John Townsend’s Investment Opinions June 2020

Intelligent individuals learn from everything and everyone, average people from their experiences. The stupid already have all the answers.” Socrates

The financial crisis started by the reactions to the global Coronavirus pandemic calmed down as quickly as it started. The panic which caused investors, both institutional and retail, to attempt to sell every asset that they had irrespective of price, ended almost as quickly as it began with institutions in particular emerging blinking into the cold light of reality. The sentiment that caused massive panic is now working the other way and combined with government support, is causing investors to re-invest. This is often called a ‘bear market rally’. The major problem here is that such sentiment is fragile and could easily turn negative again. If as expected, a second wave of corona infections emerges at the end of the summer, prices will fall again if a second pandemic surge becomes apparent, but they will then resume their slow and laborious path upwards.

While many equities have recovered strongly, some bond-based assets still have a way to go because interest rates have now dropped to zero and below. The frothy levels of 2019 will probably take at least two years to be reached again. In the meantime, nervous investors will encounter more shocks in the months ahead and may react with less fear than before but will none-the-less feel inclined to sell some of their assets. Long-term investors could use this phase as a time to buy at the lower prices.

The crisis has treated many geographical areas differently. Developed Asia saw a disciplined reaction to the pandemic and is now recovering.  In Europe, the systems which had been developed to manage pandemic risks failed and internal and external geographical borders were closed. These systems will have to be reconstructed, especially as the virus which caused so many deaths has not been defeated. The reaction in the USA, dependent as it was on the whims of one man seeking to adjust the facts to aid his re-election, was tragically too little too late.

In the meantime, in order to support the economies and to prevent the economic collapse of banks and system relevant employers, western central banks and their governments have announced massive debt increases. This largesse will be passed on both in the form of outright grants and soft loans. Whether this will be enough and indeed whether the right targets will have been hit by this support remains to be hoped for.

Globally the world has already seen over 400,000 COVID-19 related deaths. This figure is probably too low, as some countries are simply lying about their figures for political and doctrinal reasons or not recording the deaths at all. The death toll will undoubtedly rise as political buffoonery in the USA, some parts of South America and indeed the United Kingdom continues unapologetically unchecked.  A study from Imperial College London suggests that the overall European death toll without a severe lockdown would have been at least 3 million higher. The virus will in time be controlled, but never eliminated. A vaccine is hoped for and is being worked towards but is unlikely before the end of 2020.

While the equity markets have begun to recover, the initial recovery phase is partly a recognition that the markets fell too far too fast during the first wave of the crisis in March 2020. The deepest point of the financial collapse was 23rd March, but the political reaction in the USA was initially based on the hope that the problem would miraculously disappear if ignored for long enough. Even now it is unclear what US government policy is actually going to be.

The US Federal reserve has advised that it sees a need for an increase in debt of up to 3,000 Billion US Dollars, but the recently announced unemployment figures which were much better than expected, might cause a revision in this figure. These statistics themselves are open to doubt. The US has a history of revising statistical data after they have been announced and the headlines have been made. The present figures seem to be politically supportive of the present president.

The European Central Bank, under the headline TINA (There Is No Alternative), has devised a plan to provide 1,250 Billion Euros of support to financial markets across Europe. The ‘frugal’ states, Austria, the Netherlands, Sweden and Denmark might still block or reduce the package, but their governments are acutely aware of the crisis facing the region. This is no time to be bashing Greece, Italy, Hungary or the South-East European states.

With so much more debt hitting the markets, there is a massive oversupply of debt obligations, just as interest rates are either near Zero or in some cases negative. Some institutions, especially pension funds, will have to invest in this paper, because they have no choice under the terms of their trustee agreements. Others will switch to the Equity markets. The dependence on skilled credit analysts to distinguish between healthy companies in different sectors and ‘zombie’ companies kept alive only by high debt levels has become acute and will be ever more so as high yield debt investors look for positive returns for their portfolios. There has been nothing in the last 30 years with which to compare the current position. Analysts will need to become original thinkers!  Average corporate earnings in the US appear to have fallen some 20% since the crisis began, but investors should be warned that this seems to be a ledge stopping the fall and could crumble if there is a second wave of the pandemic.

The COVID-19 virus (or Coronavirus SARS-CoV-2 to give its official name), neither knows nor cares whether states or individuals take precautions against it. The odds of a second wave are at best 50:50, whichever way one looks at it. A second wave will be met with the experiences that society has gained form battling the first wave, so the reactions will probably not be quite so strong.  The effect of a second wave will however be to slow an economic recovery. Many announced governmental measures are designed to show willing rather than meet a real economic need. The announced 6-month reduction in VAT or ‘Mehrwertsteuer’ by 3% in Germany will in truth have only a minimal effect, but it looks good.

There will be enduring changes in global economic development, which will cause the recovery to take longer than hoped for. The Chinese economy has reopened for business, but with a politically rather than economically motivated trade war restarting before the next US presidential election, there will not be any great advance in activity there or benefit to global trade. The world has treated China relatively gently in past years, in the hope of gaining some economic benefit. This has now stopped and Chinese companies such as Huawei will face very close scrutiny.

Banks as a whole will need to become more efficient. One recent estimate suggests that up to 20% of global bank jobs will disappear altogether with digitalization replacing some 40% of the administrative positions. This will undoubtedly cause unhappiness amongst the inefficient German banks which are in any event under pressure to merge.

The European economic recovery, even without a second wave, will be affected by the realities of domestic life. Some people will have to stay at home, because the schools have not fully reopened and someone has to look after the children. The ‘new normal’ will have to wait for reality to take over.

Some companies, such as the German car builders and other engineering companies will need to reflect on the reduced demand for their existing products and consider how to attract new customers.

The press and many pundits suggest the shape of a recovery in terms of letters of the Alphabet. A ‘V’ shape, where prices rise as sharply as they fell is unlikely. A ‘U’ shape where prices rise sharply after a pause for reflection is also unlikely. Then there is an ‘L’ shape where prices do not rise at all following the fall in prices. The potential for a second wave could, it is suggested, cause a ‘W’ shape. It is comforting to describe future movements in structures that we know, but I do not think that any letter of the alphabet is helpful here. It is my belief that the panicked fall in the investment markets which reached its base on 23rd March 2020 was followed by an immediate uptick when investors realized that they had gone too far. The future is likely to show an upwards trend, which will be subject to periods of negative movement on occasions. The upwards line will remain neither steep nor straight.

Those clients with cash on deposit also need to be careful. A number of German banks, reacting to negative interest rates from the central banks, are now charging or planning to charge their clients, penalty interest rates on cash deposits over a relatively small level. For clients with a longer-term view of their investments it does simply not make sense to keep large cash deposits. There is no need to invest in the higher risk equity markets, there are many other alternatives to consider.

Overall, we will undoubtedly see more volatility in the investment markets. I try to reduce the impact of this as much as possible, but in many cases, volatility will be double the levels of previous years.

My portfolios will remain strongly invested in equities. How strongly depends only on the risk propensity of my clients. In truth there is now no alternative to investing in equities. There should be more encouragement of monthly regular investments, as cost averaging helps to reduce the volatility in a portfolio.

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the

Chartered Institute for Securities and Investment in London. (Townsend@insure-invest.de)

John Townsend’s Investment Opinions January 2020

There is only one good, knowledge and one evil, ignorance. – Socrates

A very Happy New Year and a Happy New Decade to all.

There have been many changes in the past decade. Everyone has their own list of events, some good, and some bad. The one certainty is that the next 10 years will have many more changes and there is no certainty as to what these changes will be.

The investment markets are influenced on their returns by the acts of politicians. Some acts are obvious, such as those in the US at present, some are less clear, as in Germany, but will probably have a long lasting effect.

