ALL EYES ON GERMANY AS EUROPE LOOKS TO A YEAR OF CHANGE / THE FINANCIAL TIMES OP EDITORIAL

All eyes on Germany as Europe looks to a year of change

Chinese authorities move to boost the country’s flagging economy

Sir John Redwood


Volkswagen, in common with other German carmakers, faces dual challenges: falling sales in China and the prospect of regulatory and technological changes © Bloomberg


During rough times in share markets late last year the FT fund held 15 per cent in cash and was at the bottom end of the permitted range for share investments. This gave it some protection against the falls.

Coming into the new year, I put money into China and some into Germany, where I had sold out months ago ahead of the economic and trade problems encountered by those countries.

I also added to investment in the new economy following the sell-off in technology in December, this time through an exchange traded fund (ETF) that invests in general digital companies. I anticipated a January rally which has duly materialised, with good bounces in some of the most hard-hit markets and sectors. The fund is up nearly 4 per cent so far this year.

My policy of holding nothing in the Eurozone last year worked well. I added something in Germany because it had fallen more than most last year as people came to understand the way its economy was going to be slowed by the effects of tighter money on the world car market. The negative effects of trade wars on an economy that has a particularly large dependence on manufacturing exports have shown through. Sales into China have been weak.

The German car industry could also be on the wrong end of the technical and regulatory challenges to conventional car production and sales. Governments are forcing a switch to electric from petrol and diesel. EU emissions regulations have caused some impediments to car sales. New companies are emerging that meet changing customer demands and companies with established brands are rushing to adjust their products and approach, incurring costs as they do.

There were two immediate triggers for my purchase of some German shares. The first was the decision of European authorities to cut a deal with Italy over its budget. One of the biggest risks to euro investment was temporarily removed when they decided not to try to do to Italy what they did to Greece and Cyprus and squeeze the country by withholding liquidity through the Central Bank.

That would have been deeply damaging to markets. The second trigger was the big deflation of prospects for Germany brought on by poor third-quarter GDP figures showing an actual decline in activity, and poor forward-looking indicators as well. This hit German shares and leaves the market ready to think about how reflationary action might come to the economy’s rescue. The country still has some strong brands with revenue potential.

I remain nervous in the longer term, because there is no clear path to full political union such that German taxpayers stand behind poorer countries and weaker banks elsewhere in the Eurozone.

The position I have bought is quite small and based on what I hope is a temporary undervaluation of German strengths within a weak Eurozone. This issue in popular form will be part of the background to the European elections in May, when challenger parties look likely to do much better than traditional pro-EU establishment parties in many countries.

In Germany itself, the AFD and the Greens seem set to take seats from the CDU and SPD, which have slumped to new lows of support. The AFD will not be keen to extend more credit and grants to the rest of the euro area. The May elections matter both because the European Parliament now has more powers as a co-legislator to the European Council, and because it will influence the personnel chosen for the new Commission to be formed after the results.

The traditional centre left and centre right pro-EU blocs together may fall short of half the total seats in the European Parliament for the first time, while challenger governments such as Italy, Hungary and Poland will be choosing commissioners with different views from the establishment.

My purchase in China follows a halving of the Shanghai Composite stock index from the peak of 2015. The background has been a slowing in the Chinese economy, which seems to have worsened towards the end of 2018. While the official figures pick up a small deterioration in overall GDP growth, western companies dealing with China report a deeper slowdown.

The Chinese authorities have responded with a policy to get more loans and equity money into private sector businesses to allow them to expand. There have been tax cuts to boost consumption and a further expansion of loans to local authorities undertaking infrastructure investment. They have cut the reserve ratio requirements for banks, encouraging more expansion of credit. I suspect they will do more of this until the Chinese economy picks up pace. This should be positive for Chinese shares.

Technology was hit late last year because people had made big profits on it and wanted to reduce their risks. Some of the large US companies also had their own bad news to report as sales slowed. I did not take any evasive action for the fund, so a good year for this section of the portfolio was rounded off with a bad final quarter.

There were regulatory pressures that now require these companies to spend more for the same amount of business. Despite this, they still look well set to benefit from consumers who like digital solutions to their problems.

The fund has a substantial position in smaller technology companies through ETFs in robotics, cyber and digital, as well as in the larger stocks through Nasdaq. It looks as if the decline of many traditional businesses stuck with shops on the high street, advertising on mainstream television and labour-intensive ways of delivering service will continue in the face of intense digital competition.

With the US Federal Reserve lifting the threat of a bigger credit and money squeeze, markets can make a bit of headway before we get to the next set of worries. A trade deal between presidents Trump and Xi would also help and is possible. The purchases are so far doing well, but I need to keep an eye open for any relapse.

Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing.