John Townsend’s Investment Opinions February 2017

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.