Why the Germans Do it Better

One of my summer reading books was “Why the Germans Do it Better” by John Kampfner. The book is somewhat mistitled because much of it is taken up with the history of political developments in Germany since the Second World War. That is interesting but it does also cover why Germany has been so successful in developing its economy since it was destroyed in the war years.

This is a short extract from the book: “On the eve of the currency reform and lifting of price controls [by Ludwig Erhard], industrial production was about half of its level in 1936. By the end of 1948 it had risen to 80 per cent. In 1958, industrial production was four times higher it had been just one decade earlier. By 1968, barely two decades after the end of the war that had left the country in ruins, West Germany’s economy was larger than that of the UK. The trend continued remorselessly. In 2003, it became the largest exporter to Eastern Europe. In 2005, it surpassed the US as the leading source of machinery imports into India. It is the largest exporter of vehicles to China. Most impressively, in 2003, Germany overtook the US to become the biggest total exporter of goods in the world”.

Why do we in the UK import so many German cars and other products. Just looking around my own house we have a Siemens refrigerator, a Bosch kettle, dishwasher and washing machine, an AEG cooker and I just bought a Braun electric razor. Like many readers no doubt, all of our domestic appliances are German apart from a Japanese bread maker.

The UK used to be a leading industrial manufacturer and although our car industry is not as moribund as it used to be, it is still only below tenth in the world for vehicle production while Germany is fourth.

Why has the UK become deindustrialised and in practice become primarily a service economy? Education is part of the problem but as Mr Kampfner makes clear, it is also an issue of how we organise our companies. Comparative productivity shows we have fallen well behind with GDP per capita now only 85% of Germany’s.

In Germany there seems to be a stronger consensus between management and employees with employee representatives on the supervisory boards. The culture of companies is different in essence.

Mr Kampfner’s book highlights many of the differences and points to how the UK should rethink some of its educational and corporate structures if we are improve our productivity. It’s well worth reading for that alone.

But it is also a good primer on political developments in Germany, written by someone who knows both Germany and the UK well.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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The Population Issue and Historic Evacuations

Roman Withdrawal from Britain – From Cassell’s History of England

My previous blog post on the IPPC report on climate change generated a number of comments. Here’s a good one in the past from Sir David Attenborough that is very relevant: “All our environmental problems become easier to solve with fewer people, and harder – and ultimately impossible – to solve with ever more people”. That’s certainly an area where Governments could take a stronger lead.

While the stock market is relatively quiet, it’s a good time to ponder the subject of evacuations as is currently happening in Afghanistan. Was it necessary and what might happen in due course are the key questions?

Evacuations after military withdrawals are quite common in history. Britain suffered such an event in the years 405-410 when the Roman Empire withdrew the legions to fight off attacks on the continent. The Emperor Honorius finally told the Britons to “look to their own defences” in 410 which marked the effective end of Roman rule. After 400 years of Roman administration and cultural dominance in Britain it rapidly disappeared. All we have left now are a few straight roads.

The USA gave the same exhortation in Viet Nam after a failed attempt at establishing a western style democracy in the South to thwart Communist expansion. Militarily the war in Viet Nam was a disaster with much gold and lives lost to ultimately no purpose. The regime they established was a puppet one ridden by corruption and without widespread popular support. Despite heroic efforts by the US military, support from the US public eventually withered away. Joe Biden is old enough to remember that failure of US policy when the war was continued for far to long. It is hardly surprising that both he and Donald Trump were keen to withdraw from Afghanistan as soon as possible. Viet Nam is now a peaceful and commercially vibrant country.

Britain faced the same problems in Afghanistan in the 19th century when we invaded twice to thwart suspected Russian influence. The first Afghan war was a military disaster and after the second we rapidly withdrew having learned our lesson. In the 1980s Russia invaded the country but after 10 years withdrew after effectively suffering military defeat. The history of Afghanistan and the reasons why it is so difficult for foreign armies to gain control was well covered in a TV documentary by Rory Stewart in 2012 under the title “The Great Game” – it was rebroadcast this week and acted as a good reminder why military success in the country is always a mirage.

Ultimately the US and UK’s efforts in Afghanistan followed the same problems as in Viet Nam. The regime they established was corrupt and only kept afloat by oodles of money while the western culture they attempted to establish was not accepted by most of the population. Afghanis looked on western armies as invaders of the wrong religion. This was never going to work.

Ultimately, and when otherwise facing a military situation that could not be won, withdrawal was clearly the best solution after the original reason for the US invasion was forgotten after 20 years of war (originally intended to stop terrorism promoted by al-Qaeda).      