Cleon was an Athenian General who died in 422 BC. In his lifetime he earned a reputation amongst his peers for being a loudmouthed, unscrupulous and war-mongering demagogue. He accused his peers, especially Pericles of maladministration of public money, though the latter was able to clear his name. Cleon went on to dominate Athenian Politics, misusing the democracy that was applied there. He was rough and unpolished, but he knew how raise the emotions of the poor Athenians who in turn supported him in making false charges against his political opponents so as to remove them from power. He criticised the Athenian generals, but was himself a failure when it finally came to leading an Athenian army. The actions of Cleon led inevitably to the downfall of the Athenian Golden Age.

Although an aristocrat, he found it politic to break off all connections with his own noble background. His influence lay in a forceful and bullying style of politics and a tone which was both anti-intellectual and anti-aristocratic. In his treatise ‘History of the Peloponnesian war’ Thucydides described Cleon as being an opponent of peace because if tranquillity were ever to be restored, his crimes would be more open to detection and his slanders less credited.  Lessons can be learnt from history, even from 2,500 year ago.

Careful investing means having to look beyond the immediate and past movements in the markets. Whereas major US corporations and their shares have contributed too much of the profits in the past years, some could now be running out of steam.  Many companies in the US and in Europe have borrowed heavily while interest rates were (and are) low, in part to buy back their own shares, which in turn has helped to raise equity prices. This increased debt has also been used to cover inefficiencies. The problem is that much of this additional debt will come back to haunt the lenders when interest rates begin to rise again as one day they will and when companies fail as a result. A major change in the past decade has been that it is no longer the banks that lend to companies and foreign governments, it is the investment funds. When the crunch comes, the banks will have earned their fees as arrangers, but the funds will have carried the risk and will bear the brunt of any down turn. It is time to limit investment in fixed income products severely.

Investors have to be able to understand the risks their funds are taking. ETFs are the archetypal ‘fake’ investments. An ETF does not carry out an analysis, but instead follows a market blindly; when an index changes its composition, so will an ETF.  The difference between the selling price of the old asset and the purchasing price of the new one is then disguised in the undisclosed costs. In a strong and rising market, a lack of decision making analysis does not show. When an economy weakens, critical analysis becomes essential to understand the risks and avoid or at least mitigate them. An ETF invests using borrowed money attracted by the seeming lack of costs. Analysis and risk management costs money. Analysts mitigate losses; without such knowledge there is no understanding and therefore no protection against sudden market movements.

Investment sectors in the coming decade must include equity funds which earn dividends from the companies in which they invest. These companies have to pay dividends from earnings and not from increasing their debt. Only careful analysis will identify these.

There is an increasing market for sustainable investments. This market will continue to grow rapidly and the prices of shares from companies whose activities are clearly sustainable have risen and will continue to rise based on the demand for such assets. The bandwagon effect has of course taken hold and many fund management companies have labelled their funds as being sustainable, even when their assets are not. This is called ‘greenwashing’. There are inevitably many agencies which offer sustainability ratings. Some of these are credible, others, again, are not. The United Nations has issued a list of 17 Sustainable development goals which investors should adhere to when selecting their investments. Many of these goals are contradictory and professional fund managers have had to sub-divide these criteria into five broader groups to make conscientious investing possible.

Economic markets too have their problems. Investors have benefited greatly from the rise in demand for US and European equities, but the US economy seems to have reached a plateau which Europe has yet to arrive at. The warning signs are there and caution is called for. Third-world investments especially in Asia, including China, presently show a great deal of promise.

Japanese companies have quietly become profitable again. Japanese institutions are investing domestically and abroad and the stock markets, which have been at a low level for too long a time, have begun to rise, especially as alternatives to the US markets are being sought. The usual divisions between value and growth stocks are not particularly relevant here. Good companies are being supported by rising demand. Fund investors should concentrate on finding competent and experienced fund managers to access this market.

Chinese companies have been vilified because of the involvement of the Chinese state in many aspects of their activities. In truth, those companies which are big enough to warrant overseas investment do probably have governmental oversight, but many are inherently dynamic and profitable. There is an argument that larger companies even with state oversight, still have a spirit of entrepreneurship, yet are unlikely to suffer the economic volatility in times of adversity, particularly because of government support. The banks are another matter however. The Chinese government, having clamped down on excess lending from secondary banks, especially for investments outside China, is now encouraging local banks to support small and medium companies which could be suffering from concerns over the trade dispute with the USA.

There is presently an attempt at cooling the so-called trade war started by President Trump when playing to his red-neck US crowd. He might have had more success had he reined together the other global economic players, but teamwork has seemingly never been his strength. In the end, it is US farmers and industry that have suffered more than any Chinese sector. Many US companies are now terrified that the markets for their products (the biggest market for Apples iPhones is in China) will dry up. There will be a treaty of sorts and Mr Trump will claim the usual resounding victory in this, an election year. In reality the US has missed its target and has gained only scorn and increasing distrust from China as well as from traditional US allies and much of the rest of the industrialised world.

The investment markets will not continue their steep upward path in 2020 and beyond. There will be increasing volatility and investment portfolios will need to be adjusted to meet these challenges. This means that the proportion of equities in even the most dynamic portfolios will need to be reduced. Above all, portfolios will need to be diversified within investment sectors and between them. There can be no alternative to broad diversification. The hype over low cost ETFs should be ignored in favour of safer returns from the best performing managers with real analysis, high returns over their indices (Alpha) and a proven track record.

Past performance is no guarantee of future profitability.

John Townsend’s Investment Opinions 03 January 2019

“Wall Street indexes predicted nine of the last five recessions” – the late Nobel prize-winning economist Paul Samuelson

In the last three months of 2018 we experienced a major correction in the global Equity- and Debt markets. It is the nature of a panicked market, especially one fuelled by the actions of politicians of ill-will, that there will be severe overreactions. The end of 2018 saw such a panic, coupled with an avoidable trade war with China which the US is unlikely to profit from, an expected slowdown in Chinese growth from 6.6% to ‘only’ 6%, a British exit from the European Economic Community, for no good reason other than xenophobia and a vague, though possibly unfounded hope, that other non-European countries will step in to fill the inevitable trading void. This is leading to the slow suicide of a once proud economy and political system and its fall into relative obscurity.

All of the above, despite a global growth rate of some 3.7% in 2018, caused embattled traders, who were waiting mainly to square off their trading positions for Christmas and the New Year to seriously overreact. Something which will cause a rebound in 2019.

A year-end correction had been expected. The developed economies had experienced some 10 Years of growth and a deep breath was to be expected. Equally, the global economies are at a late stage in their economic cycles, though not yet at the end of them, based on the experiences of history. Market sentiment cannot be predicted and when an unadvised US president follows his ‘gut instincts’ based on reports on Fox news rather than the advice of his own staff, the gyrations caused by ill-considered twittered announcements produce only negative results.

Yet the US and Chinese economies are both strong and growing, there is no sign of recession there, perhaps yet. In the US, a major tax relief exercise helped to boost corporate profits for the time being, though this is unlikely to be repeated. President Trump is blaming the increase in US interest rates of 0.25% for any future weakness in growth. In China, the government has realised that a relaxation in the credit availability had helped growth in the past, but is in danger of going too far. A clampdown on loan availability from the private sector and secondary banks is taking place, which is leading to insecurity on the part of the manufacturing sector which is worrying about funding for future trade and investment. This too will find a new balance in 2019.

In Europe uncertainty is being caused not only by Brexit and where to find the billions that the UK has in the past paid to Europe to support various schemes and the ever needy southern ‘olive oil’ countries. Italy and France are beginning to show signs of economic slowdown too. The French government is trying to take counter measures but is being met with predictable violent demonstrations. In Italy, a new populist government does not even want to discuss financial rectitude and the Italian economy is likely to be a source of concern in the year ahead.

The emerging markets are dependent to a large extent on the demand for their goods from the developed world. They are working hard to build some interdependence, though a decline in the developed markets will undoubtedly cause a slowdown.

