Chairman's letters

11 March 2015

2014 Q4 Investor Letter (Extracts)

The global political situation remains volatile and contentious. One only has to look as far as our neighbours in Greece, where the victory of Syriza in recent elections rekindled talks of a Greek exit. Whilst the early signs seem to suggest that this isn’t likely, there is still debate over whether Greece will be able to back out of its commitments to repay loans and reform its economy. Allowing it to do so would give strength to extremist anti-EU parties such as UKIP in the UK and Le Pen’s Front National in France which could raise questions about the existence of the EU more widely.

In the US, the mid-term elections were lost by the Democrats, not won by the Republicans. The feud between the parties will continue for the next two years, with a lame duck president now facing united opposition in both houses of Congress.

In the UK, politicians are highly unpopular and there is a strong anti-politician feeling. With the Conservatives virtually certain not to get a majority at the next election due to the Liberals blocking reform of the boundaries, it is likely that the next UK election will see no major party with a majority, and possibly unable to form a ruling coalition without having to bring in both liberals and nationalists. In this case, we will probably face a second election in October.

If UKIP is brought into a coalition then we have to accept the real possibility of the UK leaving the EU.

The change in the balance of power in Europe that a British exit from the EU would produce would be dramatic and would substantially increase the long-term likelihood that a core group of European countries including Germany will either split from the EU or move to a two-speed, two-tier Europe.

We have also seen tragically in Paris that social media can be used to mobilise groups of people with core hatreds, so that trouble can escalate at any time.

In the Middle East, we continue to experience genocide in large areas of Iraq and Syria, with ISIS having control of a quarter of Iraq and a third of Syria, something that could never have happened so quickly before social media. ISIS has used social media to attract recruits, raise its initial finance, transfer money and mobilise support both locally and internationally.

This use of social media by ISIS and the military and political success it has led to contrasts with our experiences in the West. Over the last 50 years – from Korea to Vietnam to Iraq – the West has been remarkably unsuccessful with its military engagements mainly ending in stalemate, outright defeat or a new government that becomes openly hostile to Western beliefs over time.

ISIS has no such long-term memory of defeats and, along with its affiliates, it is engaging in further military campaigns under the momentum of its victories, waging war against Western values and moderate Muslim beliefs right across the Middle East, North Africa and into Europe.

But we should remember that over the course of 2014 the world economy improved to the point that it is now in its best condition since 2007. By some metrics, it is even better.

There are several factors behind this momentum in Europe. Firstly – and this doesn’t get enough attention – countries like Spain and Ireland have implemented structural reforms that have increased their competitiveness and are starting to reap the rewards.

Secondly, investors are refocusing allocations on Europe. As concerns over the European crisis have faded, Europe is increasingly benefiting from a ‘wall of cash’. Whether that comes from China, the Middle East, other sovereign wealth funds, private equity funds or big companies’ balance sheets, money is getting invested in Europe and that is increasing business activity.

Thirdly, the banks are getting stronger. Capital adequacy at European banks has improved, albeit from a weak base. But we must not be under any false pretence. The biggest contributor to European, and indeed global, economic momentum today is central bank liquidity. This gives an illusion of economic health, which is beyond the fundamentals. It is the excess liquidity out there that is the real driving force behind increasing valuations and that has produced a positive sentiment.

This market exuberance is especially dangerous given the increasing likelihood of a collective decision at some point by the main central banks around the world that there is simply too much liquidity out there. While cheap money could still be with us for some time to come, particularly in Europe, there will be an inevitable reversion to normal interest rates at some point in the future.

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