Economic Commentary January 2020


As we move into a new decade, the United Kingdom sits on the cusp of seismic change.  A Conservative majority will lead the United Kingdom into the next phase of leaving the European Union.  The only thing that is certain, is uncertainty. Trade deals, negotiations and political drama will dominate the media for the foreseeable future. Business as usual. 

There is no crystal ball and predicting the future with any degree of accuracy is folly. We can look to the past, to guess at what the pressing issues will be for the next decade.  10 years can pass in a blink of an eye, yet also feel like an eternity.  

The Eighties gave birth to the internet.  The Nineties brought the internet into the family home.  And the Noughties gave rise to the smartphone.  In the last ten years, we saw an explosion in technological advances, to the point where the layman has yet to catch up:

  • Apple debuts the iPad
  • Scientists create synthetic life
  • Augmented Reality becomes viable
  • Synthetic transplants
  • Voyager 1 left our solar system
  • Touch screen technology became commercial
  • Smart Phones became commercial
  • Nasa landed a probe on a comet
  • Genome sequencing
  • Biometric scanners
  • Automated agricultural and manufacturing robots
  • Electric and Hybrid Vehicles
  • Early stage automated cars
  • Completion of the Genome Project
  • The progression of the "internet of things" (smart everything)
  • The roll-out of 5G

The above barely scratches the surface.  As technology becomes more advanced, the time it takes to become outdated becomes shorter, so we can expect the next 10 years to provide more disruption and more products, that we cannot yet conceive - perhaps we will finally get the flying cars we were promised so long ago.  Which doesn't seem as far-fetched, when you consider that 10 years ago, an online supermarket and package delivery service, went on to become one of the largest companies in the world, controlled by the (now) richest man on the planet.

Looking at the world today, and projecting to the future, we can see two key themes emerging, that will need both political will and scientific discovery to solve.

Climate Change

Whether climate change is man-made or a naturally occurring event, is still up for debate in some quarters.  But what cannot be denied, is that the climate is changing.  Reports suggest that an average rise of 1.5 degrees could lead to the extinction of 30% of species on earth, and a rise above 2 degrees would see most ecosystems struggle (Nasa, 2020)[i].  We could experience:

  • Changes to farming seasons
  • Changes in weather patterns and more extreme weather events
  • More droughts and heat waves
  • Sea levels rising by up to 4 feet

With these levels of sea rises, it is possible major cities such as London could be underwater (Ecowatch, 2018).[ii]

This could dramatically change how the world operates.  There will be a need for new infrastructure, new power reintegration systems, and better water technology to name but a few.  The decarbonisation of the 21st Century society will take a massive upheaval, but something we believe will inevitably be necessarily.

Over the last twelve months, we have begun to incorporate ESG factors (Environmental, Social and Governance) when creating our fund shortlist. Sustainability will be key in the future.  Over time we believe that ESG will become more prominent in the fund management industry.  In addition, we continue to source and seek out themes and investment ideas that will benefit from decarbonisation and the promotion of renewable energy and sustainable infrastructure.

Automation

We have spoken about this previously, but it is worth reiterating again.  Whilst technological advances of the 20th century generally displaced the less educated workforce; we will see an increasing threat to skilled jobs.  A report by PWC are predicting 3% of jobs will be at risk of automation in the early 2020’s rising to 30% of jobs by the mid 2030’s (PWC, 2019)[iii].  This mirrors other estimates, whilst none of them may hit the target, it does suggest this is the direction of travel (BoE, 2020)[iv] (UKGovt, 2019)[v].

Economists suggest that automation could boost GDP by an additional $15 trillion or an estimated 18%.  This extra wealth will create demand for more jobs, but the unanswered question is doing what!

Education will be critical.  Something we hope this new government will get to grips with now, as it will be too late in 10 years.  Governments and businesses will need to help people adjust throughout their lives, retraining and career changes, as the idea for a job/industry for life disappears.

We continue to hold positions where we feel clients can benefit from the increased demand for automated products, and are continuously looking at new themes, which could benefit from the rise of the robots, in the future.

Undoubtedly, something will happen in the next 10 years that will cause another crash.  War, politics, protectionism, populism, civil unrest, the burgeoning weight of global debt, automation and job destruction, global warming or a true black swan - that no one has even considered. 

Whilst there are many opportunities in the world, and we actively seek out new investment ideas where we think future growth is possible, we are not ignorant to these threats.  Our job as asset managers is to spread the risk, so in the event of another large-scale financial crisis, your assets are as protected as they can be.

Our thoughts for the year ahead are as follows:

 

  1. Cash

Cash continues to represent poor value, and the noise from Market Commentators and the Bank of England suggest that there is a greater probability for interest rate cuts over interest rate rises.  With total Global Debt to GDP (IMF, 2019)[vi] in the region of 226% it is unlikely that any government or central bank will increase interest rates for the foreseeable future.

Cash remains a useful tool in protecting against short term volatility in markets, but over the longer term it is unlikely that it will generate interest above inflation.  We believe there are two essential elements regarding cash to consider before investing;

  1. Ensure a sufficient emergency fund is kept.
  2. Clearing debt and reducing interest payments is a form of saving.

The Investment Committee have agreed to keep the cash allocation neutral for the next 6 months and review the position again in July 2020.  This is the cut-off point where the UK Government can request an extension to the transition arrangement with the European Union, and we will have a better understanding of what type of Deal the UK government has negotiated.  Our initial thoughts are; if the deal is positive, the UK market will be a more attractive place to invest and we would consider moving slightly underweight in cash assets for UK equity.

 

Verdict: Neutral for now – but we could move underweight in Q3 2020.

