Category Archives: Inflation

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 February 2022

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There are decades when nothing happens and then there are weeks when decades happen. – Vladimir Lenin

The Russian invasion of Ukraine is a human tragedy ordered by an elderly autocrat with no popular support and will result in a great deal of innocent suffering. It is at present unclear how it will evolve, but it is likely to lead to the internal destruction of modern Russia. The events in Ukraine have changed the world, probably irrevocably, but we have seen crises before, and they have been met and mastered. It is important not to lose one’s nerve.

This paper does not set out to minimize the disaster, but rather to recognize the effect that this action will have on my clients’ investments. Clearly however, now is not a time for politicians especially, to be over friendly towards Russia and some political parties, in Europe especially, will lose their popularity. As it is, past pro-Russian politicians are issuing a deafening silence or are running from their erst-while ally.

The investment markets are unemotional when it comes to wars and human suffering. Past experience has shown that the aggression that we have seen since 24th February, as long as it occurs away from the global economic and financial centres, is not necessarily considered a disaster.

The traditional emotional response to international aggression is to react with fear and then sell one’s investments. Indeed, there is an international index known as the VIX, which tracks the expectation of volatility expected by traders in the US S&P index over the forthcoming 30 days. However, this would not necessarily be wise, despite the wish to show solidarity with the people of Ukraine and will hurt only the investors themselves.

And yet… tensions between Russia and Ukraine have heightened over the past weeks and the VIX index has risen sharply. Using the reverse of an old adage, the investment markets have been selling on the rumour and can now be expected to buy on the fact. On Thursday 24th February, the VIX closed at 30, well above its average since 1990 of 19. This is a sharply higher than the level 17 at the start of 2022. As the war progresses and casualties mount, the increasing sanctions against Russia could cause even this level could be exceeded.

The global investment manager Schroders points out that rather than being a time to sell, historically, periods of heightened fear have investors have in the past earned the best returns. To quote Schroders “On average, the S&P 500 has generated an average 12-month return of over 15% if the VIX was between 28.7 and 33.5, and more than 26% if it breached 33.5.”

Europe, which was just beginning to regain its economic composure after the Omicron/Covid pandemic is likely to suffer some weakness and a delay in its recovery in the next 2-3 months. However, once the situation becomes clearer economic growth will resume.

The uncertainty will bring with it a downturn in corporate growth. It is likely that Russia will drive energy costs much higher at least for a while. The big oil companies will drive the price of fuel at the pumps higher without much encouragement. Globally the economic impact will less hard-felt, though the belief in a short period of inflation before a return to normality is now likely to scotched.

The USA is likely to be less effected by events in the Ukraine. Especially as US growth has begun to rebound strongly. Much the same is true for China and the emerging markets, though slower economic growth in the developed world will affect these areas too. The US Federal Reserve, which had signaled aggressive interest rate rises in 2022/3 will probably wish to be more careful. Europe, being closer to the centre of the crisis is unlikely, after all, to want to raise interest rates for the foreseeable future. This will support companies and encourage investment even if it does also encourage continued inflation.

Assuming no warfare creep outside Ukraine, after a period of reflection, perhaps three or four months, the investment markets are likely to return to their pre-crisis trends and activities.  Post-Covid growth in Europe will probably resume; such growth has been held back for too long and is bursting to get out, so growth here could be quite strong.

The attack on Ukraine is likely to leave Russia itself badly scarred. Economic sanctions, as long as these are adhered to by all players in Europe, Asia and the US will prove expensive for the Russian people and could cause dissent there. It is worth remembering that the decision to attack was not a popular one, the Russian people were not consulted and have only to pay the price in terms of dead soldiers and economic shortages.

In the long term, again barring a military spillover from the present warfare there is unlikely to be an impact on European economies. Russian teams have become expert at Cyber-attacks on the West, whether companies or governments. It would be a surprise if these were not increased in the near future. The clear message will be the need to diversify away from a dependence on anything Russian, especially energy. This will further encourage the growth of renewable energy as well as nuclear power stations. US natural gas, delivered by sea will probably become interesting again especially as the Russians can so readily affect oil and gas prices.

It is possible that Russia will take over the Ukraine and the Russian Kleptocrats against whom personal international sanctions have already been announced, could take over the resources of the Ukrainian raw materials. This would be a major blow to those who sought to westernize the country. The cost to economic growth in Ukraine and possibly Europe will be immense.

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 April 2021

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All I can say is that on this earth there are pestilences and there are victims– and as far as possible one must refuse to be on the side of the pestilence. ― Albert Camus, The Plague

A number of important factors have impacted on investors so far in 2020/21. These will have long lasting effects.

The COVID pandemic, featuring incompetent populist politicians with total policy paralysis thereby carelessly condemning many of their fellow countrymen to unnecessary suffering, is the pressure presently most in the news. In the USA, the era of incompetence, responsibility-shirking and name-calling has come to an end and the new president is proposing serious legislation to help the people and US infrastructure rather than a few party donors. An aggressive political and fiscal policy will help the country achieve a pole position in terms of economic growth.

The world goes on despite the pandemic. People fall ill and die of other ailments or accidents, economies thrive or falter and investors seek to make a return on their capital and continue to take risks they are unable to recognize.

In Britain, the appointment of a competent administrator to take charge of the vaccination program has produced remarkable results with a rapid vaccination programme providing lifesaving coverage. This has however, left unled and directionless politicians to continue their habit of stabbing each other in the back, breaking their word to their own countrymen and to foreigners and the private profiteering from contracts and connections in a depressingly undistinguished way. It is another sign of a malaise that will ultimately drive investment and employment out of the country.

