GPF Economic Commentary July 2017


A wise man once said to me that “businesses do not stand still, they’re either moving forwards or backwards”. If this is true of businesses then surely the same thing can be said of leaders and we await with cautious interest the next political steps for our country. The recent UK election has cast yet another shadow over financial markets and, seemingly as ever, the only thing we can be certain of is that nothing is certain.

Uncertainty seems to be enveloping today’s political landscape; the rise of populism, the rise of the far-right vote in Western Europe, a US President with – shall we say – a “fresh” approach to running a country, a growing wealth gap; the list goes on.

In amongst all of this uncertainty, our long discussed “four horsemen” of the financial world very much remain on their seemingly unnoticed charge;

1) Growing debt; increasing global indebtedness will eventually begin to weigh upon economic growth, there can be no doubt about that. Whilst Central Bank policy has clearly kicked the can down the road to an extent, repaying debt will at some stage need to be prioritised. Increasing savings to our children and grandchildren’s Junior ISA’s for this eventuality may not be the worst idea!

2) Ageing population; the higher the proportion of the population taking out of the pot than putting in, inevitably, will mean that pressure will be applied upon public services and, of course, the financial system.

3) The rise of the robots; this is a theme we have been talking about for some time, and one which we feel is really beginning to gather momentum – even at this early stage of this particular cycles’ “S curve”. Pictet Asset Management will be offering their expert opinion on this area at our annual Investment Seminar in September, but this developing trend does pose a huge threat to financial markets as we know them.

4) Offshoring; the movement of jobs offshore to economies with lower earnings remains on an upwards trajectory. We have seen in 2016 many large banks cutting UK jobs for this very reason.

Central Bank policy continues to keep these horsemen at bay, but for how much longer? Eventually the general public will lose faith with policies which see the real value of their savings dissipate unless investment risk is taken. The “no other choice” factor is unquestionably a large factor to consider in the continued bull-run in equity markets of recent years. The fundamentals would seem to not support such rapid growth, yet the markets continue unabated, onwards and upwards.

With this very much in the forefront of our thinking, we remain as adamant as ever that diversification of assets is the safest way to approach things. Our long standing clients will no doubt be growing tired of us repeating this mantra, but in a world where nothing is certain, hedging your “bets” must surely carry more weight than an approach which puts too many eggs in one basket, and comes unstuck due to an unpredictable political landscape.

This core belief continues to be the beating heart of our investment process, and can be identified clearly in the comments which follow.

Debts

Debts: As ever, our advice is simply to repay debts. Whilst we appreciate the temptation of fixing in long term debt at a low rate of interest in the current climate, our advice would always be to repay debts where affordable.

Asset Allocation

To keep things relatively simple, each of our six asset classes has been assigned one of the following verdicts; overweight, top weight, neutral, low weight or underweight. These verdicts reflect our current view on each.

Cash & No Risk: The defensive component of a portfolio is the area which poses us the biggest challenge in the current climate. Traditional “lower risk” investments no longer represent a genuine lower risk in our opinion but, equally, rising inflation poses an inflationary risk to cash holdings.

However, on the basis that rising interest rates carry the potential to add unprecedented risk to interest-bearing invested assets, we feel that cash must continue to form the majority of a defensive portfolio.

Verdict: Top weight.

Loans & Debt: This is an area we previously described as “low risk”. It is important to reiterate that we no longer feel that funds in this space can be described as such, and the removal of this “low risk” banner has enabled us to include less traditional income generative funds with a debt underpin; funds that we feel will stand up to scrutiny if or when interest rates begin an upwards trajectory.

Commercial ground rents and short dated, floating rate notes form the dominant part of our Loans & Debt portfolios at present and we remain very active in trying to source other legitimate “alternative income” funds which we feel could add value for our clients.

The inclusion of such funds within our portfolios means that we have a less bearish outlook than we had adopted previously, but it doesn’t alter the fact that cash should still be viewed as the only truly defensive asset.

Verdict: Bottom weight.

Property: Domestic property markets came under real pressure following the Brexit vote, although the subsequent decimation of our currency has increased the attractiveness of our property markets to foreign investors. This no doubt has played a part in the subsequent recovery of prices, but we still feel caution should be adopted here as the as yet unknown fallout from Brexit takes shape.

