Investment Newsletter July 2015
A Broken Record Mike Deverell Investment Manager
In recent newsletters we have been emphasizing the need for caution. Events of the past few weeks illustrate just why we have been doing so!
writing (morning of 13 July) the deal needs ratifying by the Greek and other European parliaments and is far from secure.
When I first sat down to write this the FTSE 100 was at 6,473 (morning of 8 July) having hit a record high of 7,103 on 27 April. That’s a drop of almost 9% in price terms.
So what would the potential impact of Greek default and banking collapse be? On the positive side Greece is only 2% of Europe’s GDP and it is only the 45th largest economy in the world.
Other markets have dropped too, most notably those in Europe. For example Germany’s main Dax Performance Index is down 13.4% from its peak on 10 April (to 8 July). The recurring Greek crisis has become a bit of a broken record and I’m sure you’re all sick of hearing about it by now, but the potential for a default is one of the main reasons for the slide in stocks. Over the weekend there has been an agreement in principal between Greece and its creditors, meaning the markets have rebounded. There was no celebratory plate smashing in Athens however, with the deal far from popular in Greece. At the time of
However, that’s not to say default would not have an impact, especially in Europe. For example, Greece owes Germany directly around 15bn Euros. If that disappeared that would hurt the German balance sheet but given their GDP is around 2,143 bn Euros it would be more than manageable. However, Greece also owes money to organisations like the European Financial Stability fund, European Stability Mechanism and the European Central Bank (ECB) which all are ultimately owned by the member states of the
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 July 2015
A Broken Record
Euro. Adding this liability to the direct debt, Barclays estimates that Greece owes Germany more like 94bn Euros, or 3.3% of GDP.
Greece that had an incentive to do a deal. The chart below shows what Greece owes to each country within the Euro as a percentage of that country’s GDP:
This is not insignificant and shows why it is not just
Total Exposure to Greece as a % of GDP
Source: Barcalys, Zero Hedge
On the positive side, the exposure of the banking sector to Greece is far lower than in 2011. Should we see a Greek banking collapse then it is likely international banks will be ok, even if some European banks may need additional ECB support. Saying that, with the banking system you just never know, as everything is so interconnected and there’s no way of working out exactly who owes what, to whom!
explain more about some of those opportunities later, but there’s also another big market event happening right now, which might be more significant than Greece.
We remain cautious about Europe as we have been for some time, but in the rest of the investment world the recent dip has thrown up some opportunities. We’ll
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 July 2015
Broken China
Over the past few weeks, the bubble in Chinese equities has burst quite spectacularly. Since the Shanghai market peaked in mid-June it has lost around 30 per cent of its value. According to the FT, that has wiped $3.2tn off the value of Chinese stocks, around 13 times the total GDP of Greece and comfortably more than the market capitalisation of the French and Spanish stock markets combined! This is clearly a huge move and a huge amount of money, and this sort of event cannot occur without having a knock on effect to other markets and assets. However, it is worth putting in context. Firstly, I would mention that our China exposure is largely via Hong Kong rather than Shanghai. In past newsletters I have expressed frustration that this means we have not quite captured as much of the past gains as we would like! However, it also means we’ve not had nearly the
level of losses. It is also worth putting in context with performance prior to the recent dip. Over the 12 months to 7 July the Shanghai Composite is still up 100.77% even including the recent drop. In other words, it has doubled over that period. Our Hong Kong based fund (Invesco Perpetual Hong Kong & China) is still up over 13% over the same period. Looking even longer term, the chart below shows both the Invesco fund and the Shanghai index over the past decade. The first point to make is that the returns have been stunning, with Shanghai up 440% and the Invesco fund up 253% over the 10 year period even after the recent dip:
Shanghai Stock Exchange Composite in GB [440.08%] Invesco Perpetual - Hong Kong & China Z Acc in GB** [253.11%]
The second point to make is that this is not the first time that Chinese stocks have had a very steep run up followed by a steep drop. We can see a similar thing happening in 2006 /07 on the chart. We are not the only ones who generally access China via Hong Kong rather than via the mainland exchanges. Most foreign investors do the same, even though access to Shanghai has recently improved. As a result, most Chinese shares are owned by Chinese citizens and corporations, limiting the knock on effect overseas.
07/07/2015 - 07/07/2015 Data from FE 2015
the market drops did not derail the economy, and given that the market is still well in profit taking a longer term view, we would hope this would not be too significant. As with Greece, it is always difficult to tell as we don’t know who is sitting on huge losses, who they might subsequently owe money, and what (if any) domino effect there may be. However, our best judgement is that this should not have a significant global impact.
Given the scale of losses there could of course be a knock on effect to Chinese economic growth. However, in 2007
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 July 2015
Action Stations
If these two events are only to have temporary or at least no long lasting significant impact, then the market dip becomes an opportunity. We were cautious when markets were around 7,000 but at current levels they look more attractive. To date, since markets have dipped we have carried out a few actions: •
We set up a new Defined Returns product when the FTSE was at 6,753 as detailed in last month’s newsletter.
•
We bought an index tracker at a market level of around 6,583 in the latest of our “volatility trades”. We will likely sell this again if markets return to around 6,900.
•
We have reduced property exposure and increased tactical cash.
•
We are about to make a second property reduction.
and this not only protected portfolios as markets fell but gave us the opportunity to buy in. We believe that is still the right approach. We have begun to reduce property as it has been the best performing asset class over the past couple of years and we think returns are starting to slow. Returns may still be ok, but nothing like as good as they have been. In addition, property has done its other job and carried on making returns regardless of the fall in the equity market. We are therefore reducing from our previous “overweight” position back to a more “neutral” weighting. We always try to think ahead, work out what might happen and plan accordingly. Even without a crystal ball just having the discipline to reduce equity after markets have gone up, topping up on the way down, means we can enhance returns and keep risk under control.
The cash from the property reductions may be used for another defined returns product and another volatility trade if markets continue to drop. We would likely carry out a volatility trade if the FTSE got down to 6,350, selling it should we see a 5% or more recovery. For all defined returns product we prefer to use nonEurozone banks as we see those being more exposed to risk from Greece. Given the recent recovery in markets we might need to wait for the right opportunity holding cash in portfolios in the meantime. We held cash going into this market dip
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 July 2015
General Economic Overview Whilst the UK and US economies continue to do well, the global economy has slowed. Emerging markets are no longer growing at the pace they were, however Europe and Japan are being boosted by quantitative easing. In general we expect slow and steady growth but the global economy remains sensitive to shocks, with Europe and China seen the most likely sources of risk. Inflation remains low but should pick up as the year increases, and rate rises are not likely before the end of this year Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Our equity score is neutral which means we expect somewhere in the region of 10% pa over the next 18 months. The recent dip has made valuations look more attractive than they had been. We still favour Japan, Asia and smaller companies in the UK.
=
Fixed Interest Our score remains -4 which means we expect perhaps 3% to 4% pa over the next 18 months. Long dated bonds may be affected by interest rate rises but we believe our funds should hold up well as they are shorter dated making them much less rate sensitive.
-4
Commercial Property Commercial property returns have slowed after a very strong 2014. Last month we reduced our score to -1 after previous positive scores, meaning we expect slightly less than the normal 7% pa. We are therefore reducing our previous overweight position.
-1
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 have a neutral equity weight together with 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, 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.
The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. 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. 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.