Draghi and Yellen are both facing their own moment of truth in the short term. For the latter, it may well be this month. Communications from Fed members have obviously been carefully orchestrated in August so as to suggest a more hawkish stance, despite the fact that there are still signs that activity in the US might be more subdued than thought (1% GDP run rate in the first half and labour data showing from time to time weaker than expected).

If Yellen is intelligent enough to learn from her own mistakes, and especially her rather naïve handling of financial markets’ anticipations/reactions, she should hike in September rather than wait for December (i.e. not repeating the mistake she made last May). This hike is almost priced in and the rather limited surprise it would create would help to show that she is regaining the upper hand over the market whereas up to now she has been led by the nose by that that very same financial market. For Draghi, the deadline is March next year (though he may signal something ahead of that). In his last press conference, he stuck to his broken record routine that: 1) the ECB’s policy is working and 2) that it is not hurting the banks. All lies of course. The consensus for GDP growth rate for the Euro area in March 2015, prior to the launch of QE, was 1.6% for 2016 it is now 1.5%. Where is the improvement? The Euro area CPI was -0.3% in the first quarter of 2015 (largely due to the collapse of the oil price). It is now -0.1% (but with the oil price not contributing at all to this decline). Can someone tell me please how Draghi can claim his policy is working? When confronted with the same question the only answer he has to offer is “Imagine if we had not done it”. “What if...” is a literary genre. It gave a few rather good Science Fiction novels, but Draghi is no Philip K Dick, he should stick to the “here and now” reality rather than refer to some hypothetical alternative reality. He also found the audacity in his last press conference to declare that “We shouldn’t hold interest rate policy responsible for everything that goes wrong at banks”. Has some one at the ECB bothered to explain to him the meaning of “transformation” and how banks are supposed to operate?

All my questions are of course rhetorical. Draghi knows full well that he is lying on these two grounds, but he cannot afford to officially admit that the real purpose behind the ECB’s QE is to avert as long as possible the implosion of the Euro area. The initial plan was that he would be buying time as governments would do their utmost to enforce economic convergence between their various economies. He stuck to his part of the deal, but politicians did not. Divergence within the Euro zone is greater than ever. So the most likely decision from his part, is that he will have to extend QE, otherwise I would not give more than 6 months for the Euro zone survival. He is already running out of bonds to buy in some countries, so what next? Some are already musing loudly about equities. Helicopter money in Japan and the ECB buying German equities. The world has gone insane.

Finally, just a few words on Brexit. Just a month ago, it was the only one subject in minds. Fast forward 60 days later, and it is almost as if it never happened! The FTSE100 which dropped 5.6% in the 2 trading sessions following the referendum has been steadily rising since then (+13% from the low). In the run up to the vote, CEO’s had lined up in media to scare British citizens over the evil they would unleash if they voted to exit the EU, but later these same people asked in the last result season whether they thought their own individual companies would be impacted by Brexit unanimously replied by the negative!

I have had to interact with CEOs for most of my professional life and collectively, they have never struck as having more foresight than you or me. Armageddon simply did not occur, much to the dismay of many commentators who had sided against Brexit. As I had noted in my last comment, emotions rather than common sense had been ruling many heads. However, investors are in danger of becoming too complacent if I am to judge based on the rally enjoyed by many domestic UK cyclicals. I do not subscribe one minute to the nightmare long term scenarios painted by economists, first because the last persons you should ever listen to in terms of forecasting are economists as this profession has proven incapable of forecasting anything (if you need proof, just drop me an email and I will send you charts proving this point beyond any possible doubt), second because the future of the UK will simply be what it will make of it.

Brexit could be a fantastic opportunity to revive the economy away from the stifling influence of Brussels-based bureaucrats or it could turn out to be a total disaster if the country falls for the sirens of political and economic isolationism. It is way too early to decide, even though the way a new government has quickly and rather smoothly been ushered in is encouraging. Brexit opens an era of uncertainty and economic agents dislike uncertainty. There will be a negative impact on activity, probably not large enough to bring the country into recession, but nonetheless material. There was a general sigh of relief as UK companies reported 2Q results which did not appear dented by the outcome of the referendum. In my opinion, this sigh of relief was misplaced.

The vote took place in the last week of the second quarter. Much too late to have an impact on results. I would be wary of the next reporting season.

Lionel Rayon

Lionel joined Schroders as part of the acquisition of Cazenove Capital in the summer of 2013, having been at Cazenove since 2005. He is a senior member of the pan-European equity team and manager of the Schroder ISF* European Alpha Absolute Return (circa $1 Billion AuM). He is also responsible for developing and maintaining a fundamental and valuation screen of European stocks. The screen forms the basis for generating ideas for potential further detailed investigation by the European team within the framework of their disciplined Business Cycle Approach. Lionel joined from Citigroup where he was a Director in the European Tech Research Team. Prior to Citigroup, Lionel had been with Schroders Securities, as a French specialist, Nomura Research Institute, as a metals & mining specialist, Enskilda and Chevreux de Virieu. Lionel graduated from Indiana University (MBA) and Institut d'Etudes Politiques de Paris (BSc economics & finance). He has 20 years of equity research experience.

Website: www.schroders.com


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