June 2017

Country Ranking Trends

  • June was one of the occasional months in which no countries were upgraded or downgraded. Magni reviews during the month confirmed existing scoring.

Come See the Softer Side of Britain

  • Prime Minister Theresa May’s political gamble of calling early elections backfired spectacularly when she not only failed to gain the stronger majority she sought, but also lost the Conservative majority in Parliament. The Tories obtained a majority in Parliament through an agreement with the small Democratic Unionist Party (DUP) from Northern Ireland. As the leader of a fragile coalition government, she now faces the already-difficult prospect of negotiating Brexit. Nearly three months have passed since the Prime Minister started the two-year countdown to the UK’s departure from the EU, and unless all EU nations agree to extend the negotiations the UK, by treaty, will leave the EU in March of 2019. Given the UK’s weakened negotiating position, some are predicting a more accommodative soft exit with freer trade and immigration vs. her initial hardline EU exit strategy. The business community and many lawmakers want to retain closer ties with Europe. However, the EU wants to show that there is a price to be paid for exiting, making it hard for continuing members to allow market access without commensurate concessions from the UK side.
  • Implications: Ultimately, the United Kingdom has strong governance and should do well. Until issues are resolved, there will likely be uncertainty over the country’s future and its equity markets will probably trade at a discount. With so many issues in Europe there are a multitude of potential scenarios. Magni will continue to watch these events. Further, Magni believes the European countries with strong governance have significant upside opportunity as uncertainty is reduced; almost regardless of the ultimate solution.

France: Vive la Majority

  • In what may be a rare bright spot in global politics, the pro-Europe En Marche party recently formed by the newly elected French President Emanuel Macron won an overwhelming majority of 350 seats in the 577 seat French parliament. This will give Macron greater leeway to pursue his reformist agenda without having to rely on the support of other parties. However, record low turnout for the second-round vote may reflect a narrower mandate for drastic changes. Macron has called for loosening France’s restrictive labor laws, making it easier for businesses to hire and fire employees, and reducing worker protections with the goal of creating more jobs. In September, Macron is expected to bring forward a major labor bill that would, among other things, allow companies to lengthen hours and adjust wages on a case-by-case basis, as opposed to observing uniform rules. Unions have already voiced their opposition. Given unions’ history of disruptive protests, Macron will need strong support from within the government as well as the broader French society in succeed with long delayed reforms.
  • Implications: Many have underestimated Macron. Perhaps he is the Margaret Thatcher or Ronald Reagan of France. Time will tell. The optimistic scenario includes rapprochement between France and Germany on fiscal policy matters; strengthening of the EU and the euro; and, reversal of the populist trend across Europe along with a stronger French economy.

Brazil’s Downward Spiral Continues

  • The political turmoil brought about by seemingly unending corruption shows no signs of abating. As previously mentioned, President Temer has now been charged with accepting bribes. However, before the case can move forward, two-thirds of congress must vote to allow it to go to a trial. Temer continues to deny the charges and has refused calls from opposition politicians to step down. For now, despite his record low 7% approval rating, it seems he may have enough support in congress to stave off a vote to move to a trial. Temer and his allies argue that it is more important to have stability to move forward with important economic reforms than to endure the further trauma of removing a second president in just over a year. Given the damage wrought so far (economic output has contracted by approximately 11% since the investigations began) it’s an argument that has its share of supporters.
  • Implications: It is increasingly unlikely that any meaningful reforms will move forward in the current environment. In the short term, the focus will instead be on whether any new developments tip the balance in congress towards allowing a trial to move ahead. There is already talk of additional charges being filed against Temer, which would necessitate him surviving multiple votes in congress. That’s a difficult feat for an historically unpopular president.

Chinese Success Increases Urgency for more Reform

  • The MSCI has announced that beginning in June of next year, it will include 222 (out of 448) China A Large Cap shares in the MSCI Emerging Markets and MSCI ACWI indexes. Recognizing that further reforms will be needed for the A share market to meet international standards, MSCI is giving each stock an initial weighting of only 5 percent of its market cap collectively representing around 0.73% of the weight of MSCI Emerging Markets. If China makes progress on further opening its market, MSCI will consider using the full market cap of the existing 222 companies, as well as including the remaining roughly 226 companies. Given the uncertainty over the pace of reform it could still take as long as a decade for MSCI to include Chinese shares at their full weighting.
  • Another vote of confidence for Chinese economic reform came earlier this month when the European Central Bank exchanged 500 million euros worth of its US dollar reserves into Chinese yuan. The move, while positive, is largely symbolic given the European Central Bank’s overall €68bn of forex reserves. As with international acceptance of Chinese shares, the pace and scale of internationalization of the yuan will depend on the successful implementation of market opening reforms.
  • Implications: These recent successes place even more focus on much-needed reforms. Magni will be monitoring whether these reforms are implemented. Magni’s upgrades of China over the last two years have moved the country into “striking distance” of several countries in the emerging markets. If implemented, the reforms could move China into the middle of the emerging market rankings.