the positive growth prospects lacking in the UK. From their positions of influence they will favour a BUY UK policy due to familiarity with the system and, naturally, the rosy glow which generally surrounds those university years.

The Germans and other states have been following this policy for years.

The second criticism at the 2010 gathering was on aviation policy. The incoming government had ruled out a third runway at Heathrow airport. As a West London resident who is regularly woken at 4:50am by BA 12 from Singapore or BA26 from Hong Kong – not that one cares which it is at that hour – I am well aware of the downside. But ask any UK or foreign businessman where they prefer to land in London and the majority answer Heathrow, with City Airport a close second.

In any case, setting up an aviation enquiry led by Sir Howard which will not report until 2015 is a cowardly and harmful move. It is extremely doubtful that the decision will be politically easier after the next election, whatever the political make-up of a new government.We need political leaders with the guts to stand up for what they believe will benefit their country. The popularity of many of them is at historic lows even as they equivocate on many crucial decisions for fear of losing votes. Surely it might be worth a try to take a stand? The result might surprise our representatives. Voters are not as naive as politicians assume.

One man with enough guts to spare for a whole political party is Michael Woodford, the President and CEO of Japan’s Olympus Corporation who turned into a whistleblower in 2011 when he discovered a $1.7 scandal. Speaking at a Pi Capital (Pi Capital) lunch, he took us through his personal hell when the Chairman of the company fired him and he feared for his life and that of his family due to Yakuza (Japanese gangster) involvement in the company.

As he himself writes in his thrilling autobiography Exposure: Inside the Olympus Scandal: “I thought I was going to run a health-care and consumer electronics company but I found I had walked into a John Grisham novel.”

The Japanese establishment had never been that welcoming of the gaijin (alien) from Liverpool. Following the disclosures, it slammed the door in Mr Woodford’s face. With only a handful of foreigners running companies in Japan, this tactic was possible. If we tried the same thing in London, the financial sector would close down while the racket from the slamming doors would cause an earthquake

The Bank of England’s Tucker time

Asian crisis lessons for Spain and Italy

Knees to chest in the womb position, I bounced in the harness attaching me to the two- inch thick, descending cable. Picking up speed, I accelerated to more than 70 kilometres per hour over the Costa Rican valley open before me.

The finish, 750 metres away, was lost amidst faraway trees, as was the tiny body of the fool who had zip lined across before me.

“I am a widow with an 11-year old child and a thirst for life. WHY AM I DOING THIS?!” I screamed. Perhaps I only imagined the scream as my lips were frozen in petrification. I was powerless to stop the horrific experience. There is no rational reason to be separated from the earth by 200 metres.*

The lookout point from which we started the zip lining faced a colossal volcano. El Arenal is known as Costa Rica’s most active volcano, spewing large amounts of ash, lava and gas. However from 2010 it entered an indeterminate resting phase. An erupting volcano was not the issue. Thus the obvious risk in our zip lining was not the most important one.

Likewise, Spain and Italy are residual risks for the euro. Banks from other countries have had enough time to lower their exposure to the two countries. Wholesale financial markets have been inaccessible to the Mediterranean nations for some time. They are relying on the ECB.

In Spain, a full bail-out is needed, not least to take over from a government whose economic and financial chiefs (Minister Luis de Guindos and Minister Cristobal Montoro) are apparently too intent on throwing poisoned darts at each other to focus on the crisis. Prime Minister Mariano Rajoy cannot bear the humiliation of asking for help. Every day that passes the debt burden on Spaniards becomes heavier. For this he will be judged.

Meanwhile, neighbouring technocratic Prime Minister Mario Monti, who started with a bang, now has his hands tied by a squabbling Italian parliament.

They both need an authority from outside the domestic and European political mess, which can only be the International Monetary Fund.

During the Asian crisis, the IMF stepped in with a heavy tread. With hindsight, it would undoubtedly do some things differently. But all in all, its presence was sufficient to remove the political obstacles to structural reforms while its resources were put to use in Thailand, Indonesia, the Philippines and others.

The complexity of the factors and players involved in the solution to the Asian disaster defies a short column like this one. Still, the need for an authority separate from the crisis-ridden countries is paramount. The European Central Bank is too involved and too political a body: it should play a junior role to that of the IMF, like the central banks in the Asian countries being rescued at the time.

There are those who dismiss Western Europe’s future as that of a Disneyland for tourists from the Bric and other nations in Asia. Beware facile judgments. Many voices were heard being equally contemptuous of Asian nations during their crises. Within only a few years, the Asian tigers rose even stronger.

Only two months ago, the Philippines extended a $1 billion loan to the IMF to help in stabilising the developed world economies.

Transparency has become the sacred cow of our days. Justifiably so. Shining a torch into the hidden recesses of financial institutions has revealed the murkiness of Mexican money laundering, risk exposures being fudged and clients being consistently ripped off.

But there are times when obscurity is necessary, as in the following case. Until the spring of 2012, Paul Tucker, Deputy Governor of the Bank of England, was a strong contender to inherit the governorship from Mervyn King, whose second term finishes in June 2013.

As part of the recent scandal over LIBOR, the ever-more-powerful Treasury select committee called on Paul Tucker to give evidence. They quizzed him over a 2008 email from Bob Diamond, where the (now former) ceo of Barclays alleges that the Deputy Governor told him over the phone that “it did not always need to be the case that we [Barclays] appeared as high as we have recently”.

This was understandably interpreted by Barclays Capital, as an instruction to lower the bank’s Libor submissions.

Now, there is a big difference between the unethical manipulation of the Libor rate for profit – which had been going on for awhile at Barclays and other banks – and the example in question.

The phone call took place a few weeks after the fall of Lehman Brothers, when the world was zip lining with an untested harness. The biggest fear for the central bank and the government was a bank run, which would probably have spread, leading to panic on the streets. There were already rumours about Barclays’s shaky finances in the markets. These could not be allowed to spread to retail depositors. The central bank was simply doing its job in nudging Mr Diamond, via an innuendo-laden sentence, to lower Barclays’s Libor rates so as to shore up its shaken credibility.

There may well be reasons Mr Tucker is not the right person to take over at the Bank of England. But it is incorrect to judge him negatively for doing his job as he did in that now-famous telephone call. Shadows are just as necessary as light in economic management.

A short week in Costa Rica was followed by a leisurely ten days in France. Our summer holidays moved from zip lining, monkey tribe attacks and white water rafting, to Provencal pools surrounded by the smell of lavender. Appearances to the contrary, the risk increased. France is the real risk to the euro, as will be explained in next month’s column.

*For those foolhardy enough to replicate the Costa Rican adventure www.skyadventures.travel.com.*

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.