Due to new employment, I will unfortunately be unable to keep writing posts.
Thank you for the support and I hope you have enjoyed the blog.
Due to new employment, I will unfortunately be unable to keep writing posts.
Thank you for the support and I hope you have enjoyed the blog.
With UK inflation at 2.8% for February and ever low interest rates, investors are struggling to find real returns for their investments. With 10 yr Gilts currently yielding 1.71% and inflation likely to increase over the coming years, the fixed income space is looking less and less appetising. Judging by the increase in alternative fixed income products such as infrastructure funds, investors are looking elsewhere in the search for yield. Whilst infrastructure funds, offering investment opportunities in dependable assets with visible revenues streams, may interest some investors, I think that the big opportunities lie in European equities
Europe has been riddled with financial insecurity recently but you only have to look to Cyprus to see the marked change in market confidence comparable to 2012. Cyprus’s bloated financial system, fat from the excess of Russian tax squeezes, almost toppled resulting in a serious haircut for the countries savers. Savers with uninsured cash reserves of over €100k could lose up to 60% according to the latest reports, surely causing chaos in the markets? Well not really. Markets were hit but by no means in the magnitude that they would have been should this have happened 9 months ago. Using my best market timing I invested in European Equity fund (ex UK) in the days before the Cyprus debacle started and remarkably I am only just in the red. Greece, Portugal, Italy and Ireland caused wild swings in the markets last year that had knock on effects across the global financial system. The market was sensitive and the recent events in Cyprus serve to illustrate the tidal change in investor confidence. The market believes that Mario Draghi will do ‘whatever it takes’ to save the Euro.
So why should you invest in Europe?
Amidst the tough economic backdrop, companies have had to prepare for the worse through stock piling cash in case of an extended, 1930s-eque depression. The financial stability of these companies is strong and, whilst Europe may continue to be a low growth area for the next 5+ years, many European companies operate on a global scale allowing them to generate earnings from areas where the consumer is stronger. As a result, many of the larger European income stocks have kept paying dividends and in some case offering income growth. Great Rotation or not, picking the right stocks in Europe could offer appealing returns and the scope for capital appreciation once things do pick up. There are a wealth of companies in Europe, allowing for investors to be picky and find the right companies for their investment objectives and economic outlook. For me the sort of stocks to focus on are those in the vein of Nestlé, Carlsberg and SAP AG. There are plenty of funds to choose from in the space. I picked the Allianz Continental Europe Fund which has Thorsten Winkelmann at the helm. He also the runs the (now closed for subscription) Allianz European Equity Growth Fund and has a history of generating returns for investors in this low growth environment.
Still not convinced? Well if its equities you aren’t comfortable with, I suggest you look to the latest memo from the Chairman of Oaktree Capital, Howard Marks (worth subscribing, if you don’t already). He has frank manner and his pieces often consolidate a number of topical, loosely correlated concerns that I have.
“And if I’m wrong – if there is no rotation from fixed income to stocks – I’m not that worried that I’ll end up with great regret over having failed to pile into T-bills yielding zero or the 10-year note guaranteeing 2.0%. When attitudes are moderate and allocations are low, like I feel is currently the case with equities, there’s little likelihood of investing being a great mistake. And when interest rates are among the lowest in history, it would take deflation depression or calamity to make failing to invest in Treasurys and high grade bonds a serious omission.”
As you may know from reading my previous articles, I am interested in how the financial system is regulated. Not necessarily from a compliance perspective but more through an interest of how regulation can drive the financial markets. So the recent talk at LSE on ‘What should economists and policymakers learn from the financial crisis?’ was an event I had been looking forward to for some time. It quickly became apparent though, that due to the “economic rock star” line-up, I wasn’t the only one waiting with bated breath (yes, at one point they were referred to as economic rock stars). Despite confidently applying for tickets under four different alias’s, I was rather put out not to have received one. I found solace, however, and attend the video link on campus.
A LSE professor opened with quite a good quote from Peter Diamond, an American economist. He said “When analysing a topic, only three papers normally have a real contribution. The trick is to know which three”.
The talk consisted a short speech from each of the delegates, Mervyn King, Ben Bernanke, Olivier Blanchard, Lawrence Summers and Axel Weber. Below are my highlights.
Ben Bernanke said that our recent crisis was akin to many other financial crises with the “classic prescriptions of liquidity provision, liability guarantees, asset evaluation and disposition, and recapitalization where necessary.” The difference to previous financial crises was that down to the global nature of the financial system, and the scale and complexity of the global financial institutions.