The global investment markets will recover from the current panic, as the senior traders resume their work at the beginning of the year. There will be a period of calm, but the threat of a recession is never far away and portfolios should be stabilised by additional diversity to counter the buffeting to come.

Germany has been the powerhouse of the European Investment markets for several years; however the German economy has been largely focussed on engineering and technology companies. These two sectors have been suffering badly as confidence has drained from the institutional investors. The diesel scandal affecting many if not most of the car manufacturers and their declining support they are receiving from the local politicians causes concern about profitability, although not their actual survival. Technology stocks have been hit because of the general concern about this sector on a global sector. Let us be clear; there is a very good future to be seen in both the German engineering and technology sectors  and investors would do well to sit on their hands here too until the malaise has passed.

Funds following mixed strategies have traditionally been a safe haven to reduce risk, yet it is this mixed strategy sector which has also taken an unexpected beating in the past crisis. 2019 should see a reduction in the proportion of a portfolio which is allocated to equities. However, past academic studies have shown that there are only some eight to ten days in an average year which offer strong growth to investors.  If these days are missed, a portfolio will have minimal, though positive returns. In the same average year there are normally only some five or six days which suffer heavier losses. No one can say in advance which the profitable or losing days are. The message is that investors have to remain invested and to be patient.

Investing in cash is also not advisable in the long term. Inflation rates are rising and an investment needs to earn more than the rate of inflation, currently 1.8% in Germany in order for investors and savers to retain the spending power of their money.

The final economic recession before the start of the next cycle is now probably due in 2020, having been pushed back by the turmoil created by the present market upheaval. The timing is impossible to predict, as the event has been widely discussed, possibly resulting in a move in anticipation of the reality. The very few ‘experts’ who predicted the major crash of 2007/9 are also making their predictions, though these should be discounted to some extent by the fact that so many experts are judged on the one  event they possibly foresaw and not by the ones they did not.

The sectors to follow in 2019 include those where sentiment has swung against them in 2018. These are Germany, China, Japan and technology. The US equity markets are overvalued due mainly to the fact that they are supported by major local financial institutions. This gives them inadequate value for money and buffering when it comes to a down turn.

Emerging markets depend on efficient companies selling to strong economies as long as the Chinese, European and US markets continue to prosper, they will also offer adequate returns. The New Frontier Markets, those where countries are too economically small to count even as emerging markets, can produce windfall returns, but in a volatile environment the risks and the liquidity of their investments make them increasingly dangerous.

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

(Townsend@insure-invest.de)

 

Investment Opinions December 2017

Those are my principles, and if you don’t like them… well, I have others.  Groucho Marx

President Trump has finally passed the first important measure so far of his presidency, the tax reform bill. Inevitably in his world of superlatives this is the biggest and best tax cut ever. In reality it isn’t, there have been other larger ones, but it no longer makes a difference. This particular tax cut, being undertaken with borrowed money is dangerous and shows absolutely no understanding of economic reality by a president or by the sycophants surrounding him.  The new measure is said to be a Christmas present for all Americans; perhaps more appropriately there should be an addendum in parentheses, Americans like Mr. Trump. Sadly most middle income Americans have no idea whether or not they will be better off in 2018, as the cuts to their tax deductions are desperately unclear. Mr. Trump’s other achievements to date have been to roll back anything with the name of Obama on it, whether or not it was beneficial to the citizens of the United States. We must constantly remind ourselves that he is the legally elected president of the country and until this changes, this is the price that must be paid for democracy. American influence on the global economic and diplomatic stage has declined sharply.

For investors, 2017 has been a profitable year, though with little rationality and very high volatility. The low, indeed near zero, interest rates in the United States of America and Europe have encouraged corporations to borrow to finance their operations and any kind of return on their investments. Such demand is leading to the acceptance by investors of much lower quality than in the past, which is leading to a series of irrational bubbles, particularly with junk or high yield bonds. Perhaps the most obvious bubble investment is Bitcoin, which has risen in price from US$ 1,000 in January to around US$ 19,000 in November and now US$11,000 today. This massive increase in the price of a Bitcoin is odd as it is a completely unregulated market with nothing behind it and no governing body to oversee abuse. One has to think of the London South Sea Bubble or the Amsterdam Tulip and bulb craze. The original concept of Bitcoin was as an alternative currency, but this has been lost in the panic. The main Bitcoin producers (known as miners) are in Russia and the Ukraine. Bitcoin mining is an expensive and highly technical system and despite many best efforts, uncontrolled. There is now a new futures market for Bitcoins in the US, which in the past has normally been a prelude for a disaster in the market. Investors may congratulate themselves now on the high price of their units, but when the market declines they will find no buyers for their Bitcoins and their investment will swiftly become valueless. Those whose memories are long enough will recall the dotcom era. The only advice is to stay away unless one really wants to gamble on markets more risky than even the Chinese horse races.

Other strange sectors are ETFs. I have written about these before. The market for exchange traded funds began to allow corporate investors to increase or sell equity investments quickly when they wanted to. Since then the market has exploded and even retail investors have been dragged into products which they don’t and cannot understand and where they have vaguely heard there are few costs. In fact ETFs lag behind the markets they are supposed to follow and because their investments are effectively blind, they have neither corporate analysis or governance to rely on, nor the distribution of risk by an experienced manager. This market, while not as bad as Bitcoin, is still a recipe for disaster for the private investor without adequate advice.

We can see the bubble investments in the technology sector. Companies such as Tesla may make very interesting products, but at a cost much higher than the price they can sell their cars for. They have just announced another record loss and admitted that production is way behind schedule. This is still a good company compared with some being enthusiastically supported by the market place. There are indeed good and profitable technology companies in the FANG (Facebook, Amazon, Netflix and Google) sector, but there is also an awful lot of dross which promises to go sour when the excitement dies down.

Global interest rates have fallen as low as they are likely to. The end of Quantitative Easing is being seen in the United States and in Europe.  US interest rates have begun to rise slightly and Quantitative Easing is being cut back slowly, but American corporate profitability and efficiency is such that equity prices should not be affected. In Europe however, the head of the European Central Bank Mr. Draghi has a problem. He knows that the QE program needs to be cut back to reduce the Central Bank’s balance sheet and that interest rates have to begin to rise. However, as a good Italian, Mr. Draghi also knows that the inefficient Italian economy and banks coupled with the massive Italian national debt, cannot afford higher interest rates. So these have to be held back as much as possible. However, there is very little chance of Italy becoming more efficient or disciplined and repaying its debts, so the next crisis is destined to come in the near future.

The rise in the equity markets is largely based on the fact that most of these different markets declined sharply 10 years ago. Most of the efficient companies remained profitable and the present artificially low interest rates leave investors desperate for positive returns.

The American equity markets are presently strong, having undertaken the necessary measures to improve their efficiency. The Trump tax easing measures have helped, of course, but these were largely discounted.  The US technology sector is flourishing and housebuilding has renewed confidence relying on wage growth in all sectors from the lower to the higher incomes. Coupled with that, American equities have always traded at a premium to equities elsewhere in the world; their present levels should not be seen as being excessive especially as many US pension funds and institutions only invest in their domestic markets.

Europe is also booming, especially Northern Europe. Here the Goldilocks environment where everything is felt to be ‘just right’ exists at present and many companies are showing profitability and growth. The economies of France and Spain are also showing signs of strength, though South Eastern Europe is still heavily dependent on the largesse coming from its more northern neighbours.  As long as investors rely on fund managers who have the ability to select profitable companies from the Northern European states, Europe is still a sound investment.

A decade of stimulus has helped the Asian markets to finally regain enthusiasm but has also stoked speculative fervour. Japan has now begun to find new confidence in both the blue chip and the small company sectors, with foreign investors having been reluctant to step in. This has now changed, especially as just these foreign investors need to find a profit from the money under their control. The Japanese market is showing a great deal of promise.  India too is gaining ground as a source of profitable investment. Of the original BRIC countries (Brazil, Russia, India and China) India and China are showing most promise, though perhaps India more so than China at present. The other two, riddled as they are with corruption and failing corporate governance are well worth avoiding.

