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)

The Tragedy of Greece (Part one)

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The Tragedy of Greece (Part one)

It seems that the Greek tragedy is coming to a head. The word tragedy itself has different sources, ranging from Aristotle who suggested it came from an ancient Greek hymn sung in honor of Dionysus the god of wine, where the chorus of satyrs was referred to as the song of goats. Jane Ellen Harrison suggested the term came from the ode to the fermentation of barley (or spelt) for beer, and was most recently changed to the production of wine as Greece became gentrified. In any event the meaning seems to fit what we are seeing in Athens.

At the same time we are seeing cack-handed negotiation attempts, the politics of the Mafia or of the playground; – ‘if you don’t give me your money then whatever evil arises will be all your fault’-. It cannot be allowed to work.

It is my belief that we are headed -at last- for the correct decision and one which has been long overdue. Greece should leave the Eurozone where it should never have been in the first place. This will indeed be difficult for the Greek people. They elected an inexperienced political party who promised that they would be relieved from the pressures caused by past governmental incompetence and corruption. Despite Mr. Varoufakis’ game theory and Mr. Tsipras’ bluster, the newly elected government was unable to deliver and only served to make matters worse.

The Greek people are to be asked this weekend whether they would like to accept the European offer, with the clear recommendation from the current government that the answer should be no. The reality is that the answer to this referendum will in all likelihood be whether the Greek people wish to stay within the monetary union. One has to assume (or hope) that a pro-Europe vote will also mean the resignation of the present government. A negative vote won’t leave scope for renegotiation; it will simply bring on the Greek exit from the monetary union.

The wealthier Greeks have already moved themselves and their money out of the country; it is only the middle and working classes (in so far as they actually have work) that will bear the brunt of tax increases and cutbacks.

Investment markets do not like uncertainty. Therefore all unusual changes are met with a brief and sometimes hefty sell-off as the inexperienced 16 year old traders (or perhaps the computer generated trading programs) reduce their investment positions. The markets outside Athens will rapidly recover their poise; presumably it was part of the Varoufakis game theory that such volatility would frighten European leaders. Now is however time to increase investment in Equities. There has already been a flight by investors to government, especially German, bonds. This is perhaps understandable as an attempt at a flight to quality. Government bonds however don’t yield anything; their yields are likely to move very soon into negative territory.

The near, middle and long-term investment future lies in Equities. The European markets -outside Greece- have some outstanding profitable companies giving strong returns to investments there. The United States of America is also seeing growth, albeit not as strongly as in Europe. Those investors capable of analyzing companies themselves can clearly do so, the rest of us must depend on the skills of the many, very efficient fund managers and their companies.

Recommendations:
1. Don’t allow the Greek government to unsettle you. Other markets are strong and should bounce back quickly.
2. Now is the time to invest in Equities, especially in Europe and (more carefully) in the US.
3. Avoid the fixed income bond markets; they will sell off as quickly as they rose. Remember a 10 year German Government bond will lose 7% in its price for every 1% increase in yield.

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)

April – 2015

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April 2015

Of all religions, the Christian should of course inspire the most tolerance, but until now Christians have been the most intolerant of all men. – Voltaire

2015 has so far seen a number of important events. The main Equity markets have seen an increase in value in the first three months of 2015 which could in the past have been seen as good for the whole of a year. There are a number of real or imagined reasons for this.

Firstly, the fact that the equity markets were weaker than expected or necessary in 2014 meant there was much catching up to do. The pendulum had gone too far and has now swung back. The question is how far it will go before the present swing ends and the pendulum returns?

Secondly, the policy of the main central banks has been to reduce official interest rates to or near zero. The USA, with the Federal Reserve Bank now under new management, feels the support has gone far enough and has signaled the end of their low interest rate policies. Europe perhaps unsurprisingly, has only now started their market purchases of investment bonds, the decision having been delayed, in the best European tradition, by arguments over detail. The sharp but continuing increase in the value of the US Dollar against the Euro has suddenly come to an end. This is a very good reason not to gamble on currency values within a portfolio. ‘Worldfirst’ printed an interesting statistic that the amount lost by Apple Corporation in currency valuations in the last quarter of 2014 was more than the entire worth of Google.

Thirdly, the risk of inflation had, for a while at least been removed; this brought an air of complacency to investors, but the risk is now returning, as it becomes obvious that there is too much liquidity which is not being absorbed.

