roger martin fagg, economic update, feb 2013

7/29/2019 Roger Martin Fagg, Economic update, Feb 2013

1/8

Growing Leaders. Transforming Businesses.

Animal spirits are running hot. Financial markets create

their own reality. Companies are refinancing at lower

interest rates, Eurozone Governments find it easier to

finance their deficits, the US fiscal cliff is delayed until May,

and China has avoided a hard landing. Greece is still in the

Eurozone, Spain has not asked for a bailout, the ECB has

not had to purchase outright a single sovereign bond, and

money is flowing from safe havens back to the Eurozone

periphery. The US housing market has turned, posting 5%

price increases, new housing starts are twice the 2009 low.

S&P 500 companies earnings are flat, sales up 0.5%, and

yet the index is up at its pre-slump level. The Footsie is up

6.4% since Jan 1, and Japans Nikkei is up 7% The US

economy shrank in Q4 2013, Europe is shrinking, 55% of

Chinese GDP is now state financed spending and a major

realignment of global currencies is in prospect. See next

section.

People are irrational. We make generalisations about the

whole based on the performance of one part, the so called

halo effect.

FinancialfocusA N E C O N O M I C U P D A T EB Y R O G E R M A R T I N - F A G G Invest in What you Believe In

Any business with a clearly defined value propositionbased on the customers preferences and ability to pay,

which is effectively and efficiently delivered will outperformthe economy as a whole, and by a considerable margin.

This article has been edited from Rogers Economic Update forFebruary 2013 for this publication with his support.

Irrational Exhuberance

1 Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author


2/8

I joined the

Academy so that I

could get the input of

a mentor for my

business and me. I

have found the external

input from both my

group chairman mentor

and the professional

expert speakers really

invaluable in develop-

ing the strategy for my

business. I would

recommend the

Academy for anyone

who is serious about

pushing their business

to the next level.

Victoria Campbell,

Managing Director

Rotary Watches

And we are prey to our emotions when

making decisions, these are easier to

manipulate than we think. We all think we are

above average, and our subjective confidence

in our abilities and judgments usually

outweighs the actual strength of either of

them. And above all we are herd animals; we

make decisions based on what those around

us are doing. We often justify our choices like

this, validating them on the basis that others

were following a similar course of action.

It is tempting to view the surge in stock prices

as a result of inflationary expectations driving

an exodus from bonds, but the evidence from

the USA is that it is new money flowing into

equity mutual funds.

So look at the data: the purchasing managers

index show contraction in the Eurozone, nogrowth in China (this means 7%), but

expansion in the USA. People always prefer

to carry on behaving as they have always

done, the more we repeat particular

behaviours, the more automatic they become,

and over time they become default behaviour.

So the reasoning must be this. The USA is

growing, interest rates will remain at current

levels for years to come, the Euro is fixed,

and China always creates its own reality.

Therefore time to get out of cash into equities.

Our reflexive system does not naturally check

to see if rephrasing a question would produce

a different answer. For example the market

analysts say that equities are cheap based on

long run P/E multiples, but what we are

experiencing today is a discontinuity, thus

trend is almost irrelevant.

But the talk on the street is that confidence is

returning, we are on a roll, Spring is in the air!

The cash piles will be spent, the velocity of

money will take off and we will reach the sunlit

uplands. This could happen but...............

The markets have ignored the second bailout

of Italys second largest bank, and the bailout

of the Netherlands third largest bank lastweek. They are ignoring the fact that nominal

GDP in the UK is only growing at 2.5% and

net credit is still contracting at 4%.

The UK Government will not hit its debt

reduction target and according to the IFS will

need to borrow 180Bn more than planned

over the next three years. This will push the

National Debt over 80% of GDP and close toFrance who have 86%.

I have said this many times before but it is

worth repeating. Any business with a

clearly defined value proposition based on

the customers preferences and ability to

pay, which is effectively and efficiently

delivered will outperform the economy as

a whole, and by a considerable margin. We

can take the example of John Lewis

(outperformer) and compare it to Dixons.

The Zombie businesses will go sooner or

later, leaving more market for the better

players.

2

Irrational Exhuberance

Roger Martin-Fagg February 2013 reproduced in this publication with the kind permission of the author


3/8

Membership

helps me make

better decisions. Hire

better people, plan for

success and handle

problems effectively.

