Hopes are high for the EU’s new Recovery and Resilience Facility, a breakthrough agreement to
borrow €750 billion to fund €390 bn in outright grants and €360 bn in loans to member states.
This is the first time the EU had collectively borrowed to finance expenditures, and the first time
outright transfers will made to member states primarily at the discretion of the EU not its member
states.
The ‘Recovery and Resilience Facility’ is designed to:
•
“Address
the
main
challenges
they
are
facing
identified
in
the
European
Semester,
in
areas
such
as
competitiveness,
productivity,
education
and
skills,
health,
employment,
and
economic, social and territorial cohesion.”
•
“Ensure
adequate
focus
of
these
investments
and
reforms
on
the
challenges
related
to
the
green
and
digital
transitions,
to
help
create
jobs
and
sustainable
growth
and
make
the
Union more resilient.”
Utopian dreams aside, it would be money very well spent if the EU could even restart
stalled productivity. In practice, however, €390 bn represents 3% of EU GDP, enough money to
meaningfully support southern countries: Portugal (5% of GDP), Spain (4%), Greece (9%), alongside
continued development aid to the Eastern EU.
While it is politicians’ job to dream, the balance between storytelling and numerical
forecasts has also been altered in stock and bond valuations. This is because a greater and
greater proportion of a security’s value is represented by faraway events and cashflows as interest
rates fall, i.e. well beyond the horizon of traditional forecasting techniques.
This insight and the models that flow from it underpins our Barbell Stock Strategy, currently up
31% vs benchmark since April 1, 2020.
We all instinctively relate to tales which address the journey from the ‘imperfect present’ to
the ‘perfect future’. Deep emotions are evoked by these stories; in fact, the expression, "Let there
be light" is translated from the Torah, the first part of the Hebrew Bible.
However, whether one is a left-brain number-cruncher or right-brain dreamer, hard data helps to
convince all of us that the underlying stories are correct. In which vein it is worth noting that,
today, there is no reliable numerical support for either the upbeat ECB or EU economic narratives.
Conventional econometric yardsticks and models have been seriously degraded by the collapse in
EUR r* to zero and below, and little consensus exists as to whether these models should be
replaced and if so by what.
Free from the constraints of numerical scrutiny, the EU and to a lesser extent the ECB are
free to dream. Perhaps the new Recovery and Resilience Facility will finally open the door to
similar future EU initiatives and perhaps ultimately fiscal union.
Aware of the reputational damage, if this goes wrong, the European Commission is taking its time
to agree on the priorities and conditions it will attach to the new grants and loans. As a
consequence, under 10% of the funds are expected to be disbursed in fiscal year 2021, 12-16% in
2022, with the rest later. The EU views this delay as a strength not a weakness.
The thinking is that rather than providing a traditional Keynesian stimulus, which national
governments are already implementing to the tune of 6-11% of national GDP, the Recovery and
Resilience Facility is instead designed to underpin the structural reforms necessary to boost
productivity, increase territorial cohesion, and all the rest of it. Protecting its central role, the EU
will ask national governments to devise initial plans that support its objectives but which,
importantly, the EU will be under no obligation to accept.
Well, that is the dream; the EU has fought and lost numerous battles to make financial support
conditional on politically explosive societal reforms, rule of law constraints, milestones, and
targets; Italy, Poland, and Hungary being the obvious examples.
There’s little point diving into a forensic dissection of this Recovery and Resilience dream;
dreams were never made for that. Investors must nevertheless recognise that what they are
looking at here is a dream, a hope, and worthy as it may be, it is not a forecast and has little
numerical basis.
The current combination of degraded conventional economic yardsticks and the enhanced
importance of storytelling in a low-r* environment, however, opens the door to people confusing
political dreams with reliable forecasts.
In which circumstances, every effort must be made to develop new models for the purpose of
accurately pricing assets in today’s new world.
Mark Page