Could the withdrawal have been better handled? That is debateable. It is clear that all the “hangers-on” to the US, UK and other foreign forces might want to depart but with tens if not hundreds of thousands of such people this was hardly very practical. A date was set of the end of this month and Joe Biden does not wish to stretch it out. They claim to have already evacuated 70,000 refugees. There was sufficient time given to remove military forces and the Taliban have promised an amnesty for others. It is clear that Afghanistan faces a very difficult time in the next few years both socially and economically as Viet Nam did. But extending the withdrawal by a few weeks or months will surely not help much while militarily it makes no sense. Kabul airport cannot be defended easily if the Taliban choose to block a time extension. The West should concentrate on coming to an accommodation with the new rulers and helping them to develop the country, not attacking them for perceived undemocratic failings.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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IPCC Report – The Implications for Investors

The Intergovernmental Panel on Climate Change (IPCC) have published a report that predicts in stark terms both the historic and predicted changes to the earth’s climate from human activities. This is what they say in the accompanying press release: “Scientists are observing changes in the Earth’s climate in every region and across the whole climate system, according to the latest Intergovernmental Panel on Climate Change (IPCC) Report, released today. Many of the changes observed in the climate are unprecedented in thousands, if not hundreds of thousands of years, and some of the changes already set in motion—such as continued sea level rise—are irreversible over hundreds to thousands of years”.

However they also say that “strong and sustained reductions in emissions of carbon dioxide (CO2) and other greenhouse gases would limit climate change. While benefits for air quality would come quickly, it could take 20-30 years to see global temperatures stabilize”.

Although there are a few people who do not accept the scientific consensus in the IPCC report, Governments are likely to accept the findings and implement policies accordingly. This is already happening with the UK being at the forefront of measures to reduce carbon emissions which are seen as the main cause of global warming. With the UK Government’s “net zero by 2050” policy we are already seeing major impacts and the imposition of enormous costs on many aspects of our life. All of this is reinforced by media coverage of floods and wild fires that are typically blamed on climate change.

Many such reports are anecdotal in nature – they may simply be random events that occur for non-specific reasons, while reporting of such events is now more common in the modern connected world. But the IPCC report does say “It is virtually certain that hot extremes (including heatwaves) have become more frequent and more intense across most land regions since the 1950s, while cold extremes (including cold waves) have become less frequent and less severe, with high confidence that human-induced climate change is the main driver of these changes”. They also say that heavy precipitation events have increased since the 1950s over most land areas and it is likely that human-induced climate change is the cause. It has also contributed to increases in agricultural and ecological droughts.

The IPCC report is effectively a call for action and that will no doubt be reinforced by the upcoming COP26 summit in Glasgow in November where politicians will be promoting their virtuous visions no doubt. Whether they turn into actions remains to be seen – the past experience suggests they may only turn into token gestures. Economic decisions often thwart the best policies.

What happens if we don’t cut CO2, and methane and other carbon emissions? The IPCC report gives a number of scenarios based on scientific models of differing levels of emissions. Under the high and very high GHG emissions scenarios, global warming of 2°C (relative to 1850– 1900) would be exceeded during the 21st century. Global warming of 2°C would be extremely likely to be exceeded in the intermediate scenario and under the very low and low GHG emissions scenarios, global warming of 2°C is unlikely to be exceeded.

That might seem to be good news, but because of the time lag of the impact of changes in emissions, under the high emissions scenario their best estimate is of a temperature rise of 2.4 °C by 2041-2060 and 4.4 °C by 2081-2100. The latter would be disastrous for many parts of the world with increases in the intensity and frequency of hot extremes (heatwaves and heavy precipitation). The Arctic might become ice free in summer under all the scenarios and sea levels will rise “for centuries to millennia due to continuing deep ocean warming and ice sheet melt”. This could mean a rise of 2 to 3 metres in sea levels if warming is limited to 1.5 °C or 19 to 22 metres with 5 °C of warming!

With so many of the world’s cities on seaboards you can see that flood defences may be totally inadequate to cope with such rises and incapable of being built to resist them. Investments in City of London property would be one casualty. The current Thames flood barrier may be overwhelmed in future years even if GHG emissions stop growing.

The changes will likely affect the Northern Hemisphere more than the Southern, and there is some good news. For example, the reports says that the growing season has lengthened by two days per decade since the 1950s in the Northern Hemisphere. Farming might extend further north and unproductive land brought into use, but droughts might also remove a lot of marginal land from farming activity. These impacts will be greatly affected by the increase in GRH emissions.

Who can really affect the emissions? Only the big emitters such as the USA, China and Russia can have much impact. The UK produces less than 2% of world emissions.

Does the decarbonisation of transport, particularly in the UK, help at all? In reality not. For example, converting users to electric cars is likely to have minimal impact because the energy requirement and associated CO2 emissions to construct the batteries and make the steel for the car bodies offsets most of the likely benefit. The cost of building a network of charging points and enhancing the electric grid to cope will also be high. Investing in electric car makers or buying electric cars is not going to save the planet.