Bernanke went into detail about the uncoordinated abandonment of the gold standard in the 1930s and the ensuing competitive depreciation of rates. Countries used what he called ‘beggar thy neighbour’ policies, which intended to boost domestic economies through stronger exports achieved by the depreciation of exchange rates. The problem with this type of response was that the gains that this country felt were offset by the losses their trading partners felt. This then depreciated the currencies of their trading partners and due to the relative nature of currencies, removed any gain felt by country who had depreciated first. Everyone was worse off. Currency depreciation has been in the news a lot this year and was a major worry until the G20 nations agreed to not target exchange rates competitively. Bernanke continued his talk along the same vein, making note of the collaboration between central banks across the world and celebrating this coordination as the reason the global economy is showing signs of recovery. The financial industry is riddled with global complexity and the coordination of regulators and central banks will be integral to its future. Later in the talk Axel Weber argued the need for a global regulator, referencing the trouble he has as Chairman of UBS to coordinate operating globally but adhering to differing national laws. He emphasised that, when the Basel III initiative was formulated, harmonised implementation was key. This has not been seen and the focus on national implementation hurts large multinationals.
A particularly enjoyable element to the talk was reflecting on the recent crisis without politics being involved. A point that was reinforced by almost every speaker was that the independence of central banks is important. The pioneering move by Mervyn King to make the Bank of England responsible for setting interest rates was lauded and it was implied that economics works better without politics.
The ‘rockstars’ in concert (by videolink)
The talk gave me a fresh look at economic figures. The speakers had all devoted their lives to understanding the economic history from the past so they could better control our economic futures. It felt very much as though I was in front of a group people who has pressed the buttons and pulled the levers to guide us through such a drastic economic depression in the best possible way.
The talk was not without warning though. Axel Weber said that we need to be mindful of implementing regulation during a period of recovery. The quick speed of implementing regulation can hurt growth at a particularly sensitive time. Axel also took the opportunity to have a dig at the press, stating that when regulators change the time frames it should not be construed as a result of bank lobbying – the banks were asked for their opinions.
The current situation in Cyprus was flagged as a stark reminder of the risks still out there. Whilst indicators are positive, the recent rally could be a misleading signal and the underlying progress of the economy still lacks a necessary forward leap. A fundamental rebound is not yet clearly in sight and when is does occur it will be against a debt ridden backdrop.
A video podcast of the talk can be found here
As I am sure you have seen, the Cypriot parliament have voted down the levy on savings deposits perhaps marking the start of more volatility within the Eurozone. Whilst stocks have seemly shrugged it off so far, Greek bonds have taken a hammering with yields rising 60bps to 11.55% yesterday. The Euro has also struggled, falling to $1.2843 on the news.
As Cyprus has voted against the levy, all that is left is uncertainty. A German official warned that Cyprus’s banking system faced insolvency if the bailout programme fell through and that the islands two largest banks were “effectively illiquid” (FT). Only time will tell how the crisis talks with Cyprus’s finance minister and Putin will pan out.
If all else fails however, they have €1m sitting in an MoD airplane to tick them over.
Tomorrow is budget day and George Osborne is expected to stick to his guns, continuing austerity for into the next tax year. Savers will undoubtedly find little reassurance in minutes released for a Bank of England policy meeting that suggest they will use ‘monetary balm’ to counteract the fiscal pain (FT).
Some things to look out for:
Tax avoidance is in the news a frustratingly large amount recently. Often due to comments from politicians seeking to rile up major corporations. Unfortunately for Mr Cameron, Starbucks is unlikely to wake up a smell the coffee until he does.
The FT today reports on how the big four accountancy firms were yesterday ‘grilled’ on the morality of tax avoidance and I can’t help thinking how theatrical it all is. Politicians have decided to cling onto this rhetoric of companies not acting ‘in the spirit of the law’. The spirit of laws that they could change. These ‘grillings’ are not much more than an attempt to gain votes through loosely backing fashionable topics. Perhaps this is democracy.
The accountants are being used as sacpegoats as they are being told one thing and shown another. Whilst they do not have a fiduciary duty to their clients, they are bound by the rules of capitalism and should they not serve their clients in this manner someone else will. Whether this is morally right or not is irrelevant. We live in a world where there are enough immoral citizens to ensure that if the service of tax avoidance remains possible,and as lucrative as the Ernst and Young head of taxes salary would suggest, someone will provide it.
Therefore, for the sake of not hearing this contradictory debate in a few years from now, politicians should decide their stance and stick to it.
‘Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlwind of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill done’
This quote by John Maynard Keynes in 1936 formed the final words by David Tuckett in his pioneering emotional finance book Minding the Markets. In Minding the Markets, Tuckett explains how he believes that modern economic theory is unsuitable in light of the wild market fluctuations of today, and he, like Keynes did, believes that the markets are not as efficient as the economic theories on which they are built would suggest.
David Tuckett has a background in both economics and psychology putting him in a somewhat unique position of being able to comprehensively analyse the role that psychology plays within the financial markets. To do this he interviewed a sample of hedge funds managers various times over a number of years (before and during the sub-prime crisis), evaluating the affect that the competitive environment had on them, how they made investment decisions and how the associated gains and losses affected them.
