Investment Newsletter February 2013
An inflated opinion The Bank of England’s latest inflation report finally admits what we’ve been concerned about for some time. Inflation continues to be worryingly persistent and will remain high for the forseeable future. Each time the Bank reports on inflation they provide a “fan chart” showing a predicted range with the expected probability of each part of the range. The chart below shows the predictions from February 2012:
Essentially, the “fan” is divided into bands. Each band has a 10% likelihood. The darkest red is the central prediction, that which is deemed most likely. The actual inflation is expected to be within the predicted range 90% of the time. The Bank’s central prediction for current CPI from this time last year, was around 1.7%. It is actually 2.7%. This is out by around 60%. They have persistently predicted lower inflation than has actually been the case. The latest report shows a markedly different picture:
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission
Investment Newsletter | February 2013
Inflation (as measured by CPI) is now predicted to remain above the Bank’s 2% target until at least 2015. It could be as high at 5%, or as low as 0%! The previous prediction was between -1% and 4%, so effectively they have pushed the entire range up by 1%. Inflation is a big danger for investors, particularly in the lower risk parts of the portfolio. Cash and fixed interest securities are particularly vulnerable. Equities provide some protection as, should prices rise, so to do company earnings where those price rises can be passed on to consumers. At the same time, interest rates on cash are coming down and bond yields hover near record lows. We have many clients who have cash coming to the end of previously acceptable fixed rates, and who are therefore finding that there is no point renewing those deals. According to Moneyfacts, the best three year fixed rate deposit is now 2.6%, below CPI inflation at 2.7% and far below RPI at 3.3%. Based on RPI, tying your money up for three years gives you a real rate of return of MINUS 0.7% pa if you are a non taxpayer. For a basic rate taxpayer, this is -1.22%. You are losing more than 1% of your money in real terms and have given up access to it for three years. We have recently adjusted our core portfolios to buy more inflation linked bonds. We will be watching carefully and ready to make more adjustments as necessary. We have also just launched a new, lower risk “defensive” portfolio, designed with the aim of beating cash and inflation. Many clients are finding this an attractive alternative to poorly performing cash rates.
Markets In last month’s newsletter we wrote about equity markets and explained that the FTSE had hit, and gone beyond, 6,100. This is clearly good news for portfolios and has pushed values upwards. Markets continued to move even higher and the FTSE closed at 6,347 on 1 February. That is an increase of around 7.5% compared to where the market was on 31 December. Whilst we are very pleased to see the market rise we have become slightly concerned that things have moved a little too far, a little too fast. We remain very positive on equities taking a medium term view. Valuations still look quite attractive based on predicted earnings growth. However, the valuation argument is less compelling than it was.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission
Investment Newsletter | February 2013
Also in our previous newsletter, we explained that in our ideal cautious portfolios, we had reduced equity by 3%. We felt this was the right thing to do despite our optimism, as cautious investors are most likely to be uncomfortable if the market dropped back. After the further increase in market levels we decided to reduce equities by another 2% for cautious portfolios (making 5% in total), and by 3% for balanced portfolios. For adventurous and speculative portfolios, we have not reduced equity exposure as these investors are generally more content to ride out market turbulence.
We remain overweight equities – in other words we are holding more equities than we would if everything was “normal” – but less so than we have been for some time. If the US budget talks run into trouble, or if elections in Italy cause more uncertainty, we could see markets drop back. We think it is entirely possible we see 6,000 again before we see 6,600. If this happens, we believe it would be a buying opportunity.
Mike Deverell
Investment Manager
Equilibrium Asset Management LLP Brooke Court Lower Meadow Road Handforth Dean Wilmslow Cheshire SK9 3ND United Kingdom Visit us at www.eqasset.co.uk t : +44 (0)161 486 2250 f : +44 (0)161 488 4598 e : askus@eqasset.co.uk Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission
Market Views | February 2013
General Economic Overview The global economy has generally picked up, with emerging markets and the US growing relatively strongly. Challenges remain, particularly in Europe and the UK. We believe the UK will avoid a triple dip recession. Inflation remains high and is unlikely to fall back any time soon. Interest rates are unlikely to rise for some time, and more quantitative easing is possible in the UK.
Asset class key + positive - negative = neutral (normal behaviour)
+5 -5
strongly positive strongly negative
Equity Markets We remain positive taking an 18 month view, based on company valuations. After a fantastic run, we have reduced our score and have typically banked some gains in portfolios. Fixed Interest After a strong run in corporate bonds we believe returns will tail off. We are avoiding conventional Gilts whose values have been inflated. We are diversifying into inflation linked bonds.
Outlook
+1 -2
Commercial Property Commercial property prices have been falling over the past 12 months or so but this appears to have slowed. The rental yield remains potentially attractive and if the economy picks up we may look to re-enter this asset class. We have upgraded our score from a -5 to a -3.
-3
Residential Property
-5
We believe prices are likely to remain largely flat over 18 months. Cash With interest rates remaining at record lows, returns on cash could remain below average for some time. Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and cash, neutral fixed interest and hold no property. A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.
These represent Equilibrium’s collective views. There are no guarantees. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.
-5