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John Townsend’s Investment Opinions September 2022

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The day is short, the work is much, the workers are lazy, the reward is great, and the master is pressing. It is not incumbent upon you to finish the task, but neither are you free to abstain from it.  

Rabbi Tarphon in the Mishnah. Pirkei Avot chapter 2 (Ethics of the Fathers)

The Russian invasion of Ukraine, following on the heels of the Covid pandemic and adding to price inflation has caused deep uncertainty in the investment markets. In times of severe insecurity, the instinctive reaction of the inexperienced investors is to sell as many of their investments in the affected areas as possible, especially those positions that were bought with borrowed money. At present, institutional investors have been heading for the safe haven of the US markets to invest in treasuries and large corporate equities.

Politicians in the West have tried to hold together in the defense of Ukraine though some voices, especially in Italy, and among some major German companies, have tried to press for a peaceful settlement where Ukraine should give up its territory, thereby giving the Russians a reward for their aggression, and at least reducing the risk of war albeit temporarily for the rest of Europe.

The Russian economy is weak and has been further weakened by the invasion. The threats from Moscow have become ever more blood curdling reflecting the increasing weakness of their position, up to and including the use of tactical (i.e., small) nuclear weapons on Ukraine itself, even if they are probably bluffing. The threats are more for the benefit of a domestic audience who have no alternative information sources but are noticing the casualties among their sons who have been poured into the furnace of a war. There is at present no viable opposition in Russia that has not already been locked up, so alternative news is hard and dangerous to come by. The propaganda from Moscow may be palpably wrong, indeed it may be utterly the reverse of reality, but it is hyperbole aimed at encouraging the home audience and discouraging the weak at heart in the rest of the world.

Russia is benefitting from the high prices its energy exports can achieve in those markets that are still willing to buy their oil and gas, for instance India, in place of its exports to Europe. Russia is also trying to assert itself by turning off the gas supply normally delivered by the Baltic pipeline Nord Stream 1 and thereby putting the European governments and their economies under pressure. Western Europe, having become complacent about the lack of diversification of gas supplies has been suddenly shaken by this move which has caused gas prices to soar by up to 10 times their previous levels. This move will not be long lasting, but it causes concern. The ensuing panic and the search for alternative sources of energy to circumnavigate the problem will cause much more rivalry and much less concentration on the real issues. The pressure is on in some political circles to abandon Ukraine and to gratefully resume taking Russian gas. Surely it would be better to remove the temptation to surrender for some European countries and buckle under the pressure and instead simply blow big holes into the Nord Stream 1 pipeline and its completed but not yet commissioned sister project Nord Stream 2 pipeline which was in any event a vanity project by a previous German chancellor which his successors did not have the courage to cancel, thereby removing them as an obstacle to finding a more logical and longer lasting solution to a diversified energy supply problem.

The equity market investment peak was reached in December 2021, after a period of increased volatility. European smaller companies (those with a market capitalization of between 300 million and 2 billion Euros) suffered severely as the search for quality and the covering of short positions took hold. I believe that the market ‘s low point was probably reached in September 2022, but unlike the rapid recovery from the Covid scare of March 2020, there is still plenty of room for panic and downward jolts and the recovery this time is likely to be much slower,

Rising energy costs help to fuel household and industrial inflation which in turn need to be brought under control. Western central banks, after a period of supporting the markets with additional liquidity and quantitative easing during the covid crisis are now reversing their actions by raising interest rates and slowly disposing of the bond purchases which had been used to give liquidity to the markets. The danger is always that the difficult times occurring now in the various markets will be emotionally extrapolated into the future, whereas they are unlikely to last for the long term.

A recession in the USA has probably already started and a recession in Europe is likely to follow by the end of 2022. However, the employment figures in the USA are encouraging and indicate a near term increase in demand. The strong boom years we have just experienced, have filled warehouses with inventories that need to be sold to make room.  The economic recovery from the Covid shutdown will mean however that the recession will be quite mild. This is a time to look for value in the markets rather than to focus on the companies that have generated earnings growth for so long. Indeed, some companies can fall into both camps. It takes a competent fund manager with a good analytical team to find the right quality investments.

A recession, even a short-term recession, has an impact on the daily lives of everyone. Equities can lose their value or simply stagnate until a recovery begins. In the meantime, house prices will begin to fall from their already very high levels, as the money to buy properties is more difficult to borrow and consumers begin to worry about their ability to service debt. This is likely to be a mild recession however and the discomfort will probably be short lived.

