— Feb 26, 2019

Now what’s going to happen to us without barbarians?

They were, those people, a kind of solution.

Extract from “Waiting for the Barbarians” by C. P. CAVAFY.

The “B” word (and we don’t mean “Barbarian”)

We have resisted the urge to discuss Brexit with a passion since the referendum for two main reasons:

  1. because we do not think we have anything particularly original to say on a subject that is tiresome at best
  2. and because the probabilities of the leading options (deal, no deal, delay, second referendum etc.) are volatile and are not reducible by analysis.

That a deal has been so hard to conclude is unsurprising: the objectives of the protagonists are not aligned. The EU is principally focused on its survival; members leaving cannot be encouraged and the punitive nature of the proposed deal was predictable. A successful deal from the EU perspective leaves the UK chastened and poorer. This was unlikely to be palatable.

The politics was always another fundamental hindrance. It would have been helpful if the UK political party that was negotiating the deal had a large majority, but the outcome of the 2017 general election did not deliver that.

Even if it had would either party have been able to deliver sufficient cohesion to deliver the votes required on this subject? Possibly not. Brexit cuts across party political lines. The Conservatives are split, but so is everyone else; every political party, province, north and south, city and country, by demography, class, occupation and background.

These divisions run deep and are “definitional” – this is not an argument over (for example) the better organising of police services where debate and experiment can be influential. It is a subject that is a defining cornerstone of how politicians frame their beliefs; Thatcher on trades unions and the Labour party on the NHS for example. On certain things there is little budging. Its nature is more akin to religious beliefs and you can’t reason someone out of a position they did not reason themselves into.

It would also have been helpful if the referendum result was more decisive on what is a binary outcome on a contentious subject. 52/48 is clear but not overwhelming enough for the losing side to fit themselves to the outcome without rancour.

The land border in Ireland provides additional complexity with, again, actors with little common political interest between them. It may be that Northern Ireland has to “take one for the team”, at least temporarily, but when group solidarity is already in short supply this will diminish it further. It also revives tensions and divisions over issues that led to the aptly named “Troubles”. There is no obvious solution to this highly nuanced issue.

If one party cannot deliver any outcome that would attract sufficient support from its own members to achieve a majority then by definition cross-party support is required. Here again, the circumstances are unfavourable. While the Conservatives are politically unexceptional, the current Labour front bench is the furthest to the left that it has been for generations. Bridging this gap is problematic.

It would also be helpful if the current crop of politicians on all sides were not so unexceptional in all regards. If we get the politicians we deserve then we should all be giving ourselves a robust talking-to.

The only problems that have simple solutions are simple problems, and this is clearly not a simple problem. All things considered we are in a bit of a pickle.


So what?

We are asked by our clients sufficiently often about how we are framing our decision making in view of this context that we felt writing this short note would be helpful.

Firstly let us consider the scale of the issue. Geo-politics in general (and Brexit, Trump and trade wars in specific) are currently the most important determinant of market, currency and asset class movements. It is not quite the only game in town but the major trends in markets are overwhelmingly geo-political at the moment. Valuations in general and company specific performance have significantly diminished influence. Brexit matters to markets.

One approach when presented with this is to undertake deep analysis and scenario planning. Answering the “what if’s” and formulating a strategy accordingly. We believe this is usually helpful but in this case is probably doing the wrong thing.

Every time the Parliament channel finishes its broadcast of whatever that day’s set of amendments are supposed to achieve, we are no nearer a resolution but the probabilities shift discernibly from no deal to deal, from delay to second referendums and general elections. With so many volatile variables, with ticking clocks, shifting positions and the sheer weight of legislation required from a body that cannot be relied upon to deliver parliamentary authority to even established party policy we challenge the wisdom of attempting such a task.

In this context it is reminiscent of the scenario that faced the future Nobel Laureate Ken Arrow during World War II. He was assigned to a team of statisticians to produce long-range weather forecasts. After a time, Arrow and his team determined that their forecasts were not much better than pulling predictions out of a hat. They wrote their superiors, asking to be relieved of the duty and received the following reply: “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.

Despite geo-politics being so influential, and there being so much of it, it should be ignored where possible when making investment decisions. Firstly because we do not believe anyone can predict the outcome with sufficient certainty that a profitable investment thesis could be constructed, and secondly because people are looking at the wrong thing altogether.