Fourthly, the price of crude oil has halved since the beginning of the year, which has helped energy consuming countries, but has proved painful for the smaller energy producers.

What is also interesting, (as shown by figures published by M&G) is that when the European inflation figures are analyzed, consumers are rational in estimating that inflation over the past 10 years, as felt by them, has been higher than the official figures suggest. Prices of purchases that are needed, such as food, electricity, transport and water have increased strongly over the time period, while non-essentials such as mobile telephones, household appliances and televisions have fallen in price. The implication is that the official reduction in the inflation rates and energy costs may not be the boost to growth that the press is expecting.

Russia, or the new soviet style power block centered on Moscow, is less vulnerable to low oil prices than the press suggest, even though the cash flowing into the country from oil and gas prices is now sharply reduced. That said, Russia has very few independent companies and the risks of the Russian markets are, in my view, unacceptably high. The low energy prices are unlikely to last much longer, though where the balance will be found is uncertain. It is a relief perhaps that Britain is reaching the end of its North Sea oil reserves.

Even today, the Russian fleet, such as it is, in the Bay of Sevastopol in Crimea shows signs of decay. The ships date back to the Soviet-era and many should, in any other navy, be destined for the scrap heap. But appearances can be deceptive. The fleet, its base, and the sprawling military infrastructure that go with it, are vital to Russian President Vladimir Putin’s military and geopolitical ambitions and one of the main reasons the Kremlin has grabbed complete control of Crimea.

Also, the fleet will soon be restocked with billions of dollars’ worth of hardware. Jane’s Navy International, reports that six new submarines and six new frigates are scheduled for delivery in the near future. Russia, it seems, wants to be able to afford them.

Finally, the Greek elections have brought in a leftist party which ran on the promise of renegotiating the rescue package which had been causing strong domestic discomfort for the past two years. Election promises are all too often forgotten once a party gains power. I expect the Greek demands to be watered down, before the rest of Europe sends the Country back to the Drachma and economic isolation.

In fact such isolation may not be so bad, except that there is a fear that Italy and Spain will also discover a need to renegotiate their economic position within the Euro Area. Besides which Greece is an economic pygmy and the press excitement gives it more weight than it actually deserves.

Where does this leave investors? Low or negative interest rates and inflation mean that investing in bonds or indeed keeping money on deposit will produce negative returns. There is no sensible alternative to investing in equities, though only with fund managers who have proved their worth over several years. The glut of money going into the investment markets has inevitably led to a number of dubious schemes. Investors should beware of advertisements featuring celebrities whose only ability is, seemingly, to receive fees from PR Agencies.

For those whose stomachs are not strong enough for pure equities, there are a number of mixed funds (Mischfonds) that can be subdivided into defensive, balanced and dynamic. Again some of these funds have been managed by the same capable managers for many years and are well worth considering in a well-diversified and balanced portfolio.

Don’t be afraid of the markets. They offer opportunities now that have not been available for over 10 years. These opportunities should be grasped firmly.

Conclusions:

1. The rise in Equity market prices is probably not yet over and there are, for those willing to consider these markets, still profitable opportunities.

2. Currency movements, whether against the US Dollar or any other major (or minor) currency makes such plays dangerous. Unless an investor
absolutely wants to gamble in the currency markets, such investments are to be avoided.

3. Always invest with a diverse group of fund managers each with their own proven strategies. Investors should ensure that their advisers are aware of the risks they are suggesting and that they seek to reduce them as far as possible.

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- October 2013

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John Townsend’ Investment Opinions – October 2013

The reason we are so pleased to find out other people’s secrets is that it distracts public attention from our own. ¬- Oscar Wilde 1854-1900 British dramatist and Poet

The last month has seen much excitement over the American NSA’s collection of electronic communication between everyone else, including those who regarded themselves as friends of the Americans.

Looking back over time, it becomes clear that these complaints are hypocritical. Every country needs to know what the leaders and decision makers of other countries are thinking. Traditionally, such information has been garnered from conversations that diplomats held with individuals within government and industry or their counterparties within the foreign departments. The budget cuts that affected the CIA during the Clinton presidency resulted in an increased dependence on electronic information gathering and a reduced reliance on human intelligence (Humint) with a consequent reduction in the ability to interpret the information gathered. The electronic data collection, once started, has grown in ability and scope, to the point where every senior politician and industry leader has to be circumspect about how they communicate. A major issue is whether the scientists developing and using these electronic eavesdropping systems are in fact controlled by anyone at all.

