David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Scotland Problem Is It Does Not Have Enough Business

    It might be the threat of leaving the European Union. It might be the years of austerity imposed by the cruel-hearted English. Heck, it might even be the legacy of the crushing of its industry by Mrs Thatcher three decades ago. There are lots of potential explanations – north of the border anyway – for why the Scottish economy might not be living up to its full potential within the UK.

    But here’s the real reason. It simply doesn’t have enough businesses.

    According to figures just published by the Scottish Government, the number of companies is now falling in Scotland, while it is rising rapidly across Britain as a whole. It is hard to see that as anything other than very worrying for the future of its economy – for the simple reason that without lots of businesses, and new small businesses in particular, it is very hard for growth to be sustained.

    Unless a way can be found to turn that around, Scotland has little future as an independent economy – and if it stays, as seems more likely, it will turn into more and more of a drag on the rest of Britain.

    There can be little debate that the Scottish economy is starting to persistently under-perform the rest of the UK. An analysis by the economist John McLaren published in the summer found that Scottish GDP fell last year, while growing for the UK. Overall, it has expanded by only 4pc since the recession of 2008/2009, compared with 23pc for the UK. In the second quarter of this year, the Scottish growth rate was a whole percentage point behind the UK rate. Relentlessly, the country is lagging behind the rest of Britain, opening up a widening gap in productivity and wealth. Year after year, the Scots are getting poorer relative to the UK.

    The decline in North Sea oil has, of course, been one factor in that. But it is far from the whole story. In truth, Scotland has become an increasingly unattractive place to base a business – and that is starting to have an impact.

    The Scottish Government has just published figures on the numbers of companies operating in Scotland. They show that there are about a quarter fewer businesses in Scotland, measured on a per capita basis, than for the whole of the UK. More precisely, it has 768 enterprises per 10,000 people compared with 1,040 for the UK as whole – a huge difference given that, on the surface, you would expect the numbers to be roughly equal. Even more significantly, it now has the lowest ‘business density’ rate of any region or country within the UK – it is performing even worse than Northern Ireland and Wales, the next two regions with the lowest results.

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    Signs Are Flashing That Bond Rout Has Gone Too Far, Too Fast

    This article by Yun Li for Bloomberg may be of interest to subscribers. Here is a section:


    Expectations that Trump, along with a Republican-led Congress, would make good on pledges to spend $550 billion on infrastructure improvement to stoke economic growth sent inflation expectations to the highest since 2015. Yields on two-year notes, the coupon maturity most sensitive to monetary-policy expectations, rose to above 1 percent on Monday for the first time since January as traders added to bets the Federal Reserve will raise interest rates next month.

    "The consensus has shifted for good reason," Matthew Hornbach, head of global interest-rate strategy at Morgan Stanley, said in an interview with Bloomberg Television. "There is some concern over the timing and the extent to which President-elect Trump will be able to follow through on some of his campaign promises specially with respect to infrastructure spending and the tax cuts."


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    The post-election rally: five push-backs

    Thanks to a subscriber for this report from Deutsche Bank focusing on European equities. Here is a section:

    However, we remain cautious on the outlook for European equities, given that we see five stumbling blocks that could prevent this optimistic projection from translating into meaningful upside for the market. We maintain our cautious year-end target of 325 for the Stoxx 600 (around 4% below current levels).

    1)The Italian referendum: our European economists now see a 60% probability of a “No” vote in the Italian referendum on December 4th. Peripheral bond spreads have already widened by 20bps over the past week, but European equities have yet to react. As a consequence, peripheral spreads now point to 5% downside for European equities.

    2)Intensifying Chinese capital flight: our Asian FX analysts argue that Chinese capital flight is now as intense as in H2 2015, pointing to an increased risk of a disorderly Chinese FX devaluation, especially if the Fed hikes rates on December 14th.

    3)The risk of lower oil prices: the oil price has fallen by 17% from its mid-October peak, as the broad USD trade-weighted index has risen back above its January peak. The historical relationship between the USD and oil (R2 = 95% over the past five years) point to a fair-value oil price of around $30/bbl (significantly below the current $44/bbl) – and our FX strategists expect a further 5% upside for the USD index. If the oil price drops back below $40/bbl, this is likely to lead to renewed financial stress via widening US high-yield spreads (especially given the reduced support from low bond yields).

    4)The impact of higher rates on valuations: the fact that European P/Es are around 20% above their 10-year average is due to extraordinarily low real bond yields (i.e. the discount rate for equities), according to our models. The 40bps rise in European real bond yields since the end of October has already reduced the fair-value P/E by 5%. If bond yields keep rising, this will put further pressure on equity and credit valuations. It is also likely to lead to renewed EM capital outflows and, hence, tighter EM financial conditions at a time at which EM corporate leverage is still close to its mid-1990s peak levels.

    5)Trump tail risks remain: the market has focused on the benign elements of Trump’s agenda so far, but tail risk remain that these will be watered down or delayed in the legislative process – or that the less economically helpful aspects of his agenda (such as import tariffs or branding China a currency manipulator) return to the fore. 

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    OPEC, Russia Expand Diplomatic Push to Secure Oil-Cuts Deal

    This article by Javier Blas, Angelina Rascouet and Grant Smith for Bloomberg may be of interest to subscribers. Here is a section:

    OPEC embarked on a final diplomatic effort to secure an oil-cuts deal, with its top official heading on a tour of member states as Russia scheduled informal talks in Doha this week with nations including Saudi Arabia.

