RSJ Financial Planning
RSJ Financial Planning
RSJ Financial Planning

Investment Review

These are my personal thoughts and it is not only "location, location, location" but "diversification, diversification, diversification" - July 2010


Unfortunately we live in volatile times primarily because of the immediacy of news as every headline has to stand out so the message gets exaggerated and of course it is only bad news that is in the headlines.

Sovereign Debt - continues to "freak" the stockmarkets especially with regards to Europe including UK but is largely sentiment that is driving the market - i.e. fear.

US: since the autumn of 2009 the US has experienced a strong rebound in economic growth, fuelled primarily by Obama's stimulus package and inventory restocking. However, with these two temporary drivers now subsiding, growth has begun to moderate and rely on more traditional economic forces, including consumption. Accumulated debt still needs to be paid down by the US consumer for sustainable economic expansion and this is proving to be a drag on growth. That said, economic indicators are not overtly concerning and whilst unemployment figures have not improved and inflation remains low, we expect monetary policy to continue being accommodative. GDP growth for 2010 is expected to be 2.5%.

Europe: concerns in Europe are going to be a persistent backdrop to the global investor environment; the combination of a joint monetary policy and independent fiscal policies are not conducive to repairing sovereign balance sheets. This, coupled with social unrest and little economic growth, will be a significant headwind to any improvement in sovereign balance sheets. In particular Greece and Spain, and Ireland to a lesser extent, face significant difficulties and the scale of the necessary austerity measures may prove insurmountable for some countries. For the Eurozone as a whole, we forecast GDP growth to be 1.0% in 2010.

UK: with low interest rates, a more competitive currency and control over its fiscal policies, Britain has had more capacity to deal with its deficit than Europe. Until recently, the missing ingredient has been a realistic consolidation plan to utilise this capacity and effectively begin to cut the deficit. The new Government's Emergency Budget is certainly a significant step in the right direction and has seen Britain successfully differentiating itself from the rest of Europe. GDP growth is likely to be 1.5% in 2010.

Japan: whilst we expect GDP growth to be 2.5% in 2010, compared to -5.2% in 2009, Japan's structural problems continue to deteriorate. In order to deal with its debt, the economy needs to grow a staggering 24% over the next five years. Greece, by comparison, needs GDP growth to be in the region of 12% over the next five years. With a declining population, shrinking economy and an unsustainable level of debt, it is difficult to conceive of how Japan will generate this rise in productivity growth. Certainly, the yen will eventually need to be depreciated. Hence my concern of investing in Japan

China: this is seen as the driving force for the world's economic growth and it is and will continue to be so but that growth will not be in a straight line and there will be slow downs and even a recession in time. The other countries which are also growing at a great pace include Brazil and India. The economic situation has been very strong - almost too strong - raising concerns of inflation, overheating and the development of a property bubble.

As an economy, China is prone to engineered ups and downs - a consequence of the Government's enormous command over it - and whilst the market is very sensitive to these movements, Beijing has both the firepower and willpower to ensure the growth trajectory is maintained.

Russia: the Russian economy is emerging from the global recession at a rapid clip this year. Falling inflation has allowed the central bank to cut interest rates materially, providing the impetus for a V-shaped recovery. As the developed economies in the West struggle to grow over the next few years - looking conspicuously U shaped - with private and public sector debt burdens, Russia will be one of the key emerging economies leading global growth, with rapid catch-up potential, low debt levels and something the world will be needing a lot more of as China and India expand: natural resources. Looking at the short-run, the recent Russian economic data is strong and chimes with the positive signs that we have seen on the ground in Moscow. We expect the Russian economy to grow by 4.5% this year.

Sovereign Debt levels - of Emerging Europe & the EU Periphery - as a general rule, the sovereign debt situation in Emerging Europe is far better than in the Eurozone periphery. Most countries easily meet the Maastricht criterion limiting sovereign debt to 60% of GDP. The weakest sovereign debt fundamentals can be found in Hungary but even there the situation more closely resembles Germany than Greece. Not only is the state of sovereign financing much more sustainable in Emerging Europe, there are also some additional features that are little known and add to the attractiveness of Emerging Europe. In many cases, Emerging European countries boast strong, liquid banking systems and insurance companies and rely on the local market for (re-) financing state debt.

These comments are also true for many of the other emerging nations such as China, India and Brazil where they are paying money into the International Monetary Fund as Greece takes it out!