My business growth

and balanced personal

life owes a lot to the

learning and support Iget from my Academy

colleagues.

Graham Nye,

Managing Director

Chiltern IT

Exchange Rate

For the past 3 weeks there has been a lot of

market chatter about the realignment of the

major currencies. As the market creates its

own reality, we can expect the realignment to

take place. We do not know exactly when or by

how much. Here is the context.

We begin with Purchasing Power Parity (PPP).

If two identical goods have the same price in

two countries, each with a different currency,

then there is PPP. If you are in country B, and

you exchange your currency for As, and you

find that the identical good is now cheaper for

you in A, then using PPP, your currency is

overvalued relative to A.

Over the long run (more than 5 years)

currencies do move towards their PPP unless

deliberately managed by the Government

through direct sales and purchases in the

Forex market using the central bank. China

has deliberately done this for 20 years.

However in the short run it is financial variables

plus market expectations which determine the

relative exchange rate.

3

Each point on this triangle is determined by the other two. So what determines the relative

exchange rate? It is relative interest rates and relative inflation rates. Based on these relativities for

January 27 2013 the following PPP apply.



4/8

Since joining

the Academy my

leadership skills have

changed quite

significantly, and I

think thats to do with

the fact that I recognise

and understand what

kind of leader I really

am, rather than what I

thought I was.

Liz Smith,

Managing Director

Savvy Social

If we take Sterling it implies that $1.47 is the

equilibrium price in dollars and Euro 1.08.

Now we need to see what will feed market

expectations. First the UK balance of

payments as shown on the chart on the next

page.

For most of the last 13 years our physical

trade deficit has been partially offset by

investment income from our ownership ofassets abroad. The remaining deficit has

been financed by the sale of UK assets to

overseas buyers e.g. Tata, Mittal, Sovereign

Wealth Funds, and my village pub now owned

by a Russian (a disaster!)

We are in a spot of bother because as you

can see, the investment income flow has re-

versed. And the short term balancing from the

Greek and Spanish has gone as they decide

the Euro will survive. Normally an increase in

UK interest rates would solve this. But such

an increase (of 2%) would kill us. So themarkets now are assuming that Sterling has

to fall to enable us to balance the account. A

weak currency encourages speculative

inflows once the market thinks the bottom has

been reached.

The problem is the market always overshoots;

this creates bigger swings, and more bonusesfor Forex teams who call it right. As I write this

on February 7, Sterling is Euro 1.15 and

$ 1.56. The swing has already begun.

But there is much which can stop the

downward movement.

4

All this is relative to the US Dollar.

OVERVALUED UNDERVALUED

Norwegian Krone 90% Rupee 63%

Swiss Franc 78%Yuan 32%

Aussie Dollar 64%

Swedish Krona 47%Mexican Peso 30%

Kiwi Dollar 44%

Canadian Dollar 24%Turkish Lira 25%

Yen 14%

Euro 13%Russian Ruble 21%

Sterling 6%

Brazilian Real 7%

Exchange Rate



5/8

Membership of

the Academy has

helped me enormously.

The company now has

a very solid strategic

direction backed up

by a much stronger

management team,

which is taking us in

to new markets andcreating higher levels of

both profitability and

service.

Nick Appell,

Managing Director

Casna Ltd

For example Bunga Bunga Berlusconi could

win the Italian Election and play hard ball with

Merkel by threatening the breakup of the Euro.

When the interest rate and inflation rate

differentials are small non-financial events

become more significant. The French have

suggested that the Euro should be allowed to

fall against the dollar (achieved by a lowering

of the ECB rate of interest to 0.5% and more

QE). The Germans think not. The new

Governor of the Bank of England is suggesting

a radical rethink of the role of the monetary

policy committee, but is sketchy on detail.

5

On balance Sterling is close to equilibrium, but

we should expect more volatility than usual, as

downward movements quickly reverse. On the

next page is a chart which illustrates this for

the past year. There has been a swing of 10%

for Pound/ Euro from July last year to Feb 3

this year.

This gives the context for those of you for

whom currency values are crucial determi-

nants of your margin. I cannot tell you what

the actual rate will be on April 28th. You will

have to make an informed guess like the rest

of us.