In China, the attempt at a zero covid policy by locking down whole cities has had a deleterious effect on the planned economic growth rate. In 2021 the Chinese economy grew at 8.08%, which greatly exceeded the centrally planned target. In 2022 this growth rate is likely to be 3.3%, the lowest in more than 40 years, according to IMF figures, and is expected to grow to 4.6% in 2023. Within China, domestic and industrial demand will continue at a lower level than in the past, but the economy is huge, behind only that of the USA. China is still an investible opportunity and brings with it investments in other Southeast Asian economies.

The five stages of grief are denial, anger, bargaining, depression, and acceptance. This can also be seen in the current investment market. Bargaining was seen in the summer of 2022 when investors hoped that that the central banks would be gentle with base rate rises, which were in any event inevitable. They weren’t, so now investors find themselves somewhere between depression and acceptance. The developed market central banks seemingly had concerted programs of policy tightening, with base rate rises have coming in increments of 0.75% instead of the normally gentle 0.25%. The Federal Reserve has made it clear that it is willing to go much further in raising rates, if necessary, which is having a dampening effect on equity investors too. The tech stocks which grew so rapidly in early 2022 and formed the mainstay of the MSCI World index, benefitted from leveraged investors who are now bearing the brunt of diminishing credit availability and suffering from forced liquidations.

The fabled FAANG stocks, which are major components of the MSCI World index and together are an acronym so called after the US technology companies, Facebook, Amazon, Apple, Netflix and Google, have now become MANTA stocks, now Microsoft, Amazon, Nvidia, Tesla and Alphabet. Facebook, now Meta, has been downgraded in importance as has Apple. These stocks found favour with investors and were busily over bought. The inevitable over enthusiasm could not be extrapolated into the future and, like the Dutch tulip mania of the 17th century, it imploded when common sense prevailed. These companies do of course have their value and their logic, just not at the over-inflated price levels they reached during the craze.

Investors should not panic, and above all should stay invested at this time. The investment markets have already priced in the coming economic recession at least in part, by staying invested, investors will then move onto the final stage of the grieving process with an acceptance that the boom markets of last year are not going to be repeated in the near future. The news is uncomfortable but is not a cause for panic. Competent fund managers with the experience of many years of the ups and downs of economic and political upheavals will rebuild stability into their portfolios and profitable investing will resume, albeit at a lower level than in the recent past. A broad distribution of risks will also allow for stability in the yields of portfolios.

Investors should also resist the temptation of investing in the get rich quickly sectors such as Cryptocurrencies and other similar bandwagons. Recent history has shown that it is perfectly possible to lose most or all of an investment in this gamble. The coming years will still have profit potential, but not at the extravagant levels of the past.

The watchword remains; stay invested, but carefully diversify risk and avoid over concentration in any one sector.

 

Past performance is not a guide to and cannot guarantee future profitability. The value of investments and the income they generate may go down as well as up and investors may not get back the amounts they originally invested. All investments involve risks including the risk of possible loss of principal.

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

John Townsend’s Investment Opinions June 2020

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Past performance is no guarantee of future profitability.

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

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

Investment Opinions December 2017

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Past performance is no guarantee of future profitability.

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

(Townsend@insure-invest.de)

 

John Townsend’s Investment Opinions February 2017

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Circus Ringmaster :-“Ladies and gentlemen! We will now present for your entertainment the most stupendous, magnificent, super-colossal spectacle! On this tiny, little, insignificant ball, we will construct for you a pyramid! Not of wood, not of stone… a pyramid, of ponderous, pulsating, pulchritudinous pachyderms! I give you the elephants.”

President Trump enjoyed the campaign trail leading to the Presidential Election and now has the appearance of a circus ringmaster with top hat and bright jacket and tie, still wishing to play to the crowds. It is unusual to have a western democracy governed by decree, more unusual still to have a country where policy is partly controlled by two unelected individuals, in this case Stephen Bannon and Stephen Miller, both of whom have a capacity for promoting ‘alternative facts’.  A thin skinned and paranoid president with the reputation of having a dislike of detail, a short attention span and only wanting to accept good and indeed fake news being filtered to him by his aides, Mr. Trump’s advisers will carry an unusual amount of power when he acts as a mouthpiece for their views. President Trump’s rhetoric is full of bellicosity but contains very little actual detail. His actions will for the most part have to be sanctioned by the two US elected chambers of Congress. The project costs suggested so far are reminiscent of a spendthrift suddenly having access to someone else’s money; Mr. Trump’s track record in this regard with his projects in Atlantic City using borrowed money is not exemplary.

Despite the above, this is an interesting time to invest in US Equities, not because of President Trump and his policies, often called the Trump surge, but because the economy and the companies themselves are doing well. Indeed after a difficult and at times confusing 2015 and 2016, the US economy is very positive. The Trump election has brought with it a rally in the US equity markets, which rally would probably fizzle out if it were not for the underlying economic strength.

