Deal or No Deal

On September 10th, I headed to Europe with my two-country Eurail Pass and a notebook full of questions for some of IIM’s Swiss and German current and prospective investments. I was especially interested in their perspectives on raw material prices, tariffs and Brexit – unpredictable, but interrelated, issues.

Tariffs can be an effective method for discouraging predatory dumping and protecting domestic industries, but in the process, they can increase input costs for manufacturers and retail prices for consumers as well as lead to retaliating tariffs. Most of the companies with whom I met are able to match prices with changes in input costs, albeit with a lag, and smooth gross margins over time. Due to elasticity of demand, however, some feared that higher prices would lead to lower volume growth and dampen economic activity. While discussions on metals, dairy and autos are threatening Canada’s participation in NAFTA, Chinese tariffs placed on agricultural commodities are already having a negative impact on US farmers, and new ones have gone into effect on about $60 billion worth of US goods, including more food products, chemical products and aircraft.

Tariffs on US products could benefit European exporters, but a no-deal Brexit could create billions of dollars of tariffs on items such as food, beverages, cars and clothes on both UK and EU exports. Investors and companies all hope that UK PM Theresa May can put together an acceptable Brexit plan; but wanting to minimize the risk of other country exits, the EU has taken a hard line and rejected the most recent proposal. Exacerbating the process is the prospect of a hard border between Ireland (member of the EU) and Northern Ireland (Part of the UK) and the economic relationship with the EU SHOULD the UK actually Brexit.

In the personal opinion of some company IRs and UK fellow travelers, the current UK government would like to stall and kick the Brexit can down the road to future parliaments, but there are fears that this wouldn’t be acceptable to the EU.

We discussed many other macro challenges such as refugees, elections, climate change, emerging markets and currency in our meetings, but we also reviewed lots of positive company specific influences, such as: digitalization, productivity, innovation and opportunity.

In that context, despite all the macro uncertainties faced by many companies, I still am optimistic regarding the opportunities in careful international investing.

In my next client letter, I will explore in detail the performance, holdings and outlook for our international Folios, but please feel free to reach out with any questions you may have.

In the meantime, our hearts and prayers are with our friends and clients who are still recovering from Irma and those who are putting their lives together after Florence.

– Retz Reeves, CFA