John Townsend’s Investment Opinions September 2022

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)