Perhaps most interesting of Tuckett’s findings was the pressure on hedge fund managers to achieve exceptional returns in conjunction with lower-than-usual risks. This goes against the fundamental relationship between risk and reward; the higher the risk the higher the reward. The pressure on managers to find stocks that met such criteria resulted in them entering a ‘divided state’. A divided state is ‘an alternating incoherent state of mind marked by the possession of incompatible but strongly held beliefs and ideas’ which Tuckett says causes an influenced perception of reality. This is exacerbated by the need to constantly outperform benchmarks, meaning hedge fund managers are under pressure to be exceptional without being too different from the rest of the industry.
I am a firm believer that current market theories are flawed. Markets cannot be truly ‘efficient’ in the modern world due to the sheer amount of information and quantity of market players. Psychology and emotions play a part in every decision that we make, particularly those where the stakes are high. This is highlighted by Tuckett when he evaluates past investment decisions made by the hedge fund managers. Each of their investment stories had strikingly similar characteristics; mitigated risk through a unique position in the market, strong and reliable management, visibility of future revenues. Using interview scripts he shows how similar each of the buy stories were and illustrates how the hedge fund managers, whilst incorporating all of the vast analysis available to them, had to make their final decision through emotion or gut feeling rather than logic.
Whilst money managers may do everything possible to make decisions based on rational logic, the markets are not devoid of emotion. The sooner economic theorists acknowledge this the sooner we will be able to develop a better understanding of what makes the financial markets tick. For the next generation of prudent investors, it will be essential to have an understanding of the role that emotions play in the markets.
‘Buy Sell’ picture source: http://www.sharesinv.com/articles/2012/03/16/behavioural-finance-4/
The major issue for the global economy over the next few years is how the developed world will safely delever. On the most part this means keeping unemployment down, but when you look to Europe socialising the loss through default still can’t be ruled out. The most beneficial way for Europe to delever would be through actual economic growth and whilst recent moves by authorities point to stronger fiscal consolidation there are still many underlying issues that need to be addressed before growth can be reasonably expected. This absence of growth is likely to be exacerbated by the limited options available to policy makers in the developed world. Whilst their efforts to instil confidence through active monetary policy have been noble, a true lasting effect is yet to be seen. Markets remain volatile and fiscal intervention may be all they have left.
What this also indicates is a growing reliance on central banks. Australia is creeping into deficit territory and most economies continue to be affected by the ongoing problems in the developed world. Investors will have to be aware of the substantial impact that central bank intervention can have on the markets and act accordingly.
As I said in my previous post, investors expectations of returns are due an adjustment. The returns across asset classes over the previous couple of decades have been an anomaly. Growth will be low for the foreseeable future and without growth you can only sensibly expect low returns. The only investing style to really buck this trend is the ‘Risk On, Risk Off’ approach which takes advantage of volatility and heightened investor sensitivity.
Since the hype of American elections is likely to soon subside, I thought it may be a good time to take a look at the general outlook for the economy. Every day I seem to read articles that are either vehemently bearish or vehemently bullish and it is hard to find clarity amongst the chaos. As with all problems, it can be beneficial to strip away the noise and look at the fundamentals. In the case of the economy this means going right back and looking at the factors within an economy that are needed to promote economic growth.
Economic growth isn’t something that just occurs. It is a bi-product of a number of factors such as the consumer’s propensity to spend, employment levels, a strong infrastructure, technological advance, demographics, investment and various other elements. When you look over that list it becomes apparent that many of our 2012 economies are lacking, particularly in the Western world. Birth-rates are slowing on a global scale. Infrastructure is becoming dated and new investment is lacking (although intitiatives are being put in place to address this). High unemployment, low consumer sentiment and general uncertainty have served to decrease the consumer’s propensity to spend. Combine these factors with huge government deficits and a lack of available credit and it becomes clear that expecting economic growth may be somewhat naive.
This leads me to consider that maybe we are wrong to expect growth. The past 20, 30 or even 50 years have seen what you might consider abnormal conditions. The baby boomer period made huge population gains; stock markets saw some of the biggest bubbles on record, as well as some of the biggest busts. Rapid recoveries and the availability of credit have made us all live lives that we perhaps couldn’t afford. With reserves spent, resources reaped and prudence an old lesson that we are being forced to remember: maybe we are wrong to hope to return to pre-crisis levels.
In the FT yesterday, a representative from a London based property company said that he believed the housing market would not return to pre-2008 levels until 2015. This seemed a little off key to me as pre-2008 was a much swelled bubble and I don’t see returning there as a desirable outcome for anyone. This highlights a psychological problem which may affect the way we look at the economy. Humans tend to revert back to what is normal; but when normal is wrong (in the case of the economy, the last 20 years may have been an anomaly) reverting back can have disastrous consequences. The returns that have been experienced over the past 20 years are going to be hard to come by and to search for them will be risky. As investors make this search, proper risk management will be become more important than ever.
Here is an assignment I did for the Contemporary Issues in Finance module whilst at university. The assignment was to write an Economist article that investigated whether the regulatory proposals being made during the crisis were indicative of a convergence of international financial systems.