Some property markets are still more or less booming, Australian house prices have been fuelled by very low interest rates, with Sydney’s house prices having risen almost 70 percent and Melbourne’s 57 percent over the past five years. This has all the hallmarks of a bubble which will burst at the latest when interest rates begin to rise and demand from Chinese investors falls away. Much the same is true of property markets in Hong Kong with residential prices having risen over 180 percent since 2008. The Chinese central bank is clamping down on excessive lending by secondary tier banks and the ability of normal Chinese investors to compete in the monopoly world of Hong Kong is being severely reduced, something that will only be exacerbated as US Dollar interest rates rise again.

The almost desperate struggle to find a return on investments has meant that many banks, institutions and funds have begun to lower their risk thresholds and invest in debt from companies and countries they would otherwise never have considered. Ample liquidity has to be used, is the feeling not only by the traditional markets but also by the Chinese financial sector. Prudential lending and probably prudential reserve positions are being ignored, and once again investors need to observe fund managers carefully to see which are following careful strategies and which are merely seeking yield at the expense of quality. It is worth mentioning that the growth in high yield bonds, known in the 1980s as junk bonds is likely to be one of the first victims of a new realism.

The market for multi-asset investments has begun to prove itself, especially when equity volatility and thereby perceived risk has grown. Rising inflation and interest rates, albeit only slowly increasing, make it necessary for investors to seek new sources of diversifications. Funds that invest in Equities but also fixed and floating rate debt, commodities and currencies all have their place in this category, as long as the fund managers have shown their track record of being able to handle such strategies. Some, especially the black-box trend following programs have sadly completely failed; which is precisely why careful analysis and due diligence in reviewing fund managers is so essential.

In 2018 we will see tax changes in Germany, which have a small impact on private investors but which, together with the new MIFID II regulations will increase the amount and clarity of information that has to be supplied by intermediaries and Fund managers. This is nothing to be alarmed about and will hopefully ease the dangers of the miss-selling of inappropriate investments. The days of miss-selling to the ‘A&D’ (alt und doof) clients by the German banks in particular will be thankfully numbered.

There is still strong life in the global equity markets, as long as investments are carried out carefully and with due care and analysis. These markets will become increasingly volatile as institutions become nervous. One cannot discount a sudden nuclear or intense war between, for instance the USA and North Korea which would stir financial disharmony among the inexperienced ‘16 year old institutional traders’ who have no experience, but crises in Bitcoin, Block chain and the Technology stocks are unlikely to prove a ‘Black Swan’ moment and trigger total panic as in 2007/8. It pays to be wary and careful.

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

(Townsend@insure-invest.de)

Investment Opinions December 2017

Those are my principles, and if you don’t like them… well, I have others.  Groucho Marx

President Trump has finally passed the first important measure so far of his presidency, the tax reform bill. Inevitably in his world of superlatives this is the biggest and best tax cut ever. In reality it isn’t, there have been other larger ones, but it no longer makes a difference. This particular tax cut, being undertaken with borrowed money is dangerous and shows absolutely no understanding of economic reality by a president or by the sycophants surrounding him.  The new measure is said to be a Christmas present for all Americans; perhaps more appropriately there should be an addendum in parentheses, Americans like Mr. Trump. Sadly most middle income Americans have no idea whether or not they will be better off in 2018, as the cuts to their tax deductions are desperately unclear. Mr. Trump’s other achievements to date have been to roll back anything with the name of Obama on it, whether or not it was beneficial to the citizens of the United States. We must constantly remind ourselves that he is the legally elected president of the country and until this changes, this is the price that must be paid for democracy. American influence on the global economic and diplomatic stage has declined sharply.

For investors, 2017 has been a profitable year, though with little rationality and very high volatility. The low, indeed near zero, interest rates in the United States of America and Europe have encouraged corporations to borrow to finance their operations and any kind of return on their investments. Such demand is leading to the acceptance by investors of much lower quality than in the past, which is leading to a series of irrational bubbles, particularly with junk or high yield bonds. Perhaps the most obvious bubble investment is Bitcoin, which has risen in price from US$ 1,000 in January to around US$ 19,000 in November and now US$11,000 today. This massive increase in the price of a Bitcoin is odd as it is a completely unregulated market with nothing behind it and no governing body to oversee abuse. One has to think of the London South Sea Bubble or the Amsterdam Tulip and bulb craze. The original concept of Bitcoin was as an alternative currency, but this has been lost in the panic. The main Bitcoin producers (known as miners) are in Russia and the Ukraine. Bitcoin mining is an expensive and highly technical system and despite many best efforts, uncontrolled. There is now a new futures market for Bitcoins in the US, which in the past has normally been a prelude for a disaster in the market. Investors may congratulate themselves now on the high price of their units, but when the market declines they will find no buyers for their Bitcoins and their investment will swiftly become valueless. Those whose memories are long enough will recall the dotcom era. The only advice is to stay away unless one really wants to gamble on markets more risky than even the Chinese horse races.

Other strange sectors are ETFs. I have written about these before. The market for exchange traded funds began to allow corporate investors to increase or sell equity investments quickly when they wanted to. Since then the market has exploded and even retail investors have been dragged into products which they don’t and cannot understand and where they have vaguely heard there are few costs. In fact ETFs lag behind the markets they are supposed to follow and because their investments are effectively blind, they have neither corporate analysis or governance to rely on, nor the distribution of risk by an experienced manager. This market, while not as bad as Bitcoin, is still a recipe for disaster for the private investor without adequate advice.

We can see the bubble investments in the technology sector. Companies such as Tesla may make very interesting products, but at a cost much higher than the price they can sell their cars for. They have just announced another record loss and admitted that production is way behind schedule. This is still a good company compared with some being enthusiastically supported by the market place. There are indeed good and profitable technology companies in the FANG (Facebook, Amazon, Netflix and Google) sector, but there is also an awful lot of dross which promises to go sour when the excitement dies down.

Global interest rates have fallen as low as they are likely to. The end of Quantitative Easing is being seen in the United States and in Europe.  US interest rates have begun to rise slightly and Quantitative Easing is being cut back slowly, but American corporate profitability and efficiency is such that equity prices should not be affected. In Europe however, the head of the European Central Bank Mr. Draghi has a problem. He knows that the QE program needs to be cut back to reduce the Central Bank’s balance sheet and that interest rates have to begin to rise. However, as a good Italian, Mr. Draghi also knows that the inefficient Italian economy and banks coupled with the massive Italian national debt, cannot afford higher interest rates. So these have to be held back as much as possible. However, there is very little chance of Italy becoming more efficient or disciplined and repaying its debts, so the next crisis is destined to come in the near future.

The rise in the equity markets is largely based on the fact that most of these different markets declined sharply 10 years ago. Most of the efficient companies remained profitable and the present artificially low interest rates leave investors desperate for positive returns.

The American equity markets are presently strong, having undertaken the necessary measures to improve their efficiency. The Trump tax easing measures have helped, of course, but these were largely discounted.  The US technology sector is flourishing and housebuilding has renewed confidence relying on wage growth in all sectors from the lower to the higher incomes. Coupled with that, American equities have always traded at a premium to equities elsewhere in the world; their present levels should not be seen as being excessive especially as many US pension funds and institutions only invest in their domestic markets.

Europe is also booming, especially Northern Europe. Here the Goldilocks environment where everything is felt to be ‘just right’ exists at present and many companies are showing profitability and growth. The economies of France and Spain are also showing signs of strength, though South Eastern Europe is still heavily dependent on the largesse coming from its more northern neighbours.  As long as investors rely on fund managers who have the ability to select profitable companies from the Northern European states, Europe is still a sound investment.