Is it worth considering investing in disaster insurers, although there are now few such listed vehicles? Munich Re produced a good report on this area which you can read here: https://www.munichre.com/en/risks/natural-disasters-losses-are-trending-upwards.html . An interesting point they make is that less than half of all losses are insured and it is even less in developing countries. It is very clear that poorer countries in less developed markets are those that are going to suffer from more extreme weather events and rising sea levels.

The big problem which the IPCC report does not cover is that GRH emissions are directly related to the size of the human population and their activities. Particularly what they consume, where they live and how they earn an income.  

Unless there is a concerted effort to halt the growth in population and to restrict urbanisation, I doubt that the growth in GRH emissions will be halted. More population means more farming to feed the people and that is a big contributor to methane emissions which is a significant GRH factor (this is highlighted in the latest IPCC report). Similarly construction of homes and offices is a big contributor. Nobody has yet figured out how to produce cement without generating carbon. Hence the suggestion that we should revert to constructing houses out of wood. Investing in growing trees for timber might be one interesting investment approach to look at. But that is a 20+ years project and it can take 50 years to grow to harvestable size for timber, or longer in northern latitudes.

In conclusion, it’s worth reading the IPCC report (see link below) and pondering how you think the Government should deal with these issues. Please don’t fall into the trap of encouraging your local council to declare a “climate change emergency” as some have already done. Their initiatives such as closing roads to restrict traffic and persuading everyone to cycle will have no impact whatsoever. Gesture politics is what we do not need.

Even the UK Government alone will have no impact unless they can persuade other major countries to take suitable steps. But will they is the key question?  If they don’t all we can do is to try to mitigate the impacts by weather proofing our properties and the transport network while purchasing air conditioning to cope with the heatwaves.

I am sure some readers of this article will consider that I am being too defeatist and that we can all contribute to reducing the problem by eating less meat, looking at the food miles of what we consume, cutting out long holiday flights, changing your central heating boiler, reducing investments in oil/gas/coal producers and other peripheral affectations. But only Governments can really tackle the problem which we should all encourage them to do.

IPCC Sixth Assessment Report: https://www.ipcc.ch/assessment-report/ar6/

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Chancellor’s Budget Speech – Positive for Business

I listened to Rishi Sunak’s budget speech today and here is a summary of some parts of it with some comments from me.

He said that £280 billion of support had been provided, but the damage to our economy despite this has been acute. However our response to the coronavirus epidemic is working. Employment support schemes are being extended and business rates holidays also. The OBR is now forecasting a swifter recovery but the economy won’t be back to normal until the middle of next year. Unemployment is expected to rise to 6.5% but that is less than previously forecast.

There will be another £65 billion of support for the economy when we have borrowed £355 billion this year which will be a record amount.

The stamp duty holiday is extended to September. That should please my oldest son as he is trying to move house at present and delays are happening in the chain because of local authorities not responding to inquiries. There will also be a new mortgage guarantee scheme which as Keir Starmer pointed out may simply encourage a rise in house prices – OK if you already have one but not otherwise. Fuel duty will be frozen as will beer, wine and spirit duties.

Now the bad news: personal allowance tax thresholds will be frozen at the end of the next tax year until April 2026. That effectively implies a rise in tax equivalent to inflation over that period. Inheritance tax thresholds will be maintained at their current levels until April 2026 and the adult ISA annual subscription limit for 2021-22 will remain unchanged at £20,000. There is no mention of changes to capital gains tax as widely rumoured and the pension Lifetime Allowance will be maintained at its current level of £1,073,100 until April 2026 when it really should be increased to match inflation (high earners already have problems with the current limit).

Corporation tax will rise to 25%, but there will be a taper for larger companies. Only 10% of companies will pay a higher rate. Comment: that will still be a competitive rate.

The Chancellor said we need an investment led recovery. Therefore for the next 2 years companies can reduce their tax bill by 130% of the cost of capital expenditure. This is the biggest business tax cut in history he claimed.

There will be a new UK infrastructure bank and a new handout for small businesses to fund IT investment and obtain management support (see https://helptogrow.campaign.gov.uk/ for details). He also mentioned a review of R&D tax reliefs which are quite generous at present. It is planned to cap the amount of SME payable R&D tax credit that a business can receive in any one year at £20,000 (plus three times the company’s total PAYE and NICs liability), but a review is also mentioned.

There are a number of hand-outs for greening of the economy, as one might expect, but there are also more hand-outs to protect jobs and to support Covid-19 vaccination roll-out and research projects.

The FCA will be consulting on Lord Hill’s review to encourage companies to list in UK markets.

There will be more Freeports with 8 locations already identified.