We have taken the view that infrastructure and overseas commercial property is able to mitigate some of the risks present in our domestic property market, and we are currently very much in favour of holding weighty positions in infrastructure as opposed to UK commercial property. Government spending and political sentiment towards this sector remain strong globally, and for so long as interest rates remain suppressed (and even if they rise gradually) we do not envisage demand for infrastructure income streams subsiding to any great extent.

Verdict: Neutral, but shift the bias towards infrastructure and away from the UK commercial market.

Mixed: We view the Mixed asset class as the component of our portfolios which should be capable of providing stability and a place from where monies can be sourced during an economic downturn. We continue to be advocates of diversifying between investment strategies; traditional “upside” funds, less traditional “downside” funds, and highly flexible “target absolute return” funds. By blending these three strategies we feel that the overall return stands a reasonable chance of remaining fairly steady during most points of an economic cycle.

We have been actively sourcing Mixed funds which are keen to take a genuine alternative approach to asset allocation, and have started introducing funds which carry an exposure to “alternative income” as opposed to traditional fixed income instruments. We feel this is a growing trend within financial markets and is reflective of the growing opinion that traditional government and corporate debt is carrying more risk than has been the case for some time

Verdict: Neutral. But ensure that the assets are diversified across a range of strategies and not concentrated exclusively upon “traditional” balanced managed solutions.

UK Equity: A few years back we took the decision to amend our standard asset allocation from a 50:50 split between UK and overseas shares to one which was biased in favour of overseas equity 60:40. This was not so much based on strategy as it was on common sense; the overseas asset class accounts for a larger proportion of the globe! Nonetheless, in recent times this has yielded excellent results as the value of our currency continues to depreciate.

We acknowledge the fact that the UK stock market looks “toppy” at first glance. Our domestic indices have been breaking records on an almost daily basis and with political uncertainty in the air it is understandable that nervousness could come to the fore. We would make the following points;

  1. Domestic indices are not adjusted for inflation
  2. The large number of global companies listed in our country is high. These companies have a large non-sterling earnings base which needs to be factored in.
  3. Many experts were making the same “top of the market” predictions eleven months ago!

 

Verdict: Neutral. The market does feel high in principle and we therefore are advocating diversifying directional risk by including structured product and, possibly in the near future, equity funds with the ability to take short positions. Nonetheless, trying to be too clever can often see investors come unstuck and continuing to hold a “long only” allocation to the UK market absolutely makes sense in our view.

 

Overseas Equity: Where to begin?! What a twelve months we have had! Whilst Brexit has caused some domestic waves and no doubt there will be plenty more to come, for sterling investors into overseas companies it has resulted in fantastic returns. With the smart money perhaps not being on a recovery in our currency any time soon, who is to say that the bull-run won’t continue for sterling-denominated investors? Nonetheless, Gould Financial Planning are risk managers and asset allocators first and foremost and taking profit from these markets which have performed so well is an absolute must in many cases.

 

We are strongly advocating an exposure to physical gold for many of our clients at this stage. Whilst this should not be taken as an expectation of any imminent increase in gold prices, it is an acknowledgement of uncertainty. The perverse way of looking at this rare tactical call from us is that we almost hope it does not perform; if gold prices are plateaued then the expectation generally is that financial markets are behaving, and this is good news for the vast majority of a portfolio!

For resources investments we continue to believe in the sustainable energy story. I read with interest recently that on Wednesday 7th June, nearly 75% of the UK’s electricity was provided by non-carbon energy sources. Yes, it was sunny and windy but this does demonstrate the general direction of travel where energy markets are concerned, and whilst nuclear may very well be the long-term solution until this market develops, a more environmentally friendly solution needs to be found. Whilst Donald Trump may not agree, investors appear to have the opposite opinion!

As touched upon earlier in the piece, we remain very bullish on the prospects for robotics and artificial intelligence companies and are advocating a holding in these areas for investors who are willing and able to take the risk.

Cyber security is another theme that we feel will grow over time. Global cyber-attacks are on the increase and with an increasing volume of business being transacted online, it surely follows that this is a market with the potential to grow over the long term as even the smallest of companies are faced with the challenge of protecting their customers’ security in the modern world.

Shorter term volatility in these young but growing markets is a given, but longer term growth could, we feel, be phenomenal.

Verdict: Neutral. Look to build a passive core of global trackers, and take the active management risk in those markets where the upside potential is evidently greater.

 






Article published: 01/07/2017

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