A decade of stimulus has helped the Asian markets to finally regain enthusiasm but has also stoked speculative fervour. Japan has now begun to find new confidence in both the blue chip and the small company sectors, with foreign investors having been reluctant to step in. This has now changed, especially as just these foreign investors need to find a profit from the money under their control. The Japanese market is showing a great deal of promise.  India too is gaining ground as a source of profitable investment. Of the original BRIC countries (Brazil, Russia, India and China) India and China are showing most promise, though perhaps India more so than China at present. The other two, riddled as they are with corruption and failing corporate governance are well worth avoiding.

Some property markets are still more or less booming, Australian house prices have been fuelled by very low interest rates, with Sydney’s house prices having risen almost 70 percent and Melbourne’s 57 percent over the past five years. This has all the hallmarks of a bubble which will burst at the latest when interest rates begin to rise and demand from Chinese investors falls away. Much the same is true of property markets in Hong Kong with residential prices having risen over 180 percent since 2008. The Chinese central bank is clamping down on excessive lending by secondary tier banks and the ability of normal Chinese investors to compete in the monopoly world of Hong Kong is being severely reduced, something that will only be exacerbated as US Dollar interest rates rise again.

The almost desperate struggle to find a return on investments has meant that many banks, institutions and funds have begun to lower their risk thresholds and invest in debt from companies and countries they would otherwise never have considered. Ample liquidity has to be used, is the feeling not only by the traditional markets but also by the Chinese financial sector. Prudential lending and probably prudential reserve positions are being ignored, and once again investors need to observe fund managers carefully to see which are following careful strategies and which are merely seeking yield at the expense of quality. It is worth mentioning that the growth in high yield bonds, known in the 1980s as junk bonds is likely to be one of the first victims of a new realism.

The market for multi-asset investments has begun to prove itself, especially when equity volatility and thereby perceived risk has grown. Rising inflation and interest rates, albeit only slowly increasing, make it necessary for investors to seek new sources of diversifications. Funds that invest in Equities but also fixed and floating rate debt, commodities and currencies all have their place in this category, as long as the fund managers have shown their track record of being able to handle such strategies. Some, especially the black-box trend following programs have sadly completely failed; which is precisely why careful analysis and due diligence in reviewing fund managers is so essential.

In 2018 we will see tax changes in Germany, which have a small impact on private investors but which, together with the new MIFID II regulations will increase the amount and clarity of information that has to be supplied by intermediaries and Fund managers. This is nothing to be alarmed about and will hopefully ease the dangers of the miss-selling of inappropriate investments. The days of miss-selling to the ‘A&D’ (alt und doof) clients by the German banks in particular will be thankfully numbered.

There is still strong life in the global equity markets, as long as investments are carried out carefully and with due care and analysis. These markets will become increasingly volatile as institutions become nervous. One cannot discount a sudden nuclear or intense war between, for instance the USA and North Korea which would stir financial disharmony among the inexperienced ‘16 year old institutional traders’ who have no experience, but crises in Bitcoin, Block chain and the Technology stocks are unlikely to prove a ‘Black Swan’ moment and trigger total panic as in 2007/8. It pays to be wary and careful.

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

(Townsend@insure-invest.de)

 

John Townsend’s Investment Opinions June 2017

Henry Ford was right. A prosperous economy requires that workers be able to buy the products that they produce. This is as true in a global economy as a national one. – John Sweeney

Despite all the happenings in the political world, now is actually an excellent time to invest in equities. The financial crises happened 10 years ago and companies are once again running profitably and investing. International and domestic trade has picked up again and there is no point – at all – in investing in the fixed income markets or keeping money with the banks where the returns are negative. Investment in real estate for letting, which is in or near big cities has become wildly over-priced, is incredibly inflexible and is no longer a profitable alternative.

It is the loudest trumpet that most often has the least meaning. The United States of America under President Trump is fast losing its credibility as a world power. The Russians, Chinese and Saudi Arabians, having learned that flattery was extraordinarily productive in gaining the friendship and attention of Mr. Trump, soon realized that the benefits of such flattery had only a short life span.  Mr. Trump seems be growing old disgracefully; one can use the analogies of the Queen of Hearts in Alice in Wonderland (off with his head) or the Emperor’s new clothes by Hans Christian Anderson, where the courtiers are too afraid to say that the emperor is, in fact, naked. Then there is Shakespeare’s play the tragedy of Julius Caesar where a dominant and arrogant Caesar is murdered by his courtiers. Each work has its parallels in the court of Donald Trump. The effect on the outside world is however minimal.

Mr. Trump’s announcement that the United States of America is to walk away from the Paris climate accord has much to do with the fact that this agreement was negotiated and signed by former President Obama.  It makes absolutely no economic or social sense at all to leave the accord and merely leaves the way open for other countries to fill the economic and leadership void left by the US departure.

The US president was elected on a populist ticket. The result is, disappointingly, anything other than populist; the actions suggested so far are those that will exclusively benefit the American elite. The next big question is how the midterm elections will affect support for or pressure against this president and whether US politicians will take the chance and insist on a change at the top before then.

Within the presidential medieval court in Washington, there seems to be chaos with policies being announced off the cuff by the president using Twitter, even if this directly contradicts the statements and efforts of his ministers. Many of the administration’s more senior positions remain unfilled and stories about fits of rage and tantrums in the corridors of power abound. Policy is not being made in the White House; it is up to individual members of the Senate to guess the right moment to present their measures to the president or his coterie of close advisors. In the end however, little or nothing is being accomplished.

President Trump has yet to have a single success story in his tenure so far. His aim seems to lie principally in trying to remove the measures passed by his predecessor, President Obama. In order to do so however, there has to be a willingness on the part if the entire Republican Party to support him, but this is simply not there. Overseas, the high point seems to have been the awarding of a big shiny gold medallion from the Saudi King to Donald Trump upon his arrival in Saudi Arabia. This was followed by the signing of an agreement in principle for a 110 Billion Dollar 10 year arms deal, which is at present being held up by the Senate Foreign Relations Committee’s refusal to give permission.

At the end of the day what actually matters to investors is the fact that the US economy is performing well and that US companies are profitable. It has taken about 10 years for industry and the banking sector to recover from the market panic of 2007 to 2009.

The defeat of so-called Islamic State or Da’ish in Syria and Iraq has little economic consequence, but is more emotive. A caliphate, or territory under an Islamic steward, was declared in Mosul by Abu Bakr al-Baghdadi, the nom de guerre of Ibrahim Awad Ibrahim al-Badri, with himself as caliph in 2013.  Before its final defeat, Al-Baghdadi ordered members of Da’ish to form their own one, two or three person caliphates wherever they happened to be in the world. These have been ordered to destroy society wherever they find themselves. The weapons to be used are anything that comes to hand, with vehicles, bombs and knives being specifically mentioned. Very few young men and women will finally heed the call, but some have and still will and there will be enough for the security forces to worry about particular targets; otherwise the main aim is to destabilize western society.

The myth of Arab brotherhood in the Gulf Area is becoming apparent in Qatar, where the country is being isolated and pressured by its conservative Sunni neighbours led by Saudi Arabia. The aim is to force Qatar to cut communication with Shi’ite Iran and to curtail the freedom of the more or less independent press. The Saudis have been emboldened by the support they believe has been promised them from the US president supported by his son-in-law Jared Kushner, however short lasting this may be.

In Europe the economic picture is also looking positive. Despite Brexit, many European and British companies are showing increased profitability are expanding and are paying dividends, all the better to meet the investors’ demand for risk assets offering a positive yield. Economic growth has returned, albeit in parts in Germany and is expected to appear in France under the new President Macron. Corporate efficiency is improving with costs being kept under control. At the opposite extreme, in Italy and Greece, the upward pressure on wage costs reinforces their uncompetitive position. The Italian and Spanish banking systems are also in a very weak state. This conundrum can only be solved by a two tier European Economy with two separate currencies. Uncertainty also arises from the forthcoming Italian election where a populist and anti-European party is gaining strength and must be reckoned with.