Equity Valuations - the current equity market sentiment could be compared to movie Jaws, because investors are extremely fearful of going back into the "water", worrying there is something sinister lurking beneath the surface hence the current market volatility. Yet despite the fear contained in markets, the inbuilt valuation mechanism supports for equities for longer-term value investors. The US market recently traded on a forward PE ratio of 11.8 times earnings but consensus is positive on future earnings growth (profit improving), so the market is undervalued by about 19%. Meanwhile valuations look even more supportive in Europe and the UK. So the fundamental supports for equities are being built, but one critical obstacle to renewed enthusiasm for the equities remains that of high levels of volatility.

The other benefit of equities is their income, current yields of about 4.5% with the good prospect for improving profits so dividends will rise over the next 12 months.

It is still argued that the UK's major exporters are large multi-national companies, which face little competition in their respective markets. They are also large enough to price in foreign currencies, and so as Sterling depreciates, they take the gains in profits, rather than cut their foreign prices and increase export volumes. This applies the those French and German companies that export to the new world.
Comment - it is not the right time to sell and prudent to invest now for long term income growth and long term income.

Emerging Markets - why I am so positive towards these markets? There are several factors but mainly that the populations are becoming more urban, more middle class so wish to have the trappings such as better food and better clothing hence the rise in consumers.

Comment - remain overweight but if we see good growth then we should take profit and reinvest elsewhere, good areas to have your monthly saving plan invested.

Confidence - there are two interesting indices that give some forecast of what is happening in the world:

The Baltic Dry Index - charts the cost of freight going by sea, and is therefore a good measure of trade/world growth:
This is still 69% below its peak (although, the peak was extraordinary?)
The recovery is still weak
It is in line with rates 5 years ago

The VIX index - a US Equity volatility index - is a good guide to investor confidence in the past.
Worst level - 80 - December 2008
Long term average is about 20
currently at 28
spiked at 40 for a short period - 6 May 2010

Comments - still in a volatile situation.

UK Inflation - I am strongly against the theory of long term disinflation, and I believe that inflation will reappear in the UK in say 2 - 5 years time.

Comment - the only hedge against inflation is to invest in real assets such as equities and commodities.

Wealth Protection - The dilemma is to try to protect our capital in real terms (i.e. in purchasing power). Historically we have had to invest in real assets such as equities, and therefore have had to take some risk. Take Capital values for example - even if inflation is only 3%, if left in cash, the real value of your wealth in 5 years will drop by 14%, and by 26% over 10 years.

Asset Allocation:
I remain benchmark agnostic - i.e. do not follow prescribed bench marks - I rather equate Investment Risk management tools as like "driving a car by looking in the mirror all the time". Sensible driving is looking at the road ahead whilst occasionally looking in the mirror to see what is potentially over taking or is it safe to over take or turn into another road.

I still prefer larger weightings in equities over commercial property, though they do provide a good yield and corporate bonds - bearing in mind the latter are debt instruments!!

I am also continuing to recommend that clients shift the weighting of their portfolios away from the UK, to the economies of SE Asia and Emerging Markets, where there is a stronger economic growth and the production of commodities. That being said if a good profit has been made than take some profit to invest elsewhere - it is not only "location, location, location" but more "diversification, diversification, diversification"


Why do I have to challenge conventional view? The conventional wisdom is that if one is 65, one should have 65% of one's assets in cash and fixed income.

However, my argument is still that, we cannot rely on cash providing a sustainable income due to low interest rates and relatively high inflation numbers and due to changing demographic trends as life expectancy has increased, we may need that income for at least 20 years! In this respect, if you were to follow conventional wisdom, any income from cash and fixed income will be eroded in real terms over a significant period of time (bear in mind that interest rates fell by 80% last year).

So again in retirement there is a need to have a diversified income stream with the core being Equity Income funds including ones investing overseas with yields of 4.5% with prospect of 4% dividend growth per annum, fixed income and commercial property funds.

I do not support funds often sold by the banks where the yields offered are attractive and but are link to stockmarket returns where you are locked for over 5 to 6 years as high returns are again unsound.

Comment - taking all of this into consideration, I think it is prudent to stay invested. Moreover, I feel more confident that it is the right time to be investing into equities again as future equity income is about 4.5% which, in my opinion, will provide a better long term income than money on deposit.

So I feel we have to put the past decade into perspective and should not always be too gloomy!!

Economies and Equity markets rarely go up or down in straight lines.

Have confidence and remain invested