In summary, this budget should be good for business but small software companies may be concerned about the changes to R&D tax credits.

More details of the Chancellors speech here: https://www.gov.uk/government/news/budget-2021-sets-path-for-recovery

Postscript: Reaction to yesterday’s budget was generally negative, but nobody likes higher taxes. The general view is that the Chancellor has just kicked the bucket down the road. More borrowing in the short term to finance the recovery and keep people in employment, but much higher taxes later. I think the budget is a reasonable attempt to keep the economy afloat and could have been a lot more damaging for business if he had taken a tougher line.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Boom and Bust Book Review

Avoiding buying into the peak of booms and selling at the bottom of a bust is one of key skills of any investor. But what causes them? The recently published book entitled “Boom and Bust” by academics William Quinn and John D. Turner attempts to answer that question by a close analysis of historical market manias.

I found it a rather slow read to begin with but it proved to be a very thorough and interesting review of the subject. It covers bubbles through the ages such as the Mississippi and South Sea schemes back in the seventeen hundreds, through the railway and cycle manias plus Australian land boom of Victorian times to those in more living memory. That includes the Wall Street boom and 1929 crash, the Dot.com bubble of the 1990s and the sub-prime mortgage crisis in 2007/8.

The latter resulted in a world-wide financial crisis with particularly damaging effects in the USA and UK. Banks had to be bailed out and bank shareholders lost their lifetime savings. But the dot.com bubble had relatively minor impacts on the general economy.

I managed to sell a business and retire as a result of the dot.com bubble at the age of 50 because it was obvious that IT companies in general had become very highly valued. Software and internet businesses with no profits, even no sales, had valuations put on them that bore no relation to conventional valuations of businesses and forecasts of future profits were generally pie in the sky. One of the things the authors point out is that insiders generally benefit from booms while inexperienced retail investors and unwise speculators with little knowledge of an industry are often the losers.

How are bubbles caused? The authors identify three big factors which they call the “bubble triangle” – speculation, money/credit and marketability. The latter is very important. For example, houses owned by occupiers tend to be part of markets that are sluggish and not prone to volatility as buying and selling houses is a slow process. But when sub-prime mortgages were created a whole new market was brought into being where mortgages could be easily traded. At the same time, the finance for mortgages was made easier to obtain.

The latter was by driven by political decisions to encourage home ownership by easier credit and by the relaxation of regulations. Indeed it is obvious from reading the book that politicians are one of the major sources of booms. Governments can easily create booms, but they then have difficulty in controlling the excesses and managing the subsequent busts.

The Dot.com boom was partly driven by technological innovation that attracted the imagination of the public and investors. It might have contributed positively to the development of new technologies, new services and hence to the economy, but most companies launched in that era subsequently failed or proved to be poor investments in terms of return on capital invested. Amazon is one of the few success stories. As the book points out, market bubbles tend to disprove the theory that markets are efficient. It is clear that sometimes they become irrational.

There are particularly good chapters in the book on the Japanese land bubble in the 1980s and the development of China’s stock markets which may not be familiar to many readers.

The authors tackle the issue of whether bubbles can be predicted and to some extent they can. But a good understanding of all the factors that can contribute is essential for doing so. Media comments can contribute to the formation of bubbles by promoting companies or technologies but can also suppress bubbles if they make informed comments. But this is what the authors say on the Bitcoin bubble and the impact of social media and blogs: “The average investor was much more likely to encounter cranks, uninformed journalists repeating the misinformation of cranks, bitcoin holders trying to attract new investors to increase its price and advertisements for bitcoin trading platforms”. They also say: “Increasingly the nature of the news media is shifting in a direction that makes it very difficult for informed voices to be heard above the noise”.

Incidentally it’s worth reading an article by Phil Oakley in the latest issue of Investors Chronicle entitled “Tech companies still look good”. He tackles the issue of whether we are in another Dot.com era where technology companies are becoming over-valued. His conclusions are mixed. Some big established companies such as the FANGs have growing sales and profits and their share prices are not necessarily excessive. But some recent IPOs such as Airbnb look questionable. Tesla’s share price has rocketed up this year but one surely needs to ask an experienced motor industry professional whether the valuation makes sense or not.

The authors suggest that buying technology shares can be like a casino. Most of the bets will be losing ones but you may hit a jackpot. I would suggest you need to pay close attention to the business and its fundamentals when purchasing shares in such companies.

In conclusion the book “Boom and Bust” is well worth reading by investors, and essential reading for central bankers and politicians!

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Market Musings

The stock market seems to be positively benign at present, if not almost somnambulant. While certain sections of the economy have gone to hell in a handcart, the enthusiasm for technology stocks has not abated. My very diversified portfolio is up today at the time of writing by 0.4% helped by good news from Dotdigital (DOTD) today and a sudden enthusiasm for GB Group (GBG). Optimism about a more general recovery in the economy seems to be still prevalent.

