We’re In An Ugly Contest
Skerritts View - October 2016
The more that we analyse the markets, the harder it is to find anything that looks good value. Our favourite sectors remain cyber security and robotics from a long term thematic perspective, and once we know the outcome of the US election we will look very closely at increasing our exposure to that other multi-year theme of biotechnology, but apart from these virtually every asset class appears embroiled in an ugly contest.
The Bank of Japan has effectively written the Japanese government a blank cheque in September, so it will be interesting to see how they spend it. We remain short the Yen in anticipation of it depreciating against a Dollar that we expect to strengthen regardless of who wins the election, and so Japanese equities are potentially attractive. Other than that, let’s look at what’s left.
Cash will not reward anyone other than those whose only motive is not to lose any capital value. Gilts and Government bonds look downright dangerous as they offer little by way of income, yet sit on the verge of a precipitous drop in capital value should yields rise sharply for any reason. In the UK, since Brexit the FTSE 100, 250 and Small Cap indices all hit all time highs consecutively for the first time since December 30th 1999 (and we all know what happened at the start of 2000) as Sterling hits its lowest level since 1985. Germany’s biggest bank, Deutsche Bank, has sent jitters running through the financial sectors while in Asia the US have docked two vessels in Vietnam for the first time since that war to counter increasing Chinese aggression in the South China Sea. Within two months, one of the two least popular Presidential candidates of all time will have authority over them. Populism is on the rise around the globe, as is protectionism, as various electorates decide that they don’t much like what globalisation has done for them.
Gold has fallen back to the level it was in the Summer, while property funds are only just beginning to trade again having been suspended
The debate over whether active or passive funds are better can get quite heated amongst investors and it’s not a debate over which we have particularly strong views. To our mind, if something can give you a positive return then it merits consideration, regardless of how it is managed. There is absolutely no point in paying more than you need to, which is often the case with actively managed funds that closely track a benchmark that can be bought more cheaply elsewhere, but there is every point in paying for a superior return from active management. An example can often be found within the small cap sector where stockpicking can regularly beat the process of simply tracking the relevant index.
However, the growth of passive investing is masking an accompanying growth in risk to which many investors are oblivious.
Low interest rates and low bond yields have forced investors to put ever more of their capital into risky assets. Indeed, this is precisely what policymakers have encouraged. But is the risk becoming disproportionate?
As returns have become harder to find, so more downward pressure is being exerted upon the fees that investors are prepared to pay. This has led to an explosion in low cost passive funds in the shape of tracker unit trusts or ETFs. We’re all familiar with the traditional index tracker such as those that mirror the FTSE 100 or S&P 500, but in recent years there has been a development that has seen “smart beta” funds that group stocks into “strategies” such as momentum, quality or minimum volatility. In certain circumstances, these strategies can be very successful as the economics of the day can favour one type of stock over another, but if a strategy appears successful it inevitably attracts “the herd”; the group-thinkers that buy past performance without concerning themselves about how or why it’s been delivered.
What worries us is that many investors have no idea about in what they are actually investing, and that the funds themselves are cosmetically put together with no regard whatsoever for underlying fundamentals such as valuations of the stocks they contain. As more investors buy into the fund, so the higher the prices go and all the more jolly it seems. But what happens when fundamentals become important again? The potential for losses as the market corrects the anomaly in valuation far outweighs the apparent initial saving in the cost of the investment itself. We may have dodged a correction in September but in our view the only certainty is that we are one month nearer the next one. Some investors may be sleepwalking into a rather nasty surprise.since late June. And yet markets rally hard. Do you simply shut your eyes, jump in, and see what happens? Many investors are happy to do so, apparently.
When was the last time anyone made a right prediction about the economy? Virtually from the day that the financial crisis broke around us in 2008, every forecast about economic growth, interest rate levels and duration, inflation and bond yields has been wrong. The old adage that economics begins with an “e”, everything else is made up, rings true.
One of the main problems is that most economists have this unshakeable belief that what they say is right. And important people believe them. Unfortunately, the current generation of economists, bankers and politicians all learned the same thing at Harvard, Oxford or whichever universities they attended, and what they learned was based on the reality that existed in the 1970s and 80s. Reality today is very different, yet there’s no reference work about it because we don’t yet know how it’s going to play out. And you’re not going to hear an economist say that they don’t know about something. Consequently we’ll continue to see forecasts made, which will be listened to, and which will continue to be wrong.
The next great Chair of the Federal Reserve is probably a 27 year old undergraduate studying at Harvard right now. By the time they reach office, studies will have been published about the time that we are living through today, and lessons will have been learned (hopefully) from the repetitive mistakes that are being made by the people that lead us. Hopefully we can make it through to that day without too much damage being done in the meantime.
Sources: BCA Research September 2016
These are our views, as always, and don’t constitute advice in any way.
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