In the United Kingdom, a needless and incredibly badly handled snap general election has left the present ruling conservative party with a minority government, supported at present by a small Northern Irish party. The present prime minister Mrs. May has run out of her own feet to shoot into and is unlikely to last much beyond the autumn party conference where she will be expected to ‘do the right thing’.  Not only that, the present government is filled with characters more often found in a kindergarten. On the other hand, to allow the left wing Labour Party leader to run the country with populous messages that make absolutely no economic sense and seem to be dependent on spending money which does not exist would be a disaster. Mrs. May with an astonishing lack of skill has plunged the country into chaos just at a time when it needs to focus on negotiating even a halfhearted exit from the EU.

The conservative British government must now be seen to be supporting British Industry and the financial sector, something it had ignored in its political machinations. The British economy is still surprisingly strong, though there is cause for concern with a government that is woefully weak.

China is seeing subtle but important changes. The Chinese central bank is clamping down on the export of capital for foreign investment, while also putting pressure on the domestic secondary finance markets. The Chinese expected growth in GDP is expected to be between 6.5 and 6.7% in the present year.

There are two important developments in Chinese policy; the first is the Belt and Road initiative, a development strategy proposed in 2013 by the Chinese president Xi Jinping. The Silk Road Economic Belt and the Maritime Silk Road focus on the economic links between Europe and Asia as well the ocean-going supply routes which will provide China with a source of necessary imports. ‘Belt and Road’ is a long term project and is made possible by the Chinese tradition of long-term leadership.

The infrastructure initiative covers mainly Asia and Europe, but also includes Australasia and East Africa; it will include investments of up to 8 Trillion US Dollars and will ensure that China has the necessary import of raw materials for its industry and the necessary transport means to export its industrial production. Politics aside, there will be a significant future for Chinese industries.

The economic crisis of 2007 – 2009 has passed, the global economy has recovered and companies are thriving for the right reasons. At the same time there is no sense at all in investing in Government Bonds or putting money in the banks, which pay negative or very low interest rates, are themselves not customer friendly and are in need of reform. The only real alternative for private investors is to invest in very carefully chosen equities, using fund managers with a proven track record of managing risk and diversifying markets as widely as makes sense.

 

Past performance is no guarantee of future profitability.

The US presidential election in November 2016

Too much of something can be wonderful – Mae West

The United States of America has held its presidential election and the winner, against most hopes and expectations, was Donald Trump.

As the duly elected president of a great nation, Mr. Trump must be treated with the respect that a holder of this office merits. It therefore behooves us at least to attempt a reconnaissance through the smoke of the political battlefield and the exaggerated rhetoric, to see where the new president Trump and his putative team might be likely to act and how such actions will affect the rest of the world. The campaign slogan, ‘Make America Great Again’ has done the country a great disservice. America always has been great and presently risks being dragged down by political incompetence.

First of all, in all election campaigns there is a surfeit of hyperbole. Mr. Trump himself has traditionally had more interest in the chase and the capture (whether of women or in business) than in management. There is however a major difference between campaign platitudes and rhetoric and the reality of government. His interest is likely to be much lessened now that reality bites. There is for instance unlikely to be a wall separating the USA and Mexico. There is already a fence along the entire distance. It is equally unlikely that many or most Mexicans, legal or illegal will be sent back to Mexico; who would then harvest the fruit and vegetables in California and Florida? The landowners are mainly republicans anyway as George W. Bush discovered when he voiced similar attention grabbing ideas. There will also probably be no major renegotiation of the NAFTA and other trade agreements. It is possible there might be some tweaking to save face, but the threatened peremptory withdrawal from NAFTA would severely hurt U.S. companies with operations in Mexico such as Ford and Wal-Mart.

Trade with China was also a favorite target during the election campaign; remember however that U.S. companies such as Apple have very larges sales to Chinese consumers. Any sanctions would probably hurt the U.S. A. more than China, which has already begun to extend its interests globally away from the U.S.A. There is a suggestion that instead, the new U.S. Government will wish to impose sanctions on Chinese Steel, where overproduction resulting from the Chinese economy’s switch from industrialized growth to consumer spending has caused the Chinese to dump low quality steel on the world markets.

The forthcoming President Trump will face more problems at home, but here again the exaggerated rhetoric and untruths will probably not be reflected in the watered-down reality. The promised return to employment in the US rustbelt is unlikely to occur in the form that the voters had hoped. There could well be support for more technological activities, though it is unlikely that the miners and metal bashers without training or modern skills will benefit. There are probably less expensive options for technological manufacturing outside the U.S.A than within it.

Mr. Trump will find himself continuing his war with the major American corporations whose chief executives have never seen him as coming from amongst their own ranks and although the hedge fund managers criticized him at every turn prior to the election, they are likely to kowtow in front of the Trump tower in the hope of currying favour. Mr. Trump has promised tax breaks to industry and substantial infrastructure spending. This should, on the face of things, greatly support U.S. Industry.

The BBC reports that there is a funereal mood amongst the 4,000 or so staff members in Washington. All are likely to lose their present jobs and must stand for re-selection. The corollary is that many of the skills accumulated by these staff members over decades could be lost and it will take some time to rebuild a functioning administrative system. The Trump promises of ‘draining the swamp’ in Washington could well lead to an ungoverned country.

Mr. Trump’s oft reported lack of interest in detail (other perhaps than in his private jet) will mean he will have to delegate many decisions. At present the situation looks somewhat incoherent, but if a competent team is appointed this may change.

Foreign policy is, again despite the campaign rhetoric, likely to take a much less important role in the future administration. Many of the election promises, such as revising the defence agreements with Japan and South Korea simply cannot be met. They sounded good at the time. Israel hopes that the new government will support a stronger Jewish state. Political reality however will probably mean this dream will not be fulfilled and the Jewish voters within the United States will be disappointed. No matter, Mr. Trump has been elected and the next election is seemingly a long way away.

How does all this leave investors? U.S. industry, especially the many modern technological and pharmaceutical companies are very likely to prosper. They will probably not be allowed to be sold to Chinese investors, but their business will happily thrive none-the-less.

Interest rates were going to rise irrespective of the election results, the bond markets are likely to reflect a move toward higher inflation with higher yields and new issues will probably be less aggressively priced that in the past months.

Now is the time to look very carefully at U.S. equities, corporations will be able to thrive for the foreseeable future and there are some very good companies for disciplined analysts to consider.

A carefully constructed mixed portfolio of U.S. assets will have the potential for combining yield but without the downside volatility of pure Equities. Now that the uncertainty has passed, investors should, at the very least, consider diversifying their portfolios away from only European Equities and look seriously at the American equity markets, especially large and medium cap orientated funds to augment the diversity of their portfolios.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung.

He is a Fellow of the Chartered Institute for Securities and Investment in London.

(Townsend@insure-invest.de)

Economic and Investment Opinions September 2016

Against stupidity the very gods themselves contend in vain – Friedrich Schiller, German Dramatist 1759 – 1805

There is a great deal happening in the global economic market, much is important but little has an immediate impact on the way that institutional traders think and act.

In China, the economy is moving from an infrastructure investment base to a consumer driven one. The economic growth rate is slowing and lending from mainstream and secondary banks is at very high levels. That economic growth is declining from incredibly high figures is not news. The data is widely held to be unbelievable with numbers dictated by the government. However, even with real growth of 3% instead of the official 6%, there are still many non-government sector domestic investment opportunities with good corporate governance. A good fund manager will find these and avoid the banks, many of which seem to be headed for disaster through their unskilled lending, having wrongly believed that the state would bail them out. China’s imports are also changing, with consumer demand driving imports rather than engineering or raw materials. It is not that demand for steel, energy and engineered goods will cease, far rather demand for them is declining in favour of other imports.

