Investment opinions August 2013

Even if you fall on your face, you are still moving forward. Victor Kiam (1926-2001) US Entrepreneur

The global investment markets received a severe shock in May and June this year. All four of the normal investment sectors, equities, bonds, commodities and currencies fell sharply, leaving no room for investment managers to switch their emphasis from one sector to another. This also had a direct impact on the geographical investment centers, resulting in the fact that no one sector was able to help compensate for the losses of another.

There were for instance, market corrections of up to 10% in emerging market equities, something all too usual in the sector. The 2013 falls were due largely to a fear that the Chinese economy was showing reduced growth. Economic figures from China in July have shown this is not actually the case, but a nervous market believed the story before waiting for anything as mundane as facts.

Equities and bonds denominated in local currencies suffered too as jittery investors spurned the currency risk and flocked to the US Dollar again.

There was no real reason for this decline; it was the nervous traders in an otherwise lackluster market again. Interestingly, the experienced managers waited for the declines to finish before buying the cheap assets and July saw an immediate improvement and strong growth in the value of investments will probably continue in a positive manner and global investors will start refreshed from their summer holidays in September.

The European Central bank and the Bank of England have both made it clear that they plan to hold interest rates low for some considerable time to come. The US Federal Reserve, presumably because it is concerned about the dangers of disinflation, is also likely to continue its bond buying policy amounting to 85 Billion Dollars a month without any major changes for many months to come.

In Germany, negative real interest rates should be the source of great unhappiness. The German people are giving away their money without a whimper. The statistics issued by the German Bundesbank however show that there is no noticeable redistribution of investments away from government bonds. German institutions and private investors seem to be extraordinarily long suffering despite the real losses they have to accept. Perhaps it’s because they are not being asked. In such circumstances how can one therefore say no? German savers have been used to a system which has encouraged ‘safe ‘savings in government bonds. Now those savings are no longer safe, or at least no longer logical and yet the savers, whether institutional or private, have a resistance to investing in equities. This probably explains why the majority of shares in DAX companies are in fact owned by foreigners.

A new term has quickly established itself in the investment world, ‘financial repression’. It is any one or more of the measures that governments use to ensure that money is channeled from the investment markets to national coffers. Financial repression is especially useful at reducing government debt by way of inflation and devaluation. The measures used include keeping interest rates low, including national debt and bank deposit rates.

Governments then keep a tight control over the banks in their sphere of influence and prevent competition between them. Banks are required to have high capital reserves, which as a consequence reduces their willingness to extend loans. Banks are however being criticized for not lending to companies and consumers, though such complaints are largely for show. Keeping interest rates low would normally help to reduce the value of the currency against currencies of other countries which have higher interest rates, thereby reducing the value of the national debt which has to be repaid. This worked extremely well for the United States for many years after the second world war, but now most major countries have low interest rates, so the advantages are to a large extent lost, meaning that other means of Financial Repression have to be used.

The United States and China have both shown encouraging signs of economic growth. Where commentators had sought publicity by forecasting doom and despondency, economic growth is resuming with an expected beneficial effect on those economies trading with the big economic powers.

At a time of restructuring, especially in China and with Japan only just beginning its economic resurgence, raw material prices, including mining stocks have fallen back. US banks, especially those given a clean bill of health by the US authorities, are now showing signs of profitability again and their stocks can be taken back into conservative investment portfolios. The same is sadly not true of European banks where there is still much work to be done, especially by the regulators.

The former darling of the investment markets, the BRIC sector (Brazil, Russia, India and China) seems to have fallen apart. Brazil’s economy is out of control with high inflation, Russia still only has one product sector, oil and gas, oh yes and Russian Railways, but one has to ask the question how independent of the central government any of this is, India is still tainted by corruption and indecision which leaves China as a centrally planned, but potentially very profitable investment area.

The investment markets are trending positively again, it is time to invest in equities with a foundation of well managed mixed funds. There is good money to be lost in the bond markets, especially at a time when risks in the lower level bonds are not being properly rewarded. So-called alternative investments in exotic sectors such as timber and wine collections are dangerous quick fixes where an investor can almost as quickly lose their entire invested amount.