    The behind-the-scenes diplomacy follows an unannounced meeting in London between OPEC Secretary-General Mohammed Barkindo and Saudi Minister of Energy and Industry Khalid Al-Falih, said one OPEC delegate. Just two weeks before the group’s Nov. 30 ministerial meeting in Vienna, Saudi Arabia, Iraq and Iran are still at odds over how to share output cuts, said another delegate. 


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    Trump Fiscal Policy May Have Lessons for Britain

    The real difference between the Keynesianism of the Left and Right is that the latter tends to favour fiscal expansions driven by tax cuts, whereas the former tends to favour increased government spending. And, of course, the Right thinks of tax cuts as stimulating the supply side of the economy as well as, or even instead of, the demand side.

    At the moment, we don’t know the extent to which Mr Trump will want to offset increases in defence spending and infrastructure by reductions in other sorts of spending. But unless he does this, and/or lower tax rates do stimulate a large increase in economic activity and tax revenues, the US budget deficit will rise.

    Does this matter? The budget deficit is currently running at about 3pc of GDP. Total federal government debt is currently running at about 74pc of GDP.

    Even without any Trumpian expansion, it was on course to reach about 80pc in a few years’ time. It isnow plausible to see the debt ratio moving up towards 100pc of GDP.

    I don’t think this spells danger for America. On the contrary, both domestic and foreign investors will continue to be keen to buy US government paper, which will still be regarded as a safe haven in an unstable world.

    Mind you, there will probably be a price to be paid. Some commentators have speculated that uncertainty after the Trump victory will cause the US Federal Reserve to put off the interest rate rise that was due to happen on December 14. They could be right, although I reckon that the markets’ comparative calm argues otherwise.

    But the more important question is what happens to interest rates in the next two years. If President Trump does embark on a significant expansion, then the implication is that interest rates should go up sooner and by more than they otherwise would have done. This would be in accordance with the changing intellectual climate that has already started to swing against monetary stimulus and towards fiscal stimulus. 

    If a fiscal expansion were implemented, the result would be a faster move towards more normal levels of short-term interest rates and government bond yields. Clearly, this would hurt some groups of people, but it would also benefit others. And it would be warmly welcomed by all those people who have suffered from the long period of extremely low interest rates, and by those who would benefit from the stimulatory effects of the fiscal expansion. 

    Such a programme would have lessons for all of us on the other side of the Atlantic. The new Chancellor, Philip Hammond, has made it clear that he intends to moderate George Osborne’s planned fiscal austerity and also to give some boost to infrastructure spending. 

    So far, of course, we have yet to see the colour of his (that is to say, our) money. But such a programme from the new Chancellor would sit easily with what is probably going to be happening in America. Moreover, the bolder and more radical President Trump’s tax reforms are, the more pressure this will put upon the Chancellor to follow suit.

    In the eurozone too, monetary policy should have reached the end of the road. There is room for a significant fiscal expansion in Germany. Yet this is not at all on the cards. The reason is partly that Germany is doing well without such stimulus, largely thanks to its huge export surplus, resulting from aggregate demand created elsewhere. It is a case of: “I’m all right, Giacomo.” This policy is also the result of a belief that Germany needs to embrace hairshirt policies in order to encourage the more weak-willed members of the eurozone to stick to austerity.

    If this continues, then I suppose the ECB will probably feel obliged to persist with its policy of cutting interest rates and putting money into the system through quantitative easing. In that case we can surely expect the eurozone to continue to perform poorly.

    We are in for an interesting experiment. The US and the UK are, I suspect, about to rebalance fiscal and monetary policy, while the eurozone will continue on its current suicide run towards supposed fiscal probity. I know which of these I would back to succeed.

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    Brexit Vote Has Not Sparked a Tech Exodus

    Matt Clifford, the chief executive of Entrepreneur First, an accelerator that invests in and nurtures promising young startups, says that if anything the falling pound has made it easier for Americans, who are responsible for a significant amount of investment in the British tech scene, to put money in. Brexit clauses in fundraising sheets, which forced startups to take less money or give away more of their companies, were rare, and most likely an attempt by opportunistic investors to capitalise on uncertainty.

    As for our startups fleeing? According to officials in Berlin, a prospective post-Brexit European tech hub, a grand total of five startups have relocated from London since the referendum.

    This comes despite a major push to entice them: in July, German officials hired a van to drive around London loudly painted with the slogan: “Dear startups, keep calm and move to Berlin.”

    Frankly, it wouldn’t be surprising if five startups had moved from Berlin to London in that time: many young companies will relocate from time to time. And meaning no offence to those who have taken the plunge, none of them has had the effect that one of London’s biggest startups leaving would do.

    The truth is that right now, the attractions of the UK, and in particular London, significantly outweigh any post-referendum uncertainty for technology startups. The talent from universities including Oxford, Cambridge and Imperial College London, proximity to the City of London, the English language, tax incentives and lack of red tape (in comparison to many rival destinations) outweigh them right now. For now, startup founders and venture capitalists seem to generally agree that this will continue to be the case after Brexit.

    This isn’t to say that the UK’s tech community supported leaving: they didn’t, and would still say now that they would prefer it hadn’t happened.

    There are still significant concerns about Brexit Britain, largely related to access to talent: many founders and a significant proportion of employees at tech startups are EU nationals; they will want assurances that they can both stay in the UK and that they will be able to hire high-skilled staff afterwards.

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