One might be careful about being overheard by the Russians or Chinese, but few people will admit to being concerned about the American collection of military, political, economic or industrial information, especially when the British and French have been so adept at doing the same thing. The eleventh commandment ‘thou shalt not get caught’ springs to mind. Most European countries and indeed those outside Europe gather information about their allies and competitors and very often share it with each other, their own industry and even possibly with the Americans.

In the Eurozone the economic recovery, especially in the southern countries, is agonizingly slow und unstable. In Germany, the economy marches on from strength to strength and it is clear that the polarization within Europe is becoming harder to disguise. Low interest rates and a weak Euro helps German exports outside the Eurozone, even if exports to the Mediterranean countries with weak economies are reducing.

The European Commission is forecasting growth in Europe in 2014 after two years of contraction. But the numbers are feeble. Remember this is for Europe as a whole and while German economic growth will be stronger it means that other countries will fall below the average figure.

There are some dismal projections for the labour market too, with the average unemployment rate for 2014 being about the same as it is now at around 12%. These jobless forecasts – if they turn out to be right and that is a big assumption – show some improvement in some of the crisis countries, notably Greece, Ireland and Spain. Unemployment levels however, will remain high and there is little or no improvement forecast for Italy or France.

In China, the communist party will hold the third plenum of the 18th Central Committee in the middle of November. Past third plenums have produced major policy changes. In this case, it is likely that the Chinese leaders will suggest major reforms based on the ‘383 plan’ circulated by the government some time ago and which proposed a reform of the Chinese economy by 2020. In a recent ‘Data Flash’, Deutsche Bank suggested that China will reduce investment restrictions for private investors in key industries. China will also increase its openness by allowing foreign investors access to most service industries. Additionally the state owned enterprises and municipalities will have direct access to the stock and bond markets. The economy has already begun the swing from an infrastructure investment led growth model to a consumer demand pushed economy. This has a much better future, even with some near term weakness and the central committee is likely to encourage this move. On the other hand, it is likely that many more opportunist private banks will spring up. Corporate governance in China has not reached the levels one might hope for or expect in other countries and these banks could easily be a major source of losses. They are well worth avoiding.

In the United States of America, the profit announcements of many major companies are serving to generate positive surprises to investors. As a result, the prices of equities in the market as a whole have risen strongly. Not every company is producing increased profits; indeed some companies are showing no profits at all. So it is a wise choice to select experienced fund managers who have the benefit of competent research departments to select the most potentially profitable companies in which to invest.

The US equity market has seen interesting growth over the past 4 years and some commentators suggest the end of the rally must therefore be close. In reality, there is still room for growth in the market as corporate profitability and growth, combined with sharply reduced leverage and inventory lead to higher equity prices.

Many conservative investors, both institutional and private, believe they are safe by keeping their money on deposit with their banks. In reality they are burning their investments as the yields on government debt fall below the rate of inflation. The question is what should replace government bonds? On the fixed income market corporate debt from companies with high credit ratings have become popular to the point where their yields are very close to the levels of their own governments. Highly rated emerging market bonds, though not debt in local currency, carry a higher yield though there is an inherent credit and indeed market risk, where investors might find it hard to sell the paper in adverse market conditions. The best yields are still to be found in good quality corporate equities, while gold, fine art and real estate are too speculative and presently very expensive and potentially illiquid.

Changing markets require changes in traditional thinking and investment philosophy. The investment decisions taken when investing in corporate equities are much the same as investing in corporate debt from the same company. The yields are however higher and a competent fund manager should be able to maximize the returns while minimizing the risk.

Changing times require changing approaches. The strategies that worked in the past are now potentially loss-making and will remain so for many years to come.

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
www.insure-invest.de

Investment Opinions September 2013

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Oh Dear, is there a world outside Washington DC?

Balancing the budget is like going to heaven. Everybody wants to do it, but nobody wants to do what you have to do to get there. – Phil Gramm Economist and Politician, Chairman of the US senate banking committee, in a television interview 1990

The leading 20 economic nations of the world, as well as a few hangers on from elsewhere assembled in St Petersburg a week or so ago for the annual G20 meeting.
G20 meetings are usually fairly useless affairs with one party attempting to get some form of ratification on an issue, while the other members seem happy to chat amongst themselves. The one in St Petersburg was governed by the situation in Syria. Pressures on oil and gold prices will depend on how aggressive the rhetoric between the US, Russia and China becomes over the prospects of intervention.