It’s probably a good time to consider overall market trends with a view to adjusting portfolios for the future. It is very clear for example that the UK at least, if not the world, is heading for a “net zero” world, i.e. a world where we are not emitting any carbon which implies a very high reliance on electricity generated from wind, solar and hydroelectric sources.

Whether that can be achieved in reality, and in my lifetime, remains to be seen. Whether it is even rational, or economically justified, is also questionable. But now that the religion of zero carbon has caught on, I do not think it is wise for any individual investor to buck the trend. As with any investment fashion it’s best to jump on the bandwagon and as early as possible. So I hold no oil companies and few interests in coal miners, except where they are part of diversified mining companies who are also mining copper (essential for the new electrification) and steel (not easily replaced). But I have recently invested in “renewable infrastructure” investment companies of which there are several, and in funds that provide battery support and load smoothing systems. Wind farms and solar panels tend to generate intermittent electricity so there is a big demand for emergency sources of power.

There was a very good article by Bearbull in last weeks Investors Chronicle headlined “The Net Zero Perversion” on this subject. He commences by saying “It is surely the new paradigm – that economic recovery from the damage caused by the response to Covid-19 can only be achieved by a fundamental shift towards a zero-emissions future. This is stated as fact – that reducing greenhouse gas emissions to ‘net zero’ by 2035 will be the powerhouse of economic growth – when, of course, it’s just a contention; much like the complementary one that investing in companies that are wonderfully compliant in meeting their economic, social and governance (ESG) commitments will bring excess investment returns”.

He goes on to say, after some other comments that must have enraged the uneducated environmental enthusiasts: “Yet there is plenty of evidence that the pursuit of net zero is brimming with unintended consequences, which is what you might expect from a movement driven by a weird mixture of idealism and greed”. He points out that rewiring our homes and expanding the grid to cope with the new electricity demand might cost £450 billion, i.e. £17,000 per household. Similarly the banning of the sale of new internal combustion powered vehicles from 2035 just causes the pollution generated from the manufacture of electric vehicle power systems and associated mining activities to happen elsewhere in the world. But overall emissions might not fall.

This fog of irrationality and attacks on personal mobility via vehicles using the Covid-19 epidemic as an excuse is now happening in several London boroughs, encouraged by central Government “guidance” and funding. Roads are being closed. In the Borough of Lewisham, adjacent to where I live, road closures have caused increased traffic congestion, more air pollution and gridlock on a regular basis. There is enormous opposition as the elderly and disabled rely on vehicles to a great degree while in the last 75 years we have become totally dependent on vehicles for the provision of services (latterly for our internet deliveries). Councillors in Lewisham think they are saving the world from global warming and air pollution that is dangerous to health when they won’t have any impact on overall CO2 emissions and there is scant evidence of any danger to health – people are living longer and there is no correlation between local borough air pollution and longevity in London. Air pollution from transport has been rapidly falling while other sources (many natural ones) are ignored. Lewisham and other boroughs have partially backed down after a popular revolt but local councillors still believe in their dogma. There is a Parliamentary E-Petition on this subject which is worth signing for those who think that the policy is misguided: https://petition.parliament.uk/petitions/552306

The Bearbull article concludes with this comment which matches my opinion: “All of which means investors should preserve their scepticism. But they should also recall their purpose in investing – to make money, not to go to war with the climate change movement, however ridiculous they may see some of its follies. Sure, as consumers they should see much of the pursuit of net zero for what it is – another charge on their net income. But as investors they should see it as an opportunity to join the momentum and, at the very least, to park some of their capital in a fashionable part of the market”.

When it comes to investment, markets can be irrational for a very long time. That is surely the situation we are currently seeing with stock markets kept buoyant by a flood of cheap money and there being nowhere else to stash it. With traditional industries and businesses in decline, most of the money is going into technology growth stocks or internet shopping driven businesses such as warehousing. That trend surely cannot continue forever. But in the meantime, following market trends is my approach as ever.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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On the Wealth of Nations

The stock market’s in the doldrums and August is coming up when everyone goes on holiday. But I would guess many of my readers will not be going far, or not at all. You may need some lightweight tome to read on your sofa or on the beach though, so here is a book I have just finished and can recommend.  

It’s called “On the Wealth of Nations” by P.J. O’Rourke. First published in 2007 and claiming to be a New York Times Bestseller, it’s a digest and analysis of that venerable book of the same title by Adam Smith which was published in 1776. I tried reading that book many years ago but found it heavy going. It’s long and in a somewhat archaic style but it was the foundation of much subsequent thought in economics. For anyone interested in the worlds of business and finance, it provides a primer on the division of labour, productivity, and free markets.

