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.



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.

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.

The Chinese influenza can be catching

Stop blaming China; we taught them how to do what they are doing. – Tom Galey, Professor of Business and Economics and China expert

The Chinese influenza can be catching

The Equity markets often trade as much according to sentiment as to Logic. These markets have seen a mood of near, if not actual, panic in the last few days. This has little or nothing to do with Greece, or indeed with the Federal Reserve’s impending interest rate increase, far rather the Chinese government triggered emotions that were wholly unexpected and unintended.

The Chinese central bank, with the encouragement of the International Monetary Fund and by extension the US government, has begun a free float of the Chinese currency – the Renmimbi Yuan, or RMBY. Inevitably this has meant an initial reduction in the value of the RMBY compared to other world currencies, something which has caused much anxiety. The Chinese want the RMBY to be a reserve currency, akin to the US Dollar, the Swiss Franc and (in part) the Euro. This desire has, in my opinion, more to do with prestige than logic.

At the same time, the shares traded in the Chinese domestic stock exchanges, based in Shanghai and Shenzhen, (the ‘A ’shares) have suffered large falls. Domestic Chinese investors, the only ones allowed to invest in these shares, had often bought shares on margins with the remainder of the price taken up as loans. In a rising market this can be good news, when markets fall however it is disastrous. The Chinese central bank has moved to reduce the extravagant lending by Chinese Banks to their domestic clients, but has now been forced to lower interest rates as a sign that it will support the domestic economy. This move is also designed to offset the news that the Chinese economy is expected ‘only’ to grow by about 6% in 2015.

Even such reduced growth would under any other circumstances be regarded as good; but a jittery market, lacking even a minimal appreciation of the changes happening within China decided to get cold feet.

The International Chinese Equity market (the ‘H’ shares) traded in Hong Kong, has suffered losses by extension, all too often from panicked overseas investors not understanding the difference between the two markets.

China is deliberately moving from an investment driven economy to a consumer driven footing. This is understandable and correct, but the change will in itself result in a different economic growth pattern before it is over.

The stresses coming from China have affected the international equity markets too. There is a fear that those exporters from the west and from the emerging markets who have built up large sales in China will suffer, as indeed will their suppliers. The reality is however likely to be the opposite in the medium and long term, as Chinese consumers will gain even more opportunity to make purchases of international or domestic goods of their own choice. Much the same is true of energy, industrial and soft commodities. Let’s be clear, Chinese industry will continue to need to import.

To add to the tale of woe, interest rates in most of the western world have reached levels of nearly zero. This is wonderful for borrowers who will try to borrow as much cheap money as they can, not realizing that such high levels of debt will prove hard to service when interest rates rise.

The United States Federal Reserve has signaled its intention to raise interest rates by a small amount in September 2015. The caveat being that there are no disasters which might cause them to delay. The attention was initially on the US employment markets, but these seem stable enough. The question is whether turmoil in the international equity markets could cause a delay. Past experience suggests not, but there is a new hand at the helm.

Attention has drifted away from Greece, which is a shame, because nothing there has been settled and much could still go wrong. The Tsipras government has resigned and called an election in an attempt to gain more support in the Greek parliament. 30 left wing party members of parliament promptly left the party to form their own break away movement. The end result is anyone’s guess. I still believe that Greece will attempt to gain a reduction in its disastrously high levels of debt by leaving the Euro and demanding a debt reduction (by way of a ‘haircut’ of 50% or more). This is speculation, but another way out is difficult to envisage.

Now is the time to invest in the major Equity markets while levels are so artificially low. It is perhaps a counterintuitive step, but not necessarily an unduly risky one.

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 (

Investment opinions- October 2013

John Townsend’ Investment Opinions – October 2013

The reason we are so pleased to find out other people’s secrets is that it distracts public attention from our own. ¬- Oscar Wilde 1854-1900 British dramatist and Poet

The last month has seen much excitement over the American NSA’s collection of electronic communication between everyone else, including those who regarded themselves as friends of the Americans.

Looking back over time, it becomes clear that these complaints are hypocritical. Every country needs to know what the leaders and decision makers of other countries are thinking. Traditionally, such information has been garnered from conversations that diplomats held with individuals within government and industry or their counterparties within the foreign departments. The budget cuts that affected the CIA during the Clinton presidency resulted in an increased dependence on electronic information gathering and a reduced reliance on human intelligence (Humint) with a consequent reduction in the ability to interpret the information gathered. The electronic data collection, once started, has grown in ability and scope, to the point where every senior politician and industry leader has to be circumspect about how they communicate. A major issue is whether the scientists developing and using these electronic eavesdropping systems are in fact controlled by anyone at all.

One might be careful about being overheard by the Russians or Chinese, but few people will admit to being concerned about the American collection of military, political, economic or industrial information, especially when the British and French have been so adept at doing the same thing. The eleventh commandment ‘thou shalt not get caught’ springs to mind. Most European countries and indeed those outside Europe gather information about their allies and competitors and very often share it with each other, their own industry and even possibly with the Americans.

In the Eurozone the economic recovery, especially in the southern countries, is agonizingly slow und unstable. In Germany, the economy marches on from strength to strength and it is clear that the polarization within Europe is becoming harder to disguise. Low interest rates and a weak Euro helps German exports outside the Eurozone, even if exports to the Mediterranean countries with weak economies are reducing.

The European Commission is forecasting growth in Europe in 2014 after two years of contraction. But the numbers are feeble. Remember this is for Europe as a whole and while German economic growth will be stronger it means that other countries will fall below the average figure.

There are some dismal projections for the labour market too, with the average unemployment rate for 2014 being about the same as it is now at around 12%. These jobless forecasts – if they turn out to be right and that is a big assumption – show some improvement in some of the crisis countries, notably Greece, Ireland and Spain. Unemployment levels however, will remain high and there is little or no improvement forecast for Italy or France.

In China, the communist party will hold the third plenum of the 18th Central Committee in the middle of November. Past third plenums have produced major policy changes. In this case, it is likely that the Chinese leaders will suggest major reforms based on the ‘383 plan’ circulated by the government some time ago and which proposed a reform of the Chinese economy by 2020. In a recent ‘Data Flash’, Deutsche Bank suggested that China will reduce investment restrictions for private investors in key industries. China will also increase its openness by allowing foreign investors access to most service industries. Additionally the state owned enterprises and municipalities will have direct access to the stock and bond markets. The economy has already begun the swing from an infrastructure investment led growth model to a consumer demand pushed economy. This has a much better future, even with some near term weakness and the central committee is likely to encourage this move. On the other hand, it is likely that many more opportunist private banks will spring up. Corporate governance in China has not reached the levels one might hope for or expect in other countries and these banks could easily be a major source of losses. They are well worth avoiding.

In the United States of America, the profit announcements of many major companies are serving to generate positive surprises to investors. As a result, the prices of equities in the market as a whole have risen strongly. Not every company is producing increased profits; indeed some companies are showing no profits at all. So it is a wise choice to select experienced fund managers who have the benefit of competent research departments to select the most potentially profitable companies in which to invest.

The US equity market has seen interesting growth over the past 4 years and some commentators suggest the end of the rally must therefore be close. In reality, there is still room for growth in the market as corporate profitability and growth, combined with sharply reduced leverage and inventory lead to higher equity prices.

Many conservative investors, both institutional and private, believe they are safe by keeping their money on deposit with their banks. In reality they are burning their investments as the yields on government debt fall below the rate of inflation. The question is what should replace government bonds? On the fixed income market corporate debt from companies with high credit ratings have become popular to the point where their yields are very close to the levels of their own governments. Highly rated emerging market bonds, though not debt in local currency, carry a higher yield though there is an inherent credit and indeed market risk, where investors might find it hard to sell the paper in adverse market conditions. The best yields are still to be found in good quality corporate equities, while gold, fine art and real estate are too speculative and presently very expensive and potentially illiquid.

Changing markets require changes in traditional thinking and investment philosophy. The investment decisions taken when investing in corporate equities are much the same as investing in corporate debt from the same company. The yields are however higher and a competent fund manager should be able to maximize the returns while minimizing the risk.

Changing times require changing approaches. The strategies that worked in the past are now potentially loss-making and will remain so for many years to come.

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.