In the USA, the Government will reach their borrowing limit and begin to shut down non-essential services on 1st October. The Republican party, not bothering to hide their ferocious distaste for President Obama, are trying to hold the Democratic led government to ransom by demanding a 12 month moratorium on health spending for poor people, a measure which was passed in 2010 and is part of president Obama’s election promises. The effect on the US equity markets will probably be negligible; American companies are still showing high profit levels and the equity prices of those paying dividends based on profitability will continue to increase and be thoroughly sound investments. In the meantime Congress as currently constituted will merely display its irrelevance before the next mid-term election. It depends on how long the shut-down lasts.

The Republicans in Congress have not learned their lesson from the ‘fiscal cliff’ crisis at the end of 2012 and their rabid willingness to see the United States drop off the cliff can only be described as suicidal.

It is perhaps no wonder that in recent polls the Republicans scored lower than 10% in the Gallup approval ratings, lower that the potential approval for a communist regime to control the US, lower indeed than the popularity ratings for odious insects such as head lice and cockroaches.

The policy objections have nothing to do with what is good for the country; far more whatever is being put forward is by definition being opposed. The tea party wing of the republicans never actually looked like having a winning strategy to anyone but themselves. There are worrying signs that the fiscal cliff, the borrowing limit set by congress for the US government will bite hard by late October or early November.

The threatened tapering or reduction in the monthly 85 Billion US dollar bond purchases did not materialize. Dr. Bernanke suggested that an improvement in the unemployment statistics would allow such a move, but worse than expected figures for new house purchases showed the true weakness of the economy and put the end of the program on hold.

In the world at large much has happened, but little that will have a dramatic effect on the investment markets.

1. The Angela Merkel led union won the general election in Germany with an increased share of the total vote. This was 5 votes short of giving the union a working majority, so a coalition partner will have to be found, resulting in inevitable policy compromises as a price for being allowed to rule. The effect on investors is negligible, as most parties will in the end wish to follow the path of stability and no-one at present wants a coalition with the ‘Linke’ or former communists.
2. In the Emerging markets, especially China, the situation is unsteady. China, on the face of it, has a slowing growth rate, down from 8.0% to 7.5%. This disguises the fact that the Chinese economy is changing from one based on investment in infrastructure to one which is actually much healthier and is based on rising consumer demand. India has the same corruption based problems as before and Indonesia has burst its speculative bubble. This can be financed as long as there is cheap liquidity released by the United States’ Federal Reserve looking for a profitable home but this won’t last forever.
3. Other Asian countries including Indonesia and even Turkey are looking worryingly weak at present, with large trade deficits. If US tapering were indeed to bite, these countries could only refinance themselves at a very much higher cost, resulting in sharply falling economic prospects and the risk of having their bonds shunned by investors.
4. The use of chemical weapons against civilians in Syria and the response from the west has resulted in investors becoming more risk averse in their investments in the emerging markets as a whole. It is unclear which faction in Syria actually used chemical weapons. The government side has several strongmen only nominally under the control of President Assad. He can therefore deny having used these weapons, while forgetting to mention that others in his camp could easily have used them. T seems unlikely that the US will need to attack Syria by itself (which must be a relief for president Obama). The line in the sand has been replaced by vague threats and mutterings, with American dignity having been preserved.

Once again investors are taking fright. It is uncomfortable, but when one isn’t sure what to do next and can see no alternative anyway, it seems a reasonable choice to simply freeze with fear.

Japan seems to be emerging from 25 years of wasted time due to political dithering. From a once proud economic powerhouse, the country which is now and at last under the control of Mr. Abe and a firm and courageous government, is trying to leave low growth and deflation behind. There is so much potential in Japan, yet the first shoots of green do not make a spring and investors would do well to wait and see. There are few prizes for being first in this particular field.

In Europe it’s clear that, at a time when capital is once again fleeing emerging markets and negative sentiment has the upper hand; many investors see this as a fitting opportunity to review their allocation to emerging markets and to Asia in particular.