P.J. O’Rourke is a very unlikely person to take a stab at popularising Adam Smith’s book but he makes a very fine job of it. He is a comic writer and wit whose reporting on the war in Iraq and in motoring stories in such books as “Give War a Chance” and Holidays in Hell” are also worth reading.

O’Rourke relates much of Smith’s adages, aphorisms, epigrams, insights, observations, maxims, axioms, judicious perceptions and prejudiced opinions (which Smith produced in large numbers) to the modern world. Here’s one example: “The freedom of the market, though of uncertain fairness, is better than the shackles of government, where unfairness is perfectly certain”.

Smith lived before the rise of modern capitalism and the importance of the joint stock company. But he wisely had this to say (as O’Rourke quotes) that as the result of an immense capital divided among an immense number of proprietors [shareholders]:  “It was naturally to be expected therefore, that folly, negligence, and profusion should prevail in the whole management of their affairs”. That’s still true of many companies is it not?

O’Rourke relates two very amusing anecdotes about Smith and his absentmindedness. He is supposed to have gone out into the garden in his dressing gown and, lost in thought, wandered into the road. He walked to Dunfermline, fifteen miles away, before steeple bells broke his reverie and he realised he was wearing his robe and slippers in the midst of a crowd going to church.

At another time, deeply involved in conversation over breakfast, he put bread and butter and boiling water into a teapot and then pronounced it was the worst cup of tea he had ever had.

Some of the issues that Smith discussed in his book such as whether to support free trade or not, what are good taxes or bad taxes, and what level they should be at, are still the subject of topical debate.

In summary O’Rourke’s book is easy reading but still prompts much thought on the world of business, economics and politics.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Economic Trends, Audit Quality and the Importance of Management

The news on the epidemic and its impact on financial news continues to be consistently bad. GDP rebounded in May to be up 1.8% but that’s a lot less than forecast. It fell 20.3% in April but as many businesses did not reopen until June perhaps the May figures are not that surprising.

Masks now have to be worn in shops. This will be enforced by the police with possible fines of £100. That will surely discourage some people from shopping on the High Streets.

The BBC ran a story today that said that scientists forecast a second wave of the virus in Winter with up to 120,000 deaths. But that is a “worse case” scenario. The claim is that the colder weather enables the virus to survive longer and with more people spending time indoors, it may spread more. I think this is being pessimistic but it’s certainly not having a positive effect on the stock market.

The London Evening Standard ran a lengthy and very negative article yesterday on the impact of the virus on London with a headline describing it as “an economic meltdown”. It suggested 50,000 jobs will go in the West End alone due to a decline in retail, tourism and hospitality sectors. Commuters are still reluctant to get on public transport – trains, underground or buses. In Canary Wharf only 7,000 of the 120,000 people who normally work there are at their desks it is reported. One problem apparently is that with numbers able to enter lifts being restricted it can take a very long time to get all the normal staff at work in high rise buildings. Hotels, clubs and casinos have been particularly hard hit with the extension of the Congestion Charge (a.k.a. tax) discouraging visits. 

Audit Quality

The Financial Reporting Council (FRC) has confirmed what we probably already knew from the number of problems with company accounts – that audit quality has declined in the last year. Following reviews of audits by the major audit firms including PwC, Deloitte, EY, KPMG, BDO and Grant Thornton there were a number of criticisms made by the FRC. The firms PwC, KPMG and Grant Thornton were particularly singled out. The last firm was judged to require improvement in 45% of its audits.

We were promised a tougher stance from the FRC but it is clearly not having the required impact. Published accounts are still clearly not to be relied upon which is a great shame and undermines confidence in public companies.

There were a couple of interesting articles in last week’s Investors Chronicle (IC). One was on the investment approach of Harry Nimmo of Aberdeen Standard. He is quoted as saying: “We do measure prospective and future valuations – it’s not completely ignored. But it doesn’t lead our stock selection, and we don’t have price or valuation targets”. Perhaps he does not trust the accounts either? He does apparently screen for 13 factors though including some related to momentum and growth.

Management Competence

The other good article in IC was by Phil Oakley headlined “How important is management”. If you don’t trust the accounts of a company, it’s all the other factors that help you to judge the quality of a business and the prospects for long-term returns which are important. Phil says that “management does matter” but he thinks some investors overemphasise it’s importance.

How do you judge the quality of the management? One can of course look at the results in the financial numbers over past years but that can suffer from a major time lag. In addition management can change so past results may not be the result of work by the current CEO but their predecessor. This is what I said in one of my books: “Incompetent or inexperienced management can screw up a good business in no time at all, although the bigger the company, the less likely it is that one person will have an immediate impact. But Fred Goodwin allegedly managed to turn the Royal Bank of Scotland (RBS), at one time the largest bank in the world, into a basket case that required a major Government bail-out in just a few years”.

