In 1976, the actor Peter Finch played a frustrated and angry television news anchor in the movie Network. Playing the character Howard Beale, Finch received an Academy Award and his famous line made movie history.
He was railing against the injustice of greedy corporate owners who did not value his award-winning show and were solely interested in profits. On one of his last broadcasts he appealed to his listeners to open their windows and shout to the world these words:
They listened to the populist leaders who told them that immigrants, globalization, and cheap imports were destroying their way of life. That the reason their incomes had remained stagnant for more than two decades was because of the insatiable greed of the 1%, and that the political leaders of the developed world were part of a global elite that was going to insure that they would not improve their lot in life.
I believe that what occurred in Britain on Thursday was an example of an increasing number of frustrated citizens of many countries who feel they are not heard or represented by the status quo political parties and has led to the rise of individuals such as Donald Trump, Bernie Sanders, Jeremy Corbyn, Nick Farage, and Marine Le Pen just to name a few.
I’d like to review what has happened so far with respect to markets and what our response has been (much the same as it has always been during times of crisis: build/manage wealth with a truly diversified portfolio that generates significant cash flow and then, when certain assets drop in value, acquire more of them and their cash flow at lower prices).
But first it might be helpful to look at some of the macro issues which have caused Brexit and the rise of populist leaders globally.
WHY THEY’RE MAD AS HELL
A few weeks ago I gave a presentation to a group of accountants and shared with them the slides below:
This first chart (left) was from a report written by the Bank Credit Analysts (BCA) with some highlighting by me. Some key observations:
- Over the last century, wealth has become less concentrated in both the U.S. and France, but since the 1970’s it has remained approximately flat in France, yet increased in the U.S. The 1% are becoming wealthier.
- The chart on the right shows that the UK and the U.S. lead the pack in having highest levels of income inequality and lack of upward mobility. The Great American Dream seems to have stalled. Interesting to note that Canada is far less unequal in income and has greater upward mobility than many of our peers.
- While many right wing politicians make the case that real growth in income only comes from lower taxes, the data suggests that lower taxes simply increase the concentration of wealth.
- As a result, the BCA feels that the U.S. and the UK are likely to move towards the left of the political spectrum with a result that tax rates will rise in the future. (This has already happened here in Canada.)
Over the last few years we have written about a number of factors that are impacting the global economy, including the following:
- Aging populations tend to spend relatively less on consumer goods and save more, which would support lower inflation and potential deflation (notwithstanding record-breaking low interest rates).
- There is a belief that lax immigration laws have allowed “foreigners to steal jobs.” When it comes to labour and wages, however, the real driver has been globalization and industry’s willingness to seek cheap labour elsewhere, keeping wages low.
- In theory, an aging population should mean fewer workers supporting more retired people. In a global economy, however, there is still a very large contingent of labour that is available in the developing world where companies can set up shop. This has the impact of suppressing wages globally. It will take many years – if not decades – before emerging market labour begin to enjoy the standard of living typical in the OECD countries (Organization for Economic Co-operation and Development). This is also a deflationary factor and one that can lead to anti-immigration policies if the level of xenophobia is high enough.
- Wealth has been concentrating and “the 1%” is not entirely a populist myth.
- Upward economic mobility in the West has stagnated to the point of frustration for many.
- Globalization has restructured the industrial workforce; consequently, wages are being suppressed.
With an environment such as this it is easier to understand why someone promoting policies to build walls across borders, ban certain immigrant groups, unwind free trade agreements, and increase taxation on the wealthy would gain traction.
NOT TAKING IT ANYMORE – NOW WHAT?
Let’s turn our attention to the first day’s financial impact of Brexit and what we feel is the best approach for our clients moving forward.
At the end of Friday June 24th:
- U.S. and UK equity markets were each down just over 3%.
- European and Japanese markets each fell about 8%.
- The TSX dropped less than 2%.
- 10-year bond rates in the UK fell 29 bps to 1.09% while 2-year rates fell 25 bps to 0.25% (down by half from the day before).
- Swiss 10-year rates are -0.55% (that is negative-0.55%). This means that if you buy a 1000 Francs Swiss 10-year bond today, you can get back 946 Francs in 2026 thereby paying the Swiss government 54 Francs for the privilege of allowing you to lend them money. (Who knows what a Swiss banker would charge to hold the bonds in a safety deposit box.)
- As of now, about $10-trillion of global sovereign debt has negative interest rates.
- In the U.S., 10-year rates dropped about 19 bps to 1.56% and in Canada, fell 13 bps to 1.17%. We will have to see if this translates into even lower mortgage rates than we have seen recently.
- The British Pound at one point fell to a 30-year low of $1.33 US and ended just under $1.37 ($1.78 CAD). Our dollar was down 2% against the U.S. dollar primarily because of lower oil prices.
- Volatility in markets will probably continue for some length of time. It may take well over two years before the details of Brexit are fully understood.
- This uncertainty will mean that the Fed and other central banks are likely to keep interest rates suppressed for longer. We may see very little in the way of increases until sustainable economic growth is realized or there is a measurable uptick in inflation.
- Higher tax rates have already occurred in Canada both personally and corporately and other countries will probably follow suit in the not too distant future.
What to do:
- A well designed portfolio along with an effective corporate structure will go a long way to reducing taxes. We have always emphasized the need for all of our clients to have a detailed financial plan that takes into account tax, business, retirement income, and estate issues. Today this type of planning is more critical than ever.
- True wealth building focuses on extensive diversification and increasing cash flow, not price appreciation. Our current weighted asset allocation for clients is about 30% equities, 35% fixed income, and 35% in real estate, private equity, precious metals, and alternative strategies. About 1/3 of our equity position is partially hedged using options such as calls and puts. Our overall exposure to equities is already quite low and any negative market impact would be used to acquire more of these assets at lower prices. The same argument goes for fixed income assets that have seen price drops in the last year (such as preferred shares and high yield bonds). This has been a great opportunity to acquire more cash flow at very attractive prices.
- With our real estate we will continue to focus on adding new assets where we can add value and grow rental income over time. Low rates mean that we will continue to lock in both new and existing mortgage debt for longer terms.
Brexit is but one example of a world where the status quo is being challenged and where the EU – and certainly the World – is entering unprecedented territory. It is in times such as these that a well-diversified, cash-flow-generating portfolio maintains wealth and allows it to grow steadily and effectively over time, no matter the unexpected storms or changing landscape.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. NWM is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions.