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 Market Opinions Autumn 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)

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)

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 (Townsend@insure-invest.de)

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.
Townsend@insure-invest.de
www.insure-invest.de