RBS was also a case where the company’s financial results were improved by increasing the risk profile of the business – the return on capital was improved but the capital base was eroded. Management can sometimes improve short term results to the disadvantage of the long-term health of the business.

Is it worth talking to management, say at AGMs or other opportunities? Some people think not because you can easily be misled by glib speakers. But I suggest it is so long as you ask the right questions and don’t let them talk solely about what they want to discuss. Even if you let them ramble, you can sometimes pick up useful tips on their approach to running the business. Are they concerned about their return on capital, or even know what it is, can be a good question for example. I recall one conversation with an AIM company CEO where he bragged about misleading the auditors of a previous company about the level of stock they held, or another case where a CEO disclosed he was suffering from a brain tumour which had not been disclosed to shareholders. Unfortunately in the current epidemic we only get Zoom conversations rather than private, off-the-record chats.

Talking to competitors of a business can tell you a lot, as is talking to former employees who frequently attend AGMs. Everything you learn can help to build up a picture of the personality and competence of the management, and the culture that they are building in the company. The articles being published on Wirecard and Boohoo in the last few days tell us a great deal about the problems in those companies but you could have figured them out earlier by some due diligence activity on the management.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Oxford Tech VCT3 and other VCTs, and the Coronavirus Bandwagon

One of my shareholdings, Oxford Technology VCT3 (OTT), fell 44% this morning. Am I concerned? No because I have only ever held 10 shares in the company. I cannot even recall why I bought the shares back in 2014 but it was probably to keep an eye on their interest in unlisted Ixaris Group Holdings Ltd. That company was a major part of their portfolio and was still 65% of the net assets at the 29 February. It is also held by other VCTs. To quote from the ITT annual report, issued today, “For OT3 the initial Covid-19 pain has been most strongly felt by Ixaris, a travel payments company as a result of knock on impacts from Thomas Cook’s failure and a decline in Asian travel. Subsequent to our year end the downward pressure has increased on Ixaris with major airline disruption”. It also discloses that Ixaris received an offer during the financial year which would have meant a major exit at an uplifted price, but it collapsed at the last minute.

As a former director of Ixaris, and a very minor shareholder still, I was aware of this bad news. It looks like they are almost back at square one. That is the nature of early stage venture capital. Two steps forward and one step back, or vice versa in this case. I always took a sceptical view of the value put on Ixaris by OTT and other VCTs as I always considered it a highly risky investment.

OTT also wrote down Orthogem as it was sold for a nominal amount. This is what they said about that: “Although Orthogem had made significant technical progress with the launch of its putty product and appointment of international distributors, it was unable to raise sufficient funding to be able to continue to trade.  The OT VCTs were willing to continue supporting the company, especially given we believed the company was very close to commercial success, but the VCT rules governing the age of companies and the use to which any new funds can be applied prevented us from doing so”. VCT rules are now preventing some follow-on investments.

OTT also has a holding in listed Scancell (SCLP) which OTT says has had a moderate uplift after announcing the start of its research programme to develop a Covid-19 vaccine. They also say this: “Scancell is our third largest holding and had a disappointing year of regulatory and clinical delays in its flagship melanoma trial and its share price fell over the course of the year. Its planned Phase 2 combination trial with their initial product SCIB1 ran into difficulties with the US Food and Drug Administration (FDA) due to the delayed approval by the FDA of the upgraded delivery device from 3rd party Ichor. In the event, the trials started in the UK later than expected. Subsequently the required US approvals were received but a year has been lost and results will now be correspondingly delayed. Post period end the UK trial went on hold as a result of Covid-19 risks. Nevertheless good data from these trials could represent a significant value inflection point for Scancell and are eagerly awaited”.

There were big hopes for Scancell a few years ago but that has long since evaporated and revenue has remained at zero. It’s a typical story of early stage drug development companies which I avoid for that reason.

The Net Asset Value of OTT fell by 33% from the previous year-end, and hence the share price drop on what is a very illiquid share, like most VCTs. Normally VCTs are immune to general stock market fluctuations but not in the current recession. Some of my VCT holdings have fallen sharply no doubt because of downward valuations of some of their unlisted holdings but also because of sharp falls in many AIM shares which are a significant proportion of some VCT portfolios. This has also been compounded by the halt to share buy-backs in some VCTs – the result is just a few shareholders selling causing a sharp fall in their share prices.

Are their opportunities in VCT shares appearing, or should I be selling also? Perhaps is the answer, but VCT shares I consider to be very long-term holdings with a lot of the value coming from their tax-free dividends. I only tend to sell when I have lost confidence in the board or the investment manager.