President Trump has promised tax reforms including sharp reductions in the corporate tax rate as well as economic stimulation including greater (and sorely needed) investment in infrastructure of up to $1 TRILLION. (For the sake of clarity, a Million Million dollars). This is in addition to the additional $54 Billion he wishes to spend on the US armed forces. This latter sum sounds impressive, until it is remembered that President Obama had already requested an additional $38 Billion in defence spending. The larger sum seems to be an uncalculated figure, chosen because it was larger than the plan of his predecessor. President Trump is also insisting on building a wall along the border with Mexico, which is over 3000 kilometers long. By comparison, the Berlin Wall was a mere 160 kilometers long. Recent estimates suggest President Trump’s wall will cost over $21 Billion. It is unclear whether these election promises will or can be met; but if they are, the big engineering companies especially will benefit.

On a different level, The Federal Reserve, the US central bank, has already signaled that it proposes up to three interest rate increases in 2017. The Fed is by design independent of the US Government and it is likely that these increases will occur. Such moves will bring back a measure of inflation and begin to bring an end to the financial repression which has existed in the US and in Europe.

Low global interest rates producing zero or negative yields have allowed a heavy issuance of debt by companies.  Demand is now available to buy this debt in large amounts. The issuing companies have of course to pay a risk margin on top of the base rate for their new debt, but this is relatively small. International institutions have a problem with the fact that government debt has a largely negative yield; the insurance company trustees do not allow them to invest in large amounts of equity; they therefore have instead to find bonds to fill their investment requirements.  Interestingly, the gap between the margins between AA and BBB debt has shrunk to very low levels, reflecting the reality that the default levels in the investment sector are universally very low.

The price of oil has risen, albeit slowly. The increase from a very low level has clearly had an impact on reported inflation, but it is important to recognize that the inflation surge will pass by the end of 2017. If one wishes to wait that long, the economists from Flossbach von Storch suggest that price of oil per barrel could reach $80 in about 5 years.  This is of course unhelpful to those countries reliant on oil exports, but is manageable to those oil importers.

In Europe, the markets for Pan European equities have performed relatively weakly. There are indeed good and profitable companies in Europe, but the economic and political uncertainties give investors cause for concern.  A presidential election in France, with the possibility of a president who is hostile to the European dream, a general election in the Netherlands with an equally populist potential winner who is also hostile to Europe and the (almost) certainty that the United Kingdom will initiate a withdrawal from the European Unioin  under Article 50 of the Lisbon Treaty,(A Brexit) all give cause for concern. Greece is still a major problem, but the willingness amongst European leaders and bureaucrats to cut Greece loose from economic strangulation and the crippling debt means that more money will be poured into that particular drain.

The British Economy is performing well and has a higher growth than the average for Europe as a whole. Germany and the northern European countries are flourishing economically, as much due to a Euro currency which is too weak for their economies, as much as it is too strong for the southern countries. There is no willingness on the part of the European powers that be (not leadership, there is none) to discuss such problems. Now is therefore a good moment in history to invest in German and related equities.

Japan has suffered for more than two decades under the economic shocks resulting from a burst asset price bubble and poor lending quality based on a corporate and social system which was followed blindly. This collapse also caused a great loss of self-confidence in companies, banks and their employees. Despite high national debt, low global interest rates have allowed investment to resume. The three arrows of Abenomics, aimed at reducing Japan’s chronically low inflation, battling low worker productivity when compared with developed countries and the expenses of an aging population, have slowly taken hold in a country where change is regarded with deep suspicion. Now seems to be a good time once again to renew investments in Japanese equities.

In China, economic growth has slowed to some 6.8% a year, better than had been expected. Although Chinese national debt is high, most has been taken up by the private sector. This could bring problems to a very large secondary finance sector, but Chinese industry seems strong and has many opportunities.

A relatively new sector for investors lies in the Frontier Markets. These are countries which are smaller than even the emerging markets but have economic potential. The risks, both political and economic are higher and it takes a great deal of careful analysis in order to understand and manage the resulting risks. Potential rewards are however high for skilled analysts. It won’t be long before unskilled analysts from the big fund managers find their way to this sector and take unacceptable risks. Therefore investors should watch the original skilled analysts and not allow themselves to be seduced by unproven new competition.

To conclude, equity markets are becoming stronger, especially in the United States of America and Northern Europe, with a stronger economic support for the business of large US corporations that are already showing profitability. German companies too are in a strong position. The Equity markets will always fluctuate, nature has no straight lines, nor does investor sentiment, but the trend is important. The fixed income markets should be avoided as much as is possible outside the needs of a diversified balanced investment portfolio, until they show a much greater yield.

 

Unsettled Markets

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John Townsend’s Investment Opinions – Mid June 2016

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

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

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

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

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

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

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

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

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

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

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

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

The Chinese influenza can be catching

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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)