INVESTMENT UPDATE – AUTUMN 2018
- Far From Shore
- Beware Acronyms
- No Brexit talk here
- Using the toolkit
Far From Shore ’
2018 has been challenging for investors to navigate. In the year to date investors have not made money from owning most investments unless they were valued in a foreign currency, namely US dollars and Japanese yen. Excluding commercial property – the only asset to have a respectable year – most other positions are underwater including bonds, equities and commodities. The sharp drops in February and October wiped out any interim gains that had accumulated.
Since 2009, cheap money, fuelled by global money printing and low interest rates, has helped inflate all prices. This rising tide has lifted all ships, but choppier seas are threatening to capsize those farthest from shore. The furthest ship from shore by far this year has been Bitcoin, a prime example of an asset whose price is driven purely by demand and supply. The crypto collapse in the summer was a warning to investors of what can happen when there are less willing buyers of an asset in the face of falling confidence. Perhaps an important and early lesson for us all, as we start to see the ‘willingness of investors to believe’ waning, is not to forget how markets almost always revert to their norms.
The world’s largest economy, the US, is on fire with solid GDP growth, unemployment rates at record 40 year lows, an almost vertical stock market and booming consumer and business confidence. It is no wonder there has been an abundance of buyers with a ‘willingness to believe’ (in the extrapolation of future earnings). The biggest beneficiaries have, of course, included the FAANGs (Facebook, Amazon, Apple, Netflix and Google) not least because of the growth in Index investing which naturally gives large weights to these behemoths.
However, the prices of some of these firms have, in our view, become unsustainably high, pricing for perfection and pushing US valuations to heights not seen for 20 years. We can’t help but draw similarities to the seemingly invincible growth stocks known as the ‘Nifty Fifty’ that drove the bull market in the early 70s until the preceding crash in 73-74 and under-performance though the 80s. Perhaps better remembered are names such as Microsoft, Cisco, Oracle and again Amazon that were similarly loved in 1999.
Many readers will remember what happened 20 years ago. Stocks got more expensive, moving higher before things got really messy. Investors not willing to join in the Techno party, such as Neil Woodford, came under heavy criticism for ‘not believing’ and hence lagging the herd. What happened next was that Woodford went on to become one of the most well-known and respected investors in the UK over the next 20 years, building a reputation on his performance, surviving the dotcom crash. But today, Neil’s strategies are once again coming in for criticism. Can you see a pattern forming?
Great Price or Great Company
We remain disciplined investors and experience tells us to put our emotions to the side. Yes, many of the expensive stocks are great companies producing great products and services, but what makes a great company a great investment is the price you pay for it and at current levels, we are less willing to cough up. Black Friday may yet be followed by bargains not limited to the high street.
With rising interest rates and high US valuations, investors have been re-assessing whether equities will adequately compensate them for the risks being taken. Increasingly this year the answer has been ‘no’ and equity buyers are reducing. It is this re-assessment of risk that contributed to both corrections this year.
There are many headwinds for markets to contend with – from a China slowdown, re-surfacing Italian debt issues and Brexit to intensifying trade wars. However, hopefully you will forgive our obsession with US monetary policy at a time when there are more topical items to discuss. Upward pressure on rates is real. The Fed has indicated we are not yet at a neutral rate (one that neither promotes economic expansion or contraction) and $50bn a month is being withdrawn from Treasuries as QE is wound up and the Chinese are no longer buying!
No Brexit talk here
One of our most important roles in managing money for clients is to filter out market and media noise that can lead to poor short-term reactions which are proven to damage long-term outcomes for investors. The point here is that we do not feel any of the political distractions above are enough to individually de-rail a well diversified portfolio. However, when combined with rising interest rates, upward momentum is threatened. Rising rates are bad for all assets, including property and bonds.
So should we all be squirreling away our savings in cash deposits? Well, to some degree, we have already increased portfolio cash levels – only slightly – but generally for long-term investors, significant shifts into cash are unwise. Timing the market in this way is highly likely to leave you worse off than had you ridden the wave, especially with rates so low.
Instead, we are being smart with our holdings, making use of the tools we have in modern portfolio construction. Historically, it would have only been possible to hedge equity risks with bonds. This is not ideal when bonds are increasingly moving in line with stocks and compensating you with little interest along the way.
Using the toolkit
In the current environment we are holding a greater weighting to funds that can make use of options, a form of insurance that can pay out if markets fall. Over the short term, options can drag on performance. However their protective qualities can really prove their worth in a downturn.
We also hold exposure to commercial property in Bricks and Mortar form. This, as previously stated, has been one of this year’s top performing assets unaffected by equity volatility. This is not to be confused with property shares that often lack the same diversification benefits over the short to medium term as recently witnessed.
We have also tilted our portfolios away from the more expensive areas including the US and Tech. Despite Brexit fears we like the UK. For instance, valuations are not demanding and the beaten up stocks such as banks and miners are in good shape. Miners have cut costs, are capitalising on new technology and boasting decent Free Cash Flow yields. On the other hand, banks are finally coming through the PPI saga, with strong balance sheets and potential for a re-rating in a rising interest rate environment. Even Neil Woodford, renowned for avoiding bank stocks through the credit crisis (as well as avoiding tech stocks through the dotcom crash) is taking an interest in the sector.
In some portfolios we hold infrastructure companies. These should be less sensitive to a downturn and continue to be exposed to various projects that generate steady cash flow, often index linked, such as railroads, hospitals, power stations to airports.
We are also happy to be owners of gold at present and to balance some more cautious positions with exposure to emerging market equities. Unloved in the current bull market, developing economies are looking attractive for patient investors who can see past the short term pain of trade wars, which could still result in freer trade long-term when both sides realise they are actually losing.
All in all
We are quite comfortable with our portfolio positioning as 2018 draws to a close. At times this year our resolve has been tested as the US and the dollar charged ahead, while emerging markets and value stocks lagged and offered little reprise, creating an almost perfect storm for our strategies. However, October’s correction evened things up amid signs that some new favourable trends may be forming for us.
The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.