Market Bulletin - The wrong chemistry
The blocking of a deal between two pharmaceutical giants was just one way in which the politics of tax dominated headlines last week.
Between the two of them, Pfizer and Allergan can boast some 235 years of accumulated history. Their alliance was certainly not to be a marriage of equals. Last year, Pfizer was ranked the second-biggest pharmaceutical company in the world (Allergan ranks somewhere in the 20s) and its scientific research capabilities are legion.
Nevertheless, if Allergan might have felt like the Cinderella of the pairing, its great asset was its humbler domicile. Pfizer pays its taxes to the Internal Revenue Service in the US, a country in which the top federal rate of corporate tax is 35%. Allergan, on the other hand, is headquartered in Dublin, favoured home of many a tax-shy CEO. By allying itself with Allergan, Pfizer stood to pay $1.2 billion less in tax each year. In this particular fairy tale, Cinderella came with financial benefits.
The problem, as the White House saw it, was that Allergan offered little else. The proposed union was not about ‘realising synergies’ (the usual summary justification in such deals); it was simply a case of ‘tax inversion’. In the end, new US Treasury rules persuaded Pfizer to annul the engagement. The company’s stock then went up, while Allergan’s went the other way. The S&P 500 ended the week down 1.5%.
“Upon the announcement of the Pfizer–Allergen deal falling through, we sold the position into a rising price and achieved a good profit,” said Adrian Frost of Artemis Investment Management. “We viewed the deal as a bridge towards the next stage, being the break-up of Pfizer into its constituent parts. The failure to complete the acquisition derails this investment case.”
Many politicians around the world found themselves on the other side of the tax-dodging argument last week, as a data leak from the offices of Mossack Fonseca, a law firm in Panama, showed that a number of global political leaders (or those close to them) had placed money in offshore trusts, generally to avoid paying tax.
Within little more than 24 hours, the prime minister of Iceland had resigned and the Kremlin had issued a statement saying that claims about Putin’s closest allies represented “Putinophobia”. The Chinese foreign ministry was notable for its silence after eight relatives of senior Communist Party politicians received a name-check in the leaked documents.
The UK prime minister suffered unwelcome attention as the leak showed his father had set up and managed an offshore fund – the fact this had been legal mattered less than how it made the prime minister look, due both to his own policy positions and to the delay in his acknowledgement of having profited from the fund.
It was red meat for the Brexit campaign, since it linked the prime minister to apparently unaccountable (and untaxable) global elites. In the same week, Cameron was criticised for approving a £9 million pre-referendum leaflet drop, and the large RMT union backed Brexit. Less coverage was given to economic indicators – industrial production, the goods trade, and manufacturing output all disappointed last week, but rising commodity prices helped the FTSE 100 to a 0.95% rise.
Meanwhile, the Institute for Fiscal Studies published a report on EU finances which said that the UK’s net weekly contribution to the EU was £110 million in 2014 – far below the £350 million figure often used in pro-exit publicity. Markets are certainly not ignoring the possibility of a British exit.
“In almost any area where we do the analysis – security, economics, foreign policy – we think the case for remaining is stronger,” said Stuart Mitchell of S. W. Mitchell Capital. “The rewriting of Britain’s trade agreements with both the EU and the rest of the world would take far longer than two years – and investment spending would go down.”
The EU received a sharp rebuke from a founder member last week, when a Netherlands referendum on a proposed EU–Ukraine trade deal returned a ‘No’ vote. Only 32% bothered to vote, but the noes could claim a 2–1 victory ratio. In another sign of fragmentation, the European Commission proposed passing VAT decisions back to home nations.
Economic figures out last week were mixed. Inflation was marginally better but still negative; managing it remains a significant challenge for the European Central Bank. German industrial and factory data was disappointing. But unemployment across the currency area reached a four-and-a-half-year low in February. The FTSEurofirst 300 ended down a marginal 0.19% as banks struggled, but the Pfizer–Allergan annulment helped healthcare stocks.
Among the dominant themes on markets last week, currencies loomed large. Sterling has fallen significantly in recent weeks, and the cost of insuring against further falls rose last week, possibly on speculation about the referendum result. In the US, the Federal Reserve’s newfound dovishness has enabled the dollar to drop slightly – good news for emerging market countries with dollar-denominated debt but less good for central banks in dire need of a cheaper currency of their own.
In the developed world, Frankfurt and Tokyo are more eager to cheapen their currencies than most. As growth remains marginal, a cheaper euro or yen would offer a much-needed economic tailwind. Instead, the European Central Bank and Bank of Japan face currencies going in the other direction. The euro is up more than 7% against the dollar from its November low, but it is the yen that has blazed the more dramatic trail, rising around 15% against the dollar since mid-2015 – most of the rise has come this year.
Last week consumer confidence figures in Japan showed a slight improvement, but the more accurate description would be that they are simply less bad than they had been. The Japanese central bank has already taken extreme measures to boost growth and (it might have hoped) cheapen the yen, but thus far its approach has failed. (Some economists have argued that negative interest rates actually helped to push up the yen’s value.) Since it is hosting the G7 in May, Japan can hardly start a currency war at this point. Somewhere low down on Tokyo’s list of worries is the fact that Japanese-listed stocks are having a rotten year, and last week the Nikkei 225 slid a further 2.1%.
There was encouraging news from China, however, as the country’s foreign exchange reserves rose for the first time in five months, following a strengthening of the renminbi and less nerve-racking data on manufacturing. The heads of both HSBC and Credit Suisse said that markets in recent months had been exaggerating the problems in the Chinese economy.
The greater worry of the moment is world trade. Last week the World Trade Organization forecast that 2016 would mark a sixth consecutive year of below-par growth in international trade – the worst period since the 1980s. Trade protectionism –talked up by both Donald Trump and Hillary Clinton – is among its major concerns.
Another cause of slowing trade is slack demand for commodities, and its effects continue to be widely felt, from Brazil, where political instability remains high, to Russia, which is suffering its deepest recession in 20 years. Nevertheless, oil has enjoyed some recent support, and its rise continued last week, taking Brent crude above $41 a barrel.
Artemis and S. W. Mitchell Capital are fund managers for St. James’s Place.
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