Brexit, having caused two days of uncertainty in the investment markets then became less of an issue and calm promptly returned. The messages from the leaders of the weaker countries and the bureaucrats nominally at the helm of the European Union, that Britain should leave quickly and quietly – in other words, to fall on its own sword – have been ignored. Europe now has the opportunity to make changes within the Union, though bearing in mind the unlikelihood of reaching any decision; it is unlikely this will happen. At the recent meeting in Bratislava where the future of Europe was discussed, a number of suggestions were made. One glares out as an example of startlingly opportunistic but depressingly unrealistic thought. France suggests there should be a united European military headquarters, (presumably in France) controlling a European military force which would act in support of the European government. This is of course an interesting suggestion from the only European country capable of fielding a modern fighting force and one of only three remaining countries, after the United Kingdom’s departure (the others being Greece and Poland), to have adhered to the 2% of GDP minimum spending on defence. The major problem with this idea is that any pan-European decision, including military action, will take so long to achieve that any war would be lost long before agreement was reached to fight one. Such a force becomes meaningless because its political leaders, each with their own policies, would never willingly agree on a coherent decision. So it is with the reform proposals put forward in outline terms in Bratislava. They are unlikely to be agreed by all the states at any time in the future and so are in practice meaningless.

There is still a marked imbalance between the economic strength of the European States. The Northern Sates led by Germany for whom the Euro as a currency is too weak and the Southern States led by France, whose internal domestic issues and ensuing economic weakness make their current value of the Euro against world currencies too strong. This cannot be muddled through over the long term and a two speed Europe with different currencies and different economic strategies has to be the outcome. If one wants swift action, rather than just a swift Brexit, there should be a clear and rapid North South split in the structure and policies of the economic union. A removal of the bureaucratic overlay could be an additional advantage.

Bureaucracy makes itself felt in Germany too. The former German health minister Andrea Fischer recognized that she had a problem with the four permanent secretaries of her ministry when she took over in 1998. She swiftly removed three of them, but in a recent speech, she reflected that the fourth one undermined her just as effectively as the other 3 would have. She left office in 2001. It is clear that the whims of an unelected bureaucracy, without reference to their elected Political masters, make the execution of German policy. This is true through the length and breadth of German society and it is then left to the German courts to decide what policy was intended and what the laws actually mean.

In the USA there is a presidential election looming. What makes this one special and interesting is that the choice is between two deeply unpopular candidates. The least disliked candidate will probably win. The suggestion is that there is so much hostility towards both candidates that many more undecided voters than normal will actually get out and vote.

Under the democratic candidate, there will probably be very few changes to current policies. The Republican candidate has promised far reaching changes, not all of which are honest, logical or feasible. It must be remembered that the US Bureaucracy as much as in Germany, can dampen or alter the reality of policies.

The US economy is gaining ground and US corporations are growing in their profitability. Now seems a very good time to switch from European equities into the US Markets. However until the result of the US election is known, there is much to be said for holding back for the time being.

Risk and its management is now all-important. Where the traditional fixed income markets are showing negative returns, there is a temptation to diversify into hitherto unknown areas such as the Emerging Markets and corporate debt with much lower risk ratings than most investors had previously experienced or understood. Indeed many companies are capable of issuing debt at effectively no cost and are steadfastly doing so. Investors in such bonds are not being rewarded for the risks they are taking. Yet there is a danger of believing that these conditions will last forever and therefore acting, or not acting, accordingly. They won’t; the ancient dictum “These times will change” will inevitably make itself felt. Fund managers with analysts who are capable of assessing lower quality risk and taking coherent decisions will be able to avoid the inevitable future problems with debt from companies that fall by the wayside.

There is however now much to be said for investing in the Equities of the same high quality companies, where the yields, made up by equity market price increases and dividends, at least provide a passable return. Once again the skill of a management team and a wide distribution of risk will play key roles.

Looking into the future, there are industries that are once again flourishing after a longer term global economic downturn. Examples here are efficient oil and raw material producers. Increased consumer confidence also means an increased demand for the so-called next generation resources, such as lithium, battery storage production, renewable energy and coatings and packaging companies. These are detailed operations and need thorough competent analysis. They do however have a very strong future.

The major victims of the economic changes and zero or negative interest rates are the banks, which cannot make a profit with their lending when competition from other lenders is driving interest rates to effectively zero. Many funds from the major fund management companies had and still have a cushion of bank equities. These are now suffering badly and the entire sector is in urgent need of a substantial review. There is already a rescue scheme being organized for at least one Italian bank, even if this goes against European regulations. In Italy, regulations which would normally be adhered to rigidly in the Northern States are adjusted – almost with impunity- to meet specific political and economic needs.

Japanese and Western central banks have kept their interest rates – the rate at which the Central bank lends to commercial banks, at zero for a considerable length of time. The policy began in Japan in 1992 and was then taken up by the US Federal Reserve in 2008 to stave off economic collapse. In Europe, the ECB followed suit in March 2016. A zero interest Rate Policy was originally intended as an emergency measure to provide liquidity to the banks. As happens so often with emergency measures, they are clasped very tightly even when the need for them has disappeared. At the same time, the Fed, the ECB, Switzerland, Sweden and the Bank of England have Quantitative Easing Programs by which they buy high quality debt from the commercial banks to inject more money into their respective economies. Such cash injections were intended to increase investment demand and lift inflation rates from near to zero at present to a more normal two percent. This has not happened and has left the central banks with inflated balance sheets and often questionable assets, but without ammunition, other than the fear of uncertainty amongst investors, to steer their economies. The emergency measures have continued and will continue unabated until someone, somewhere, comes up with a better idea.

The outcome is that fixed income investments, needed by so many institutions to secure their obligations in the future, now have a zero and sometimes negative yield. Insurance companies have to incur costs to manage and meet their obligations and cannot now do so with the present low and indeed negative yields in their investments, The result is that investors, both institutional and retail have to increase the risk of their investments in order to achieve a higher yield. The concern once again is that many investors really do not understand what it means to take higher risks. Their nervous reactions to bad market news means that suddenly bonds and to a lesser extent equities will be dumped wholescale into the markets, almost at any price when the computers, who are not programmed to understand risk, signal a sell order.

Where does this leave the private investor? The safe investment havens of the past have disappeared. Not only will some life insurance companies no longer be able to meet their guaranteed payments and may be threatened with having to avoid making payments under their policies with guaranteed interest rates, but the wholesale stampede into previously unknown investment markets, such as the Emerging Markets in an attempt to improve returns, has dropped many bond prices in this sector. Some well managed funds, such as those from Nordea have seen a massive influx of institutional and other fund of fund money and have had to close their doors to further new investment. The fact that this is hot money and can just as quickly disappear as happened with the property funds in Germany in 2011, should be clear.

There is no realistic alternative to investing in Equities, either through equity funds or as part of mixed strategy strategies. The aim has to be to build up a carefully diversified portfolio of well-managed funds and be prepared for the many changes that will inevitably happen in the near and medium future.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung.

He is a Fellow of the Chartered Institute for Securities and Investment in London.

(Townsend@insure-invest.de)

 

Brexit: A first reaction

Brexit – Reaction to an unexpected referendum result in the United Kingdom
24 June 2016

The xenophobia of the elderly members of the British populace has won through. There were simply not enough educated younger voters to stem the tide of ignorance.

The United Kingdom voted narrowly to leave the European Union, citing a dislike of Brussels Bureaucrats in general and Jean-Claude Juncker in particular, European inefficiency with a marked inability to take any decisions, Southern European corruption and immigration (though not from North Africa, far rather from Eastern Europe). The results of the British referendum were inconclusive, but in the United Kingdom, with a first past the post voting system, even a small margin is enough to establish a result. The buffoons leading the ‘leave’ campaign have clearly started to wonder what the next step should be, as they had no plans beyond the referendum and my not even have expected to win; in the meantime they seem to have gone into hiding. There are calls to find an Exit from Brexit.