Weigh, not vote

“In the short run, the market is a voting machine but in the long run it is a weighing machine

Benjamin Graham

At the moment markets are more akin to a popularity contest. A failed amendment or a Trump tweet is sufficient to shift skittish markets and currencies.

But in the longer term the largest determinant of the profits you make on any investment will be the price you paid for it. If you overpay for an asset you must expect your lifetime returns on even a successful exit to be diminished. In the long run the weight of profits companies make is the determinant of their share price, not a tweet.

Valuations for many companies are currently attractive.  At 7200 the FTSE100 is on a PE multiple of 11.4x. This is cheap by historical standards. It is also providing a 4.4% dividend yield which is eye-catching. This dividend yield is supported by profits being 2x the levels of dividends so you are receiving an 8.8% earnings yield.

In simple terms (and just looking at the UK), unless you support the view that earnings are going to fall, then you must conclude that markets are cheap. We do not believe that economies will grow at historic rates (a thesis that has shaped how we invest our clients’ and partners’ assets at SORBUS from the outset – it was contentious at the time but commonplace now) but the data does not suggest a deep recession is forthcoming.

No lesson seems to be so deeply inculcated by the experience of life as that you should never trust experts. If you believe doctors, nothing is wholesome: if you believe the theologians, nothing is innocent: if you believe the soldiers, nothing is safe. They all require their strong wine diluted by a very large admixture of insipid common sense”. Lord Salisbury, 1877

The insipid common sense we would like to proffer is that Trump is likely to continue to be all sound and fury and that international trade will not be ravaged, and that a solution to Brexit is not beyond the wit of man. Either a May deal variant or a no-deal solution to Brexit would eliminate the overhanging concerns and focus investors minds anew on valuations. The risks to this are trade disruptions from a no-deal (which appear to be a) probably inevitable, b) hopelessly overblown and c) resolvable with a modicum of effort) and no resolution – further delays, extensions and elections/referenda.

The geo-political noise has suppressed markets but the data suggests that it is just noise. If the political volatility was likely to lead to material earnings declines then the correct strategy would be to retreat to cash. If earnings are maintained or grow a little then the correct strategy is to deploy that cash and buy cheap equities. Our substantial cash holdings were accumulated when the FTSE100 was over 7700 and have been deployed when the market had fallen to current levels (and lower). Absent geo-political noise we would expect the FTSE100 to trend towards its historical average (14x) which is over 20% or 2000 points higher.

We do not expect the geo-political noise to diminish in the short term; the Brexit psychodrama has a few more twists and turns yet. But, when the Barbarians retreat, what will be visible is that while things look pretty much the same as they were before this whole thing started, people can now see more clearly. This is a political crisis not an economic one and investors and institutions will quickly shift their gaze and note that equity valuations are (mostly) low.

That should be the overwhelming determinant of investment strategy and it is the basis of our decision making. 


Waiting for the Barbarians

What are we waiting for, assembled in the forum?

 The barbarians are due here today.

Why isn’t anything going on in the senate?

Why are the senators sitting there without legislating?

Because the barbarians are coming today.

What’s the point of senators making laws now?

Once the barbarians are here, they’ll do the legislating.

Why did our emperor get up so early,

and why is he sitting enthroned at the city’s main gate,

in state, wearing the crown?

Because the barbarians are coming today

and the emperor’s waiting to receive their leader.

He’s even got a scroll to give him,

loaded with titles, with imposing names.

Why have our two consuls and praetors come out today

wearing their embroidered, their scarlet togas?

Why have they put on bracelets with so many amethysts,

rings sparkling with magnificent emeralds?

Why are they carrying elegant canes

beautifully worked in silver and gold?

Because the barbarians are coming today

and things like that dazzle the barbarians.

Why don’t our distinguished orators turn up as usual

to make their speeches, say what they have to say?

Because the barbarians are coming today

and they’re bored by rhetoric and public speaking.

Why this sudden bewilderment, this confusion?

(How serious people’s faces have become.)

Why are the streets and squares emptying so rapidly,

everyone going home lost in thought?

Because night has fallen and the barbarians haven’t come.

And some of our men just in from the border say

there are no barbarians any longer.

Now what’s going to happen to us without barbarians?

They were, those people, a kind of solution.


translated by EDMUND KEELEY