However, as a European investor, I believe that, in line with the management of many of the most successful European companies, investors should use market corrections to review current investments and make sure that they are invested in the best growth opportunities in the Asian economies. The longer and deeper the correction, the more attractive opportunities and good value will open up in many markets. At this point in time, the challenges may have grown but Asia has the ability to offer good longer-term returns as the “taper tantrums” subside and the direction of policy globally becomes clearer later this year.

Blackmail seems to be in vogue at present. The former Prime Minister of Italy, Silvio Berlusconi, is trying to avoid the consequences of having been convicted of tax fraud and as a convicted criminal being thrown out of the Italian senate. At first he threatened the existing government with being toppled if they did not somehow allow him to keep his seat. (After all as we have already seen, Mr. Berlusconi is convinced the rules applying to mere mortals do not apply to him).

European economies seem to be beginning an unsteady and unequal recovery. Unequal because the northern states such as Germany are performing strongly, the olive oil countries are much weaker, though Greece for instance has recently reported much stronger tourist inflows this summer.

Conclusion

Assuming investors want to see a profit; they must avoid emotional speculation and stick to investing with those fund managers who have shown they can manage risk.

Equities have strong potential; bonds can be mixed into a portfolio, but only if they provide an efficient mixture of risk and return.

Every market has potential, but it takes an expert to find the gold where other people see only mud.

August 2013 after the (financial) whirlwind

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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.

Taper Tantrums

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For days after death hair and fingernails continue to grow, but phone calls taper off. – Johnny Carson

A new term has entered the vocabulary of investors – tapering.

Ben Bernanke, the president of the Federal Reserve Board of the United States otherwise known as the US Central Bank, suggested in a speech on 19 June 2013 that the time was coming when the United States would reduce the amount of bonds it was buying under the most recent Quantitative Easing scheme (QE 3), before finally ceasing these purchases perhaps at the end of 2014.

The investment markets, like jittery 16 year olds assisted by their computers, panicked and initiated a major sell off of fixed Income debt instruments without understanding the caveats attached to Dr. Bernanke’s statement. This was indeed expected, though the exact timing was unclear. This has been called a ‘Taper Tantrum’ by Michael Hasenstab from Franklin Templeton. Why spoil a good story with facts?

At the same time Chinese economic data announced a relative slowing of growth in the Chinese economy coupled with a tightening of the rules regarding the non-regulated lending sector. All of this was expected, but caused ructions anyway, even though the gradual changes in the Chinese economy from investment-led to consumer demand-led have been clear for a while.

Having started the panic (in truth Dr. Bernanke’s speech came after the Asian markets had begun their decline), Dr. Bernanke’s team made some effort to explain that what he had actually meant was that if unemployment figures in the US allow it, the bond purchase by the Fed would slowly begin to decline. Not only that, but clearly it is too soon for the similar schemes in Europe and indeed in the United Kingdom to be wound down. This is despite the fact that the most recent economic data from Germany and the United Kingdom is broadly positive, even if Southern Europe is still fragile at best.

Economists describe the panic as the markets pricing in the change in US monetary policy well before it actually happens. There is an expectation of higher interest rates in the USA which will reverse the capital outflows to the Emerging Markets and indeed to the high yield end of the debt markets.

Let’s get our retaliation in first.

The economies most likely to suffer are those that have large current account deficits and are therefore most dependent on offshore investment from sources of ‘hot money’. For instance, the Ukraine, Turkey, South Africa and India have been badly hit. In addition companies are more likely than governments to suffer from a tightening of liquidity. Corporate borrowers (according to the Economist intelligence Unit) are likely to roll over their debt more frequently than governments.

A shortage of liquidity will cause much higher costs and companies which have become used to spending and borrowing will have to return to the old days of abstinence. Not only that, but the available money will only be available for much shorter maturities than in the past. Governments that are facing social unrest will also find that sources of new debt are drying up. All this is due to happen in the future, but that is not (in the eyes of a panicky market ) an excuse for not pressing the panic button now.

The emerging markets, both governments and companies, are potentially very valuable areas in which to invest and should form part of all but the most conservative portfolios. It is however essential to select the best managers with professional research teams in order to make best use of the risks.

In China (so reports Professor Xiaozu Wang in the South China Morning Post) the fears of a curb on bank lending should in fact be seen as a shortage of equity financing to meet the demand for capital.