The investment and currency markets immediately and expectedly reacted to the result with a series of violent knee-jerk movements with the value of the pound falling sharply against the Euro and the Euro itself falling against the US Dollar and the Yen. Stock markets fell sharply and the institutional flight to quality caused major purchases of US Dollar and Japanese government Bonds.

It is however unlikely that trade between the United Kingdom and the rest of Europe will be affected at all in the short-term and probably not even in the medium term. London’s position as a global financial hub may be reduced, though principally probably in favour of Dublin where the financial staff at least doesn’t have to learn another language. The hopes that Paris and Frankfurt may be nursing are likely to be dashed. European governments are calling for a swift Brexit, maybe forgetting all the while that if that were to occur, it would be the first time in modern European history that any action was taken swiftly.

Where does this leave the private investor?

Nothing much will change for at least two years. While the investment markets are shaking with the fear of uncertainty at present, looked at dispassionately, good European fund managers will still find many excellent companies in which to invest, both in mainland Europe and in the United Kingdom. The sector that will suffer most are the banks, but few fund managers have investments in bank equities and bank debt can only gain in yield.

There is, strangely enough, a big world outside Europe and the United Kingdom.

The US markets will now play a bigger role in investor portfolios, both with US equity and debt funds. Good fund managers will find many opportunities with excellent companies to make a profit. The skill will be to find those good, indeed excellent, fund managers.

The energy markets are now once again in vogue, with a new discipline among producing companies. In the same vein, Emerging Markets, having had their own political problems had become less attractive, but are now selectively looking profitable again. Some markets, such as Russia, remain uninteresting and high risk, but China is as always worth considering. Despite the current flight into Yen, investors should be aware. The problems caused by Prime Minister Abe’s three arrows policy, where the third arrow missed its mark, remain and dent corporate profitability.

Now is the time to invest, while the markets are jittery and prices wonderfully depressed.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung.
He is a Fellow of the Chartered Institute for Securities and Investment in London.
(Townsend@insure-invest.de)

Unsettled Markets

John Townsend’s Investment Opinions – Mid June 2016

There ain’t no answer. There ain’t gonna be any answer. There never has been an answer. That’s the answer.
Gertrude Stein American writer 1874-1946

The panic that gripped the equity markets at the end of 2015, reached its low point on 11th February 2016. No-one noticed, because the fear affecting the markets was still so clear that it took a while for the memory of the pain to subside. There was no logic to the panic, just a number of seemingly dislocated events, such as the low oil price (which should have been seen as positive), China’s slowing economic data, terrorist acts, the EU refugee crisis, the unrest in the Ukraine, the fact that the Syrian war has de facto turned into Sunni versus Shia, and the weaker employment figures in the US all played their part. The MSCI in Euros dropped 12%, the DAX some 16%. The doom mongers who perhaps once guessed the markets decline, are now deemed to be expert prophets. I don’t believe the markets are in decline, but are instead vulnerable to volatility, especially as the downward movements in prices had no intrinsic logic, based as they were almost entirely on emotion and fear. It is also important not to confuse the national economies with the equity markets and well managed Funds. A good fund manager will find opportunities even in poor economies.

China floated its currency, the Renminbi Yuan (RMBY) last year. At the same time the Chinese central committee’s decision to turn the Chinese economy from an investment in infrastructure driven economy to a consumer demand driven one has inevitably caused a change in the rate of economic growth, but as the Chinese growth figures were largely artificial anyway, the effect should have been minimal and an encouragement of the view that the world outside China would one day see real figures. The fact remains that the Chinese economy is still very large and is showing growth; the demand for consumer products from domestic as well as foreign sources is growing. A weaker RMBY also makes imports more expensive which encourages domestic suppliers to grow.

In Europe the crises bumble on unabated. The possibility of Britain leaving the European Union (known as Brexit) has caused and is causing turmoil. Once again experts and pollsters are having a wonderful time making predictions, some for a British exit, some against. The British government has not helped their cause with the ruling conservative party being deeply split. The opposition Labour party, under its new and ineffectual leader, is effectively rudderless, though theoretically in favour of remaining within the European Economic Community, but unable to provide any consistent lead. Bookmakers and betting shops still suggest (just) that Britain will remain within the fold, but the 23rd June is the deciding date and the expert opinions will then have to be tempered by reality. It is the older generations from the comfort of their armchairs who are demanding a Brexit; the younger generation is much more pro-European and will benefit most from Britain remaining within the EU, but many either do not yet have the vote or won’t vote for whatever reason. In the meantime, the investment markets will continue to be volatile but post-election markets will show investment opportunities both in the UK and in a more stable Europe.

The ECB’s policies have caused interest rates and bond yields to drop to never before seen depths. 10 year German government bonds are now much sought after, despite the fact that yields are now firmly in negative territory. The argument is that the institutions do not expect to hold the paper to maturity anyway, but need a safe haven until the ever present uncertainty prevails. Bond fund managers have taken to increasing their returns by taking more risk, though still within the BBB investment grade boundary. By investing in corporate bonds, many of which are in any event more highly rated than some European governments, as well as selecting different maturities within their portfolios, the fund managers can protect the stability of their yields.

In the US, the Federal Reserve has begun to raise interest rates. It was at first only a token gesture but a signaled intention and more is certain to come. Europe is inevitably some way behind the US with the ECB continuing to expand the purchasing program of investment grade bonds from European banks. It seems that the major beneficiaries of the ECB’s liquidity measures are the banks (and therefore the governments) of the weaker southern European states. The Banks within northern Europe, with the occasional hiccup, do not need this stimulus, nor indeed do the northern European governments.

Rock bottom interest rates have encouraged some investors to consider investing in houses, not for their own residential needs, but rather to rent out as an investment. This needs to be treated with caution. Even houses in reasonable condition outside the biggest cities cannot, with the best will in the world, make a comparable return even to the negative yields in the 10 year Government bond markets. One has to take into account the costs of purchase (some 10% of the purchase price) the fact that prices are unlikely to rise appreciably over 10 years, the fact that all buildings will need to be repaired at the owners’ cost and also that there will inevitably be times when a property is unlet. These factors will reduce the returns of rental property to a point where a well balanced fund portfolio will provide a much better return.

Gold has once again become a topic for serious discussion. The market collapse of the past few years has caused discipline to be re-imposed, with unprofitable mines and mining companies being shut and less ill-thought out investment in new mines taking place. A certain, but small amount of physical gold – in sellable form – might be worth considering as a defence against disaster as long as it is kept somewhere safe from theft , where investors can access to it in the event of a true crisis. Banks are not ideal depositories as they are likely to remain firmly closed when disaster strikes.

Investors should, above all, seek a broad diversification within their portfolio. There are many fund managers who skillfully find sound equity investments, but these investments should be balanced with well managed bond funds. Investors should also consider mixed strategy funds, covering the equity and the bond markets as well as absolute return funds, where performance is not necessarily correlated with movements in the markets.

Many new funds and new strategies have sprung up since the markets became volatile. Not all are managed with the skill that makes them worth considering and many will not survive. Therefore, when selecting funds for a well-diversified portfolio, only fund managers who can show at least a three year track record of managing risk, including in adverse markets, should be considered.

Much is made of the costs contained within a fund (the Total Expense Ratio or TER) and the fact that fund managers might have the gall to pay themselves too much, including sometimes with performance fees. This is nonsense. Funds should be selected purely on the basis of net returns to investors over a longer period when compared to their peer group and the ability of the manager to manage risk. A successful fund manager deserves to be well rewarded as long as the investor gains the benefit. Funds that in yield and risk terms fall below the top quintile of their peer-group should not be selected for investment anyway and if they are already in the portfolio should be considered for replacement.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung.
He is a Fellow of the Chartered Institute for Securities and Investment in London.
(Townsend@insure-invest.de)