 

  1. Loans and Debt

As many of our clients are aware, we continue to be wary of government debt and traditional corporate debt, as interest rates have fallen, and bond prices have skyrocketed the yields on this debt have naturally declined.  In some developed countries such as Germany, investors are prepared to accept negative yields (a guaranteed loss at maturity).  And whilst we do not anticipate rising interest rates anytime soon, should they increase bond prices will fall.  In our opinion, this is a lose/lose situation to find yourself in.

We continue to use alternative debt themes, which we believe will be less sensitive to interest rates, and debt funds with in-built inflation protection into the contractual terms.

 

Verdict: Neutral – Continue to allocate funds that are interest rate agnostic, that deliver above inflation returns.

 

  1. Property

You may have seen in the press that the M&G Property Portfolio, a UK Commercial Property fund has suspended dealing, on the back of significant redemption requests during the last 18 months.  Selling large UK Commercial Property outlets such as offices, warehouses, retail parks, can take some considerable time.  When property funds are facing more redemption requests than available cash within the fund, it must suspend trading, this allows the fund to manage sales of properties without having to be a forced seller. 

We remain cautious on UK Commercial Property holdings, and we have been reducing our allocation, which now account for around 25% of our clients’ property allocation.  During the last 12-18 months, a number of high-profile retail businesses collapsed or entered administration/rent reviews renegotiations as the retail sector continues to struggle. 

Secondly, while the Brexit outcomes remain uncertain, sentiment for UK Commercial Property has been negative which has led to investors looking to invest their money elsewhere.

We continue to use Infrastructure as an alternative property play.  We believe that with a new Conservative Majority government, UK Budgets are less likely to adversely affect Infrastructure projects.  We could even see demand, as the Conservative 2019 manifesto did allude to more infrastructure spending over the next 5 years.

 

Verdict: Neutral – Continue to hold a diverse property allocation, which includes Infrastructure, Global Commercial Property, Global Property Shares and a small allocation to UK Commercial Property.

 

  1. Mixed

We see the Mixed allocation providing ballast to client portfolios when markets start to become volatile, and for that reason we recommend a 3-strategy approach.  Upside strategies, selecting fund managers that should deliver returns when markets are increasing (but with less volatility). Downside strategies, selecting fund managers who have a contrarian view of the world, these fund managers are less susceptible to losing money in market corrections.  Absolute Return strategies, fund managers who use all the tools at their disposal to generate growth in all market conditions.

Whilst this isn’t a perfect science, we believe this blended approach should reduce volatility and protect capital in a falling market, and should you need to sell investments during a downturn, it would be from this space we would look to first, as opposed to equity markets, where the losses will be greater.

 

Verdict: Neutral – Continue to hold a 3-strategy approach.  We appreciate this strategy is unlikely to produce above benchmark returns in a rising market, but conversely add value when markets fall – the aim is for consistent returns with lower volatility than equity markets.

 

  1. UK Equity

Political uncertainty has subsided for now.   The UK equity market is an area we will be looking at with greater scrutiny, especially over the next 6 months.   The Conservative party victory has helped re-stablish political stability, alongside a manifesto which included sizeable fiscal stimulus, and the nationalisation of key UK industry debate has been put to bed for now.  The Conservative government have also promised to cut National Insurance for employees, and not increase Income Tax or Vat, which could put more money into consumers pockets, and this should improve consumer confidence and spending.

This would suggest that the UK will become a more attractive place to invest over the next year, especially as UK equity in general has been trading at a discount to European and Global Equities.  However, much of this tailwind will depend on how talks between the United Kingdom and the European Union progress over the coming months.  There are two cliff-hanger moments to observe, the first is in July 2020 – this is the last opportunity for the UK to apply for an extension to the transition arrangement, and December 2020 when the transition period ends.

 

Verdict: Neutral for now – We will be keeping a close eye on how the politics plays out over the next 6 months, and whether the prospect of a deal is likely by December 2020.

 

  1. Overseas Equity

As discussed above, there are several geo-political events that could create nervousness in global equities, and for this reason we still recommend holding a proportion of the Global Equity allocation in gold, to act as a hedge against this risk.

Developed World economies will be breathing a sigh of relief, as the US and China have signed a deal which will calm the trade wars of the last two years, but we see this more as a ceasefire than an armistice, and if President Trump were to be re-elected in November, we could envisage the ceasefire being withdrawn at some point in his second term.

The deal appears to be a face-saving exercise for both President Trump and President Xi with farmers and manufacturers on both sides, as well as American consumers losing out.

We believe that controlling risk is paramount.  Holding US exposure in line with a global index means having almost 60% of our Global Equity exposure in the US, and we therefore remain underweight in US equity.  As an asset allocator and fund picker, this is not a position we would want to find ourselves in, as we lose diversification into areas where we think there will be opportunity for superior growth.

Our support for thematic investing remains, and technologies which will have a positive impact on the environment.  We are therefore continuing to hold our positions in Robotics & Automation, Cyber Securities, Battery Storage, Water, Renewable Technology and Agricultural Technology.

We are considering healthcare as an additional theme and will be looking for investment opportunities in 2020.  Globally, demographics are changing, and as the world population gets older, so will the demand for healthcare.

The last 12 months have seen significant market growth for most of our Global Equity funds, and we will therefore be looking to bank profits, and bring portfolios back in line with our process.

 

Verdict – Neutral – Continue to take profits from areas that have experienced high growth over the last 12 months and ensure a diverse mix of assets across all the key sub-sectors.

 

As ever, we will continue to abide by an overriding philosophy.  Make sure your risk mandate is correct, invest for the long-term and in line with your objectives.  Firstly, we are risk managers.  If risk is controlled properly, financial collapses should not have too adverse an impact upon your day to day living.

 


 






Article published: 23/01/2020

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