Investment Newsletter January 2016
Media, Myths & Markets Mike Deverell Partner & Investment Manager
Markets remain particularly volatile and very sensitive to any bad news. As we have noted several times, volatility is unfortunately a fact of life in the stockmarket. Our long term assumed return from equities is around 10% pa but that is just an average. When we have analysed the data in more detail, we have found periods where the returns from the stockmarket have been almost 20% pa over a five year period. There have also been periods where the market has been down almost 5% pa over five years on average. More than that, a 10% correction in markets happens virtually every year, and a 20% fall happens around every 4.8 years on average. Our long term 10% assumption takes into account all these drawdowns including true bear markets.
Of course, we invest in a wide range of assets not just equities, some of which have made some very good returns of late. As well as smoothing out volatility through diversification, our job is also to try and work out whether market dips are one of these short term corrections or something more major and adapt portfolios accordingly. True bear markets usually occur for two reasons. Either stocks have been in a speculative bubble where valuations are far disconnected from reality, such as in the tech crash from 2000 onwards, or we are entering a recession. We certainly don’t think markets were in bubble territory, although they perhaps became a bit overvalued. Meanwhile, the data does not currently point to a recession with the global economy steady despite a slowdown in emerging markets. The US and UK economies in particular are still well in expansion.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA 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 January 2016
Gold
We have developed a number of “crash test” indicators to help us make up our minds. Right now four of the ten indicators are green, two are amber, and four are red. That indicates some level of stress but not a full blown bear market in our view.
One other way of looking at stresses in the system is to look at the gold price. Below, our investment analyst, Neal Foundly, considers this in more detail…
When economies are booming, people buy gold jewellery and this pushes up the price. In all, jewellery accounts for around 60% of gold demand. Witness the incredible surge in economic growth in China, especially in the decade from 2000 – 2010 when the economy was not only very large but growing very rapidly; gold demand boomed (as the chart below shows).
However, sometimes things are neither good nor bad, just sort of OK. At these times, gold does not fare so well, it falls and loses value against inflation. Other investments offer more attractive returns and the euphoria that surrounded the high gold price during the Good Times simply disappears.
Demand per head of population in China more than tripled over the decade and, correspondingly, the price (the line) tripled too. China was not alone. India accounts for 32% of gold demand, with half of the gold Indians buy spent on jewellery for the 10 million weddings held each year. According to Fortune magazine, the average cost of an Indian wedding is $65,000 with 500 guests and involves 30 to 40 grams of gold (with richer households averaging several kilos of gold at a ceremony).
During the last boom – the first 10 years of the 2000’s described above - some people were desperate to buy gold with prices bid up and dealers keen to get hold of stock. In the Middle East, where retail demand was very strong they even had ATM machines that you could put your credit card in and take out mini-ingots. Here is a photo I took of such a machine at Abu Dhabi airport two years ago – it was out of order and nobody cared. The boom was over:
There is another circumstance when gold is in high demand and the price rises sharply - when the financial markets think we are all going to ‘hell in a handbasket’. Acute distress and risk aversion in asset markets means that confidence becomes shattered and investors are more concerned in the return of their capital rather than any return on capital. It’s a time of hard hats, guns, baked beans and your wealth in gold. There were plenty of commentators during the Credit Crisis who were saying that it was the end of capitalism and that you should take your money out of any bank. In these circumstances, gold’s value as a store of wealth is reflected in significantly higher gold prices.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA 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 January 2016
Gold Rush?
Caution but calm
So, where are we now? Markets are down, we are told that this has been the worst start to a calendar year for a century for equity markets. The headlines are telling us that this could be the Big One. Royal Bank of Scotland is warning of a ‘cataclysmic’ year and Albert Edwards, the Societe Generale strategist, last week told a packed hall that we are heading for “global deflation and recession….
the coming carnage is an indirect result of the failure of the Federal Reserve’s quantitative easing”. Heady stuff. So, does our extreme boom/bust indicator, the gold price, agree? No, it does not. Below is the gold price chart for the last three years. The ‘distress’ in early 2016 is well within normal volatility:
Right now, the gold price is categorically saying there is no need to panic. This doesn’t mean we are not being cautious and are focusing just as much on the risks to your portfolios as the potential returns, as we always do. This focus on risk is one of the major principles behind our approach which is designed to smooth out equity volatility as much as possible by investing in a broad range of assets. Property and alternative equity have carried on making some excellent returns which has offset equity losses, and as a result a typical balanced portfolio remains just about positive over 12 months. A zero return is not great but we should put it in context of a 10% fall in the FTSE in price terms (7.4% if you include dividends). We don’t need stockmarkets to bounce much for that zero to turn into a fairly strong positive annual return. Meanwhile, the current turmoil presents opportunities for our fund managers to take advantage of.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA 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 January 2016
General Economic Overview The problems in commodity producing countries and companies continue, exacerbated by the strong dollar. However, outside of resources and the emerging markets that produce them, the world economy remains steady with growth remaining positive. The US and UK continue to be the strongest nations. With falling commodity prices and with China’s currency weakening, deflationary pressures remain. It seems unlikely that the Bank of England will increase interest rates this year. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Our score has increased from -1 last month to 0 this month. Whilst equity markets have been relatively flat over the month we feel the recent dip in markets has been driven by sector risk, specifically energy and resources, and by sentiment that is perhaps not justified by fundamentals. We are currently more focused on active funds and continue to prefer Japan and smaller companies in the UK.
=
Fixed Interest Our score has increased from -3 last month to -2 this month. Whilst the yield on our portfolio is attractive, and the likelihood of imminent further US rate rises has reduced, there are certainly risks that must be acknowledged. Default rates in the US are creeping up, particularly in the bonds of energy and resources companies.
-2
Commercial Property Our score has remained at -2 from last month. Commercial property returns are continuing to slow but they are still providing a steady, positive return. Property continues to provide attractive diversification to equities and bonds.
-2
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest and neutral property. We are slightly overweight equity and also have additional holdings in defined returns and alternative equity.
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, 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. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. 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. Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA 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.