Exchange Rate



6/8

6

Please note that numbers in parentheses

have a negative value

The UK

UK inflation: RPI 3.2%, CPI 3.5%ACTUAL RPI 3.1% CPI 2.7%

UK interest rates: 0.5%

ACTUAL 0.5%

FOOTSIE 100 at year end 5,500

ACTUAL 5800

House Prices outside London: nominal (2%)

real (5%)ACTUAL (2.1%) (5%)

Commercial Property: flat

ACTUAL flat

GDP for the year 0.3%, Q1 and Q2 slight

contraction, Q3, Q4 some slight growth.

ACTUAL Q1 (0.2) Q2 (0.4) Q3 0.9 Q4

(0.3) 0.0% for the year

And now to my School Report for the year 2012

Forecasts for 2012 (and the actuals)

Exchange Rate

In the three

years since joining the

Academy in 2009 we

have achieved 168%

growth; the Academy

has played a major part

in achieving this.

Alistair Kight,

Managing Director

GRITIT



7/8

7

Sectors:

Manufacturingwill grow more slowly than

the last two years: European demand will be

patchy with some shocks. Asian and US

demand stronger. Non-food retail will

continue to be very difficult with more

failures. Financial services flat. Government

sector: cuts will begin to bite. CORRECT

Construction: 1% real growth ACTUAL

(11%)Unemployment: 2.8 million at year end

ACTUAL 2.6

Private sector wage growth 2%, public sector

0% ACTUAL 1.6% and 0%

The World

Global growth will be 2.5%, USA 2%, Brazil

2%, India 7.5%, China 7%

Europe (1.5%) Russia 3%

ACTUALS all correct except Europe which

grew by 1%

Oil: the Saudis

need $100 pb to break-even on the in-

creased bribes to their population. They will

cut output to maintain this price in 2012 and

2013. CORRECT

Non-food commodities, prices will fall.

CORRECT

Food commodities, harvest dependent, but

steady upwards price pressure from Asian

demand.CORRECT

These forecasts assume Europe stumbles

on. If the Greek default (likely April 2012)

creates a Lehman-like effect, then all bets

are off. It will be a repeat of 2008-2010.

GREECE MANAGED DEFAULT SEPT

Headmasters comments

This has been a surprisingly good yearfor Martin-Fagg, but we sometimes thinkhis disarming smile indicates a brainworking at half power.

(This is a direct quote from my 1964 schoolreport!)

Forecasts for 2012 (and the actuals)

The Forecast for 2013Footsie 5900 at year end

UK CPI 2.8% RPI 3%

UK GDP 0.3%

Eurozone (1.5%)

USA 2.3%

Brazil 1%

China 7.6%

Russia 3%

The World GDP 2.9%

Exchange rates

1 = Euro 1.23 average but big swings, I stillthink the Euro is at risk and sentiment will turnagainst it during this year.

1 = $ 1.55 average until late summer, thencould go to 1.45 by year end.

RogerMartin-Fagg

Roger is an Associate ofAshridge Business School,teaching all aspects of eco-nomics on Executive andCorporate programmes. Heworks with a diverse range ofclients, including the financialservices, construction andtravel industries, to design,manage and teach strategicmanagement programmes.He also works with the own-ers of SME's helping them to

read and interpret the tradingenvironment.

Current and recent clientsinclude Taylor Wimpey, BAA,Experian, Lloyds-TSB, Bar-clays, Hanson, Cairn Energy,Nandos, Specsavers, and

Allied, Milling and Baking.Prior to a career in teachingand consulting, Rogerworked in the New ZealandTreasury and the AirTransport Training Board as

an economist.

His extensive knowledge ofmanufacturing, distribution,financial services and energysectors and skill in thepresentation of complexeconomic issues haveearned him a reputation as ateacher, consultant, writerand broadcaster over theyears. He was one of the fewwho predicted the financialcrisis. As a behavioural econ-

omist he focuses on behav-iour and feedback loopswhich are largely absent fromconventional models.

A B O U T

T H E

A U T H O R

Roger Martin-Fagg,BA Hons



8/8Membership helps

8

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roger martin fagg, economic update, feb 2013

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