Chinese banks ran out of money last week. They had to scramble to find funds to meet their regulatory liquidity requirements and borrowing rates for overnight money briefly exceeded 30%. This also sent shock waves around the world, focusing attention on the health of Chinese banks and bringing calls for controls on Chinese bank credit.

The reality of life is that Chinese Banks had mismanaged their liquidity and their lack of belief in the central bank’s determination to control lending. Just as in the West, banks’ dynamic lending came about because it was tolerated. Chinese corporate growth has been faster than the ability of those companies to expand their capital base, leaving them with the easy option of increasing their debt. This works well as long as the banks can lend and then continually refinance the funding for their loans. While there is no loan crisis in China, the banks have growing non-performing loan positions on their balance sheets. This is acceptable at present, but a sudden forced reduction in lending would immediately affect investment in productive enterprises and be detrimental to future growth.

The Chinese government has not yet made equity financing a priority. This will have to come eventually as corporate growth continues and debt becomes more expensive.

In the meantime the US and European markets, seeing that the Chinese economic growth data had shown a slight decline to some 7.5% a year, decided that the boom times in China were over. It is easy to make such assumptions from the financial dealing desks of London and New York, but the reality is that the Chinese economy is moving away from being principally driven by large scale investment projects to a domestic consumer demand driven (and therefore more stable) system.

There is a lot of growth still to be seen in China and a lot of investment too; it will come from increasingly different sources than in the past, something that dealing room traders who are not even sure where China is will have to follow after it has happened.

Finally, we are seeing a new era of volatility, which is causing uncertainty, something that investors hate. The investment markets have over-reacted to this uncertainty by heading for the hills. Like a pendulum, the trend will return to where it started.

Company debt, especially that of the foremost profitable companies operating in the international markets, still makes a sound investment. Much the same thing can be said about the equity of these companies; the correlation between the two is very close whereas the yield on equity is normally higher.

Those who are not afraid of the present markets and believe in the future, will profit from the present uncertainty.

League of Nations Mark 2.0

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The League of Nations is very well when the sparrows shout, but no good at all when eagles fall out. – Benito Mussolini, Italian Dictator

The first League of Nations was set up after the First World War with the aim of ensuring world peace through collective security and the settling of international disputes through negotiation and arbitration. At its peak it had 58 members but it utterly failed in its task, was unable to do more than hold conferences and refused to impose sanctions which didn’t suit its senior member states. Ultimately it was unable to prevent the Second World War.

The European Union is still growing in size, but is also incapable of take any binding decisions. The needs and interests of its member states are too diverse; what suits Germany and its beliefs, whether economic, financial or diplomatic, all too often does not suit members of the southern bloc. No decisions are taken, no economic growth can occur, no direction can be decided upon or followed.
Europe, when judged by Europe-wide economic and social statistics, shows a poor picture. In fact the northern bloc is not doing badly, for that the southern bloc is doing far worse than even the most pessimistic reports suggest. Unemployment in Spain and Greece is catastrophic and getting worse, the Italian economy is a mess.

What does all this prove?

Probably nothing. But there is a long held habit of becoming infatuated with short term data and over-reacting to it as if it were marking the onset of the next phase in a double, triple, or quadruple dip. If any panic measures are ever decided upon, they are generally meaningless.
European governments, now infamous for their absolute inability to take any decisions worth talking about, are calling for greater regulation of the capital markets, forgetting all the while that these markets are already highly regulated. The politicians, mainly so that they can play to their own galleries, are demanding that banks and financial institutions should be even more regulated than they are now.

The reality is that the shadow financial sector is almost completely unregulated. To be clear, this sector includes investment banks, hedge funds, money market funds and Structured Investment Vehicles, which borrow money in large size from the international money markets in order to invest it in longer term securities which may suddenly become anything other than secure. It was the problems these vehicles faced in 2008 and the losses the banking sector faced from their loans to them that largely caused the economic disaster of 2008.
In Europe, we do not need Special Investment Vehicles to cause us nightmares; these come all by themselves through political lethargy, inaction and incompetence.

Dr. John Hulsman, a former CIA adviser, suggests there are four factors which are leading to what he calls a ‘terminal decline’ in European fortunes.

