Recently we have been asked for our thoughts on political developments in Europe.
Historically, we have often used the stock market aphorism ‘stocks are not the market and the market is not the economy’ when talking to investors in our funds. Another way of making the same point is to say ‘listen to the businesses not to the headlines.’ Too much equity investor time is soaked up by looking at the ever changing macro and trying to fit a portfolio to a world view that tends to be difficult to discern and to time. Our team’s approach is built on an understanding that it is the job of corporate management teams to mediate and offset the external problems that find their way into the news. Also many of the businesses we look at are highly international and are not particularly affected by local economics or politics. Finally, whilst there are always tensions between the first and third estates the political mind-set for more than a generation has been that the best way to help the economy has been to help the companies within it.
All of these things tend to add up to the business environment exhibiting a stability that astonishes those who look at the news and the movements of the market. We practise an educated agnosticism towards the idea that big events are relevant to investment but sometimes we need to turn our attention to unfolding themes.
In the UK and the US we have witnessed political events that demonstrate the remarkable flexibility of democracy. Subsequently markets are generally at higher levels and so, yet again, it has appeared to be wise not to react to big macro events. As a whole business growth and profitability have not been affected by Brexit and Trump and the market has recognised this. Our concern is that we believe similar political changes could occur in Europe and for similar reasons. The difference is that, in our view, the EU possesses less dexterity to deal with change than the UK and the US. Democracy can operate at a national level but the technocratic body that is the EU itself, might not be able to accommodate the change that results.
The new energy in European politics may prove fragmentary, with individual countries seeking greater sovereignty in response to the demands of their domestic populations. At the same time there may be a growing understanding that European integration has stalled, perhaps terminally. Whilst predictions are very difficult to make our conclusion is that there are clear risks to the EU project and that the process is unlikely to follow a linear chain of events. The forces currently rippling across the intricate intersection of politics and markets are, nevertheless, long term in nature and need to be thought about.
If events unfold in this way – and there is the potential that to do so doesn’t require populist parties taking power but merely garnering levels of support that surprise market participants – parts of the long lived EU Institutional framework could be at risk. The implications of this would be more substantial than those associated with the changes that have recently taken place in the UK and the US.
A recognition that change is constant is long lived and is contained in many of the world’s religious texts and great works of art. What is important is acceptance and incorporation of this fact. If Europe does see political change then it is possible that it will be accompanied by policy that is reflationary in nature, especially in Southern Europe. Investors may anticipate this and we may therefore ultimately witness a more extended style change in European equity markets towards weaker, lower rated companies. The thinking will be that the operating environment will become easier for them. This would not necessarily work to our advantage because we tend to invest in the companies that excel in any environment.
We believe, however, that the companies we specialise in are the best at coping with the more generalised issue of change, irrespective of how it might manifest itself. It could be economic, political, structural or technological. The quality of management teams in these types of companies tends to be very good but they also generally exhibit built-in sustainable advantages that make them more robust. LVMH is not the same company as the one founded by Louis Vuitton in 1854 but the longevity of the brand is very instructive in terms of understanding how LVMH might fare if the European political landscape does change. Having survived the Long Depression of 1873-1890 and numerous political changes and wars both in the 19th and most substantially in the 20th Centuries, the brand and the group have prospered on the global stage. Whatever happens to the political landscape in Europe, this will continue. If change does come to Europe we shall not be surprised by it but, having anticipated its possibility, we will still respond by listening to the businesses and not watching the headlines.
Dominic Wallington is head of European Equities, RBC Asset Management UK