As with the mention above of Scancell, almost all biotechnology companies are now trying to get into the coronavirus space by developing interests in vaccines, antibody tests and diagnostic products. Such an entry does wonders for the share prices. This ranges from the very largest companies such as Astrazeneca and Glaxosmithkline who are both gearing up for vaccine production to the smallest start-ups. One example announced today is that of Renalytix AI (RENX) who announced a joint venture with the Mount Sinai school of medicine to produce Covid-19 antibody test kits. RENX are focused on renal diseases which is why I picked up this news as I have an interest in this area but I do not hold the shares – historically no revenue to date. But RENX will only have a minority interest in the joint venture. I would not get too excited about this, particularly as it is possible that the epidemic will die out and there are lots of people producing test kits. But the company may be of interest otherwise as it does seem to be making some progress in renal diagnostics. There are 40-45,000 premature deaths in the UK every year due to kidney disease so you can see that it is comparable to the coronavirus epidemic and with still no effective treatments.

The coronavirus epidemic is clearly creating a bandwagon for companies to jump on. That can be a minefield for investors. Or to put it another way, an enormous amount of venture capital is being put into research of treatments and diagnostic production. It may produce results sooner or later, but a lot of the investment might produce nothing.

Lastly, it’s worth covering the dire economic gloom. Unemployment has reached record levels and Rolls-Royce (RR.) are making 9,000 employees redundant as new aero engine demand will clearly be non-existent for some time – maybe years.

To quote from the FT: “Rishi Sunak [Chancellor] has warned that the economy may not immediately bounce back from the corona-virus crisis and could suffer permanent scarring, as jobless claims soared at a record rate to more than 2 million. The chancellor struck a sombre note on a day that saw the biggest month-on-month increase in out of work benefits claims since records began in 1971. A further 10 million are now precariously relying on the state to pay their wages. He said ‘We are likely to face a severe recession, the likes of which we haven’t seen, and, of course, that will have an impact on employment’”.

Some of my readers may be facing redundancy or soon will be. Clearly we are living in exceptional times, but on a personal note it’s worth mentioning that I have been out of a job more than once in my past career. Recessions tend to only last a short time so the answer short-term is simply to take any job going. Longer term the answer is to ensure you can never be fired in future is to set up your own business. CEOs rarely fires themselves, and there is the possibility that a new business might make you rich. So that is what I did a few years later.

I don’t come from a family of entrepreneurs but from people who worked in big businesses. But it is easier than ever to start-up from scratch and redundancy pay can give you the initial capital required. Recessions don’t make it harder to start a new business but easier in some ways. As companies lay off full-time staff that gives opportunities for others, and any service or product that saves a company money can be immediately attractive. So redundancy just needs to be faced up to with some energy and initiative.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Covid-19 Economic Impact and Was It All Based on Faulty Analysis?

Readers don’t need to be reminded on the damage being caused to the UK economy as a result of the coronavirus epidemic. Most of the damage has been caused by the “lock-down” that has closed whole swathes of UK business and industry. There can’t be many readers’ stock market portfolios which have not suffered as a result. The lock-down was all done based on the advice of Prof. Ferguson of Imperial College and a computer model that he used.

This is what Steve Baker, M.P. tweeted today: “Today, I read the Imperial College Covid-19 Code: https://github.com/mrc-ide/covid-sim . I then read this for a second time with growing horror: https://thecritic.co.uk/a-series-of-tubes/ . Software critical to the safety and prosperity of tens of millions of people has been hacked out, badly. It is a scandal.”

This is what I wrote yesterday in my diary (which I have kept since the start of the epidemic to make interesting reading for my offspring in future years):

“There has been a lot of controversy of late over the role of Professor Neil Ferguson in the epidemic crisis.  He is professor of mathematical biology at Imperial College London and has been advising on the UK government’s response. His virus modelling led to the current lockdown being put in place. It seems his past forecasts of the impact of epidemics of other diseases have been wildly pessimistic. He has now resigned from the Government advisory body after ignoring the lock-down rules to meet a paramour.

But when people looked at the software code that he has been using to forecast epidemic spread, it seemed to be unreliable. It consisted of 15,000 lines of undocumented and unstructured code that allegedly gave different answers when run more than once. It very much appears to be a rather unprofessional approach to software development that one might expect from a scientist rather than an IT professional”.

I then covered my past career as a programmer and lamented the lack of professionalism in some parts of the world as regards software development, 40 years after I gave up programming. This is a good quotation from the Daily Mail on the latest fiasco: “David Richards, co-founder of British data technology company WANdisco said the model was a ‘buggy mess that looks more like a bowl of angel hair pasta than a finely tuned piece of programming’. He also said: ‘In our commercial reality we would fire anyone for developing code like this and any business that relied on it to produce software for sale would likely go bust’.”

So now you know why we are all stuck at home and in such a financial mess.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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