European countries, which have produced world beating engineers, scientists and philosophers have become swamped in a bureaucratic quagmire resulting in a complete lack of syllogism and have therefore been unable to produce dynamic measures to fight the pandemic resulting in countless unnecessary deaths. Too many commentators are now trying to make half thought-out political capital by opining against the advice of scientists and doctors and demanding an immediate relaxation of lifesaving lockdown measures. If one looks hard enough there is always some so called expert or professor, normally from a lesser-known institution who can be quoted who will try to prove whatever opinion slant that one wants. Such idiocies are hard to avoid.

Let us be clear, there will be no freedom from the pandemic, at least in its current form, until everyone in the world, as well as in our own countries, has been vaccinated against it. Individuals should not have the freedom to opt out of a vaccination just because by the fact of others having it, they do not need to. Long term recovery and the reopening of shops, concert halls, sports events and markets depend on the rollout of vaccines now and if necessary, repeatedly in the future. Any complaints at a delay in reopening the economy should be placed at the doors of incompetent bureaucrats and the politicians who hide behind them, not at the municipal leaders who try to keep their people safe.

The initial financial recession in March 2020, which was a result of a reaction to the pandemic, was effectively met and was quickly over thanks to the concerted actions of international central banks who lowered interest rates and made financial liquidity available to companies and private consumers alike in order to limit a collapse in demand as well as industrial supply.

Central banks have accepted the fact that drenching their domestic markets in liquidity will cause inflation.  The level to which inflation will rise cannot presently be measured. In general, 2% is held to be healthy in a normal environment, though the central banks are disingenuous in suggesting that that level should be seen as a long-term average. In the short term, expect inflation to rise to over 5% before beginning to fall back. The inevitable result of very low or negative interest rates will be the formation of financial bubbles. We are already seeing a jump in house prices with purchasers assuming that they can cope with large but low interest rate mortgage loans. The danger, if not the certainty, is that purchases made in this environment will lose value sharply when normal economies and interest rates resume.

While western economies were and are focusing on the pandemic and its effects, it is China, where the first mitigating steps were taken, that is emerging with a strong economy. The Chinese are refocusing on meeting internal demand for investment in consumer durables and consumer discretionary spending while also producing ever more goods for export to the rest of the world.

Economists are undecided as to whether Chinese domestic growth, which to a large extent comes from production growth and wage spending will be 6%, 8% or even 10% in 2021 and will remain at a similar level in 2022. All however agree on the fact that the Chinese economy is booming and that it is providing life and support for the economies in neighbouring countries too, much as the USA did several decades ago. We are truly entering a Chinese dominated Asian era.

In western popular culture this Chinese economic strength causes perceptual problems. China is now seen as a threat to its neighbours. The treatment of its own minorities causes unhappiness in the West. There is a view that China should behave the same way as western countries do now, all the while forgetting that Chinese actions today reflect the way the colonial powers, including the USA, treated their minorities only a few decades ago when western economic growth was taking place. We may not like it, but we cannot deny that we too undertook similar measure to build our economies in the past.

A new global economic cycle has begun. It is radically different to and potentially more fragile than any cycle we have experienced before. It was caused by the severity of the pandemic but is also vulnerable to a reemergence of the virus in a different and unexpected form to which we do not, at present have a solution.

The brakes to the international economic system come from different sources. First of all, there is a shortage of skilled labor where too many people have remained untrained or have been trained in the wrong skills. Producing and service companies cannot meet the new demands made of them. China also has a shortage of high-quality steel. Much is made of the export of Chinese steel at dumping prices, yet the reality is that China desperately needs the quality of steel they cannot at present produce enough of themselves and the country cannot use all the low-grade steel it does produce.

Raw materials too have their shortages. I have often argued that Copper is a bell-weather raw material showing how industrial production in almost every form is performing. Energy too, including the use of wood and bio methane to fuel power stations and homes is in sharp focus. One has also to be aware of the costs of transportation as seen in container shipping rates. The European Union’s Green Deal, which has just been announced, is aimed at reducing Carbon Dioxide production to zero by 2050. 73% of carbon dioxide production is related to the present production of energy, but there are political comprises at play here too. There is an emotional backlash, especially in Germany, to the production of electricity using nuclear facilities. This is still an environmentally efficient source of energy and its use will be accepted by some countries and rejected by others.

The European Union has also imposed a series of sustainability regulations for investment, especially under sections 6, 8 and 9 of the European Eco-Initiative. The political aim is to force the investment sector to become more ecologically aware. Once the fund companies themselves can be prevented from ‘greenwashing’ and mislabeling their funds, this will doubtless have more of an effect. At present it looks like a triumph of hope over reality.

There is no alternative to investing in Asian and US Equity markets, with some excellent European Assets thrown in for good measure. Still, it is absolutely essential to have a very broad distribution of assets in case a new version of the pandemic strikes home. There is little to be gained in having fixed income investments, other than to provide a source of stability to a portfolio; they yield very little without the investor having to take unnecessary risks. Funds investing in convertible bond issues can be a valuable source of distributing risk. Cryptocurrencies are a disaster looking for somewhere to happen and while presently fashionable, are best left to ambitious school and university students who have yet to learn what it means to face unnecessary and unexpected losses.

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)