1. Donor fatigue on the part of the German public. The German Chancellor Angela Merkel, with an eye firmly on the general election in September is not being open regarding the choices facing the country. Either Germany, which already owns a huge proportion of debt issued by the poorer countries, continues to pay for the deficits of other countries without limit and accept a higher level of inflation or it should end the European project.
2. Italian political fatigue. The present coalition government of left and right is facing ever declining national economic strength. It reflects the belief on the part of the Italian public that all established politicians are part of the same self-serving elite and yet rule by grey technocrats who have little personality has little or no public support.
3. The United Kingdom has European Union fatigue. David Cameron the prime minister has little support from his own party when it comes to Europe and equally little support in Europe when it comes to renegotiating Britain’s place in the EU. The British public has lost faith in the incompetence of the European politicians and the British opposition are, if anything, even more opposed to European membership than the government
4. France has reality fatigue. President Hollande is now utterly unpopular because his election promises misled a public that desperately wanted to be misled and the French political elite fear the slightest hint of structural reform. Nothing will change in France because there is still a widespread belief that austerity and indeed any form of economics are subjects for other people and not for the French. The French people do not want to hear the truth and their politicians are too afraid to tell them.
It is certain that investing in the bonds issued by European governments is potentially disastrous. There are investors who believe that the small additional margin they receive on investments in Spanish or Italian Debt is worth having. Greek debt is already completely owned by the ECB. In reality, these yields are being held artificially low and should in reality be very much higher. Given a change of policy when the northern bloc is no longer willing to subsidize the olive oil states and the ECB can no longer rely on German political and financial support, the prices on debt not already owned by the ECB will collapse.

Against that there are still excellent export driven companies in Europe and elsewhere which make the stock markets very attractive indeed.
I cannot emphasize strongly enough that high quality equities selected by experienced fund managers with a track record of success over several years are the new safe haven for careful investors.

Twisted or Sub-optimal normality

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“We have it, the smoking gun; the evidence, the potential weapon of mass destruction we have been looking for as our pretext of invading Iraq. There’s just one problem – it’s in North Korea.” Jon Stewart, American Comedian

15. March 2013 Today is (or was) Kim Il sung’s birthday. Under his Grandson, as under his son, the birthday of the founder of North Korea, is traditionally an opportunity for celebrating with a show of military might. The fact that North Korea has a strictly limited military might is unknown to its populace, but the bellicose bluster, which has worked well in the past, serves only to unsettle the jittery investors in Japan and the western world, which could in itself be a desirable result.

There is much to be said against any actual decisive action from North Korea. Firstly, there are the several hundred million dollars the Kim family has deposited with Chinese banks in Shanghai which would be at risk and then there is the fact that Kim Jong un enjoys basketball and pizza just as his father enjoyed whisky and he would be unlikely to jeopardize his own existence, let alone his access to such luxuries. Kim Il sung’s birthday will therefore probably pass with a token military gesture from his grandson; enough to make his populace and his elderly generals, believe he has taken decisive action. As long as that is believed in Pyongyang, all will revert to twisted normality.

In China, economic growth figures released today showed a ‘disappointing’ 7.7% (expected 7.9%) in the 4th quarter of 2012 and the global equity markets turned softer. This is illogical as:-
1. any other country growing at 7.7% would be seen to be flourishing and
2. The Peoples bank of China has long held a growth target of 8% as ideal, but a leviathan such as China can lumber between 7.5% and 8.5% growth without diverging from this aim.

The decline in the Chinese and global equity markets must be seen as a buying opportunity.

In the United States the first quarterly results in the current reporting season have emerged. While good, the first results came from banks which are still recovering from past troubles. Their results disappointed the analysts and in the US equity markets, while results can be good, if they are not as good as analysts expected, they are held to be ‘sub-optimal’ (or bad).

Many large companies will present quarterly results in the next days and few weeks. Many will do well, others will disappoint. The point is that a fund manager with above average analytical competence will be able to select the companies with most promise and invest in them.
There are wildly differing opinions as to whether the fixed income markets should be a target for investors. Depending on their need for publicity, some pundits suggest that now is the time to invest in government bonds in large size – others warn of the dangers of inflation and negative yields. It is hard to build a balanced portfolio in unbalanced times and many fund managers have already pumped money into the bond markets, both corporate and state, of the emerging countries. These managers are all too often unaware of the risks that they run in being able to liquidate their investments when markets fall suddenly, as they can and will.

The wiser and more experienced fund managers are presently more likely to be sitting on large cash positions, waiting for adequate investment opportunities to emerge.