Bonds - Do I need them in my Portfolio?

Over recent years, fixed income has been the place to hold your money, certain strategic bond funds such as M&G’s Optimal Income and Franklin Templeton’s Global Total Return Bond fund have performed extremely well.  It is not just the strategic funds, standard government debt has excelled as many sought safe haven assets over a rather turbulent few years. 

Now the environment for bonds has changed significantly, almost five years on from the credit crisis years of monetary easing from many developed nations has driven up the prices of government and investment grade debt to very high levels, and as prices rise the resulting yield received is diminished.  As such a 10 year gilt today will only return a mere 1.8% per annum.  Well below the 2.8% inflation in the UK.

So why hold bonds now if you are losing money in real terms? This is a good question and many investors have been reducing their exposure to fixed interest over the past 6 months.  As equity markets offer more attractive yields with some equity income funds offering 4% per annum plus the chance for capital uplift many are switching (read more on this rotation from bonds to equities).   The bond market is 5 times as large as the equity markets as many pension funds and insurance companies use debt as liability matching against policies.  Those who require a guaranteed level of income per year and a set redemption amount, bonds are the perfect asset class.  However, for those who have personal pension or investment plans, would you be better placed holding something else?

For diversification and risk reduction, fixed interest plays an important part as it offers a negatively correlated asset class to equities and smooths out returns through yield distributions.  As bond yields are at historically low levels, there will be a point where these rise.  A strong correlation to interest rates would suggest any rise in rates would flow through to the bond market and we would see significant falls in the prices for government and investment grade debt.  One can reduce this sensitivity to interest rates and falling prices by purchasing short duration bonds.  These bonds have a maturity of 1-3 years and focus less on the price and more on the yield received (the most important thing from bonds).  There are not many bond funds available that target a short duration mandate, but if you can access it, AXA’s U.S. Short Duration High Yield bond fund is a great option.

One that has a global bond and currency mandate is Franklin Templeton’s Global Total Return bond fund, ran by an excellent team, Michael Hastentab the head of fixed income at Templeton has positioned his fund in a short duration for the past year and will weather a rise in developed nation rates better than others. 

There are areas of the bond market that still offer attractive returns, emerging market debt, whilst it is more volatile offers attractive yields still. Investec’s Local Currency Debt fund and amongst many have seen 90% returns here over the past 5 years and many see this area as offering a lot more.

Bond’s play a key part in a portfolio and the correct areas and type will be very important when determining how well they do.

Japanese Equities - time to get on board?

One of the top performing equity markets this year has been Japan, since Shinzoe Abe returned to being the Prime Minster last November his determination to get the economy back on track has spurred investment back into Japanese equities.  The Yen has devalued to levels not seen since 2009 and as such this heavily exporting nation is beginning to show signs of improvement.

To further strengthen Abe's campaign the new governor of the Bank of Japan, Haruhiko Kuroda shares his doveish (favouring low interest rates) views and he has spoken out about the state of the economy.  With debt to GDP at 230%, the highest of any developed nation there is a significant amount that needs to be done to get the economy back on track.  Monetary easing of around £72bn earlier this year saw the first steps in the right direction, markets now expect utter commitment from the current administration as previous false dawns have occurred.  This first round of QE will be one of many steps that need to be taken in order to successfully navigate out of years of depression and meet the 2% inflation target set.  Any diversion from this plan will see investors running to hills yet again and markets will almost certainly crash to the floor.  

Hedge Funds - A Dying Breed?

Some of the most well-known investors in the world have been hedge fund managers.  The likes of George Soros and Jim Rogers have seen superb returns from their quantum fund and are most well known for profiting from shorting sterling crippling the Exchange Rate Mechanism (ERM) in 1992.

A hedge fund has the flexibility to place leveraged trades using a wide range of securities and derivative strategies, as such profits can be generated from the tiniest of movements.  With all investments that have the potential for huge returns, these were amongst the most sought after before the credit crisis.  But as with leveraged positions, you will always get caught out at some point meaning those gains you made could be wiped out in an instance.  This is exactly what happened in 2008, some of the top hedge funds saw heavy losses and sent many investors running to the hills.

Since 2008, the number of hedge funds out there has decreased significantly, and the remaining ones have had a difficult time.  Certain funds which rely on trends to generate investment theories have suffered the worse.   MAN group is a prime example, using trend trading algorithms to automatically take positions across the market.  Prior to 2008, markets trended very well, most notably commodities, however since the credit crisis, economic uncertainty and high volatile periods have meant market direction is very indifferent and it makes it harder to predict.

This is a very basic overview of some of the investment techniques however it highlights the change in appetite for hedge funds and the more aggressive investments.  With regulation tightening after the credit crisis, many have investors have moved to regulated investments such as unit trusts and OEICs.  Steady consistent gains have become more attractive during this period of anaemic growth and as such some who worked in the hedge fund business have moved to asset managers operating similar strategies within their funds.  Rather than trying to obtain large gains, many now aim to produce absolute gains using derivative strategies to produce a low risk fund which hedges risk across a wide range of market areas and asset classes.

Absolute return strategies have been climbing the ranks since 2008, downside risk is fairly limited and for many like Standard Life's Global Absolute Return Strategy fund they aim to produce returns of cash rates plus 6% per annum, a fairly attractive return.  This fund has reached a staggering £16bn in size recently and continues to grow as cash investors seek better returns on a fairly low risk basis.  This sector has continued to grow and certainly one which is being included in more portfolios as a proxy for cash.

Water as an Investment... Thirsty for more?

Most people consider water a necessity, rather than an interesting investment proposition. Here at fundgurus we have already written about Agriculture as an investment theme so thought it would be an opportune moment to also comment on water.

There are some very compelling trends supporting water and the two biggest are growing populations and thus an increase in demand, and second is the lack of a substitute for fresh water which should mean demand is always apparent. The global population is estimated to reach about 9bn by 2050, and with urbanisation and increase in standards of living individuals are demanding more fresh water. In order to meet this demand there needs to be significant investment in the water process and that should provide investment opportunities. These opportunities can be diverse both in terms of operations and geographical location. Utilities companies are probably what most people think of when they consider water investment and these companies should be able to provide sustainable cash flows, many linked to inflation and also often returning dividends to investors. The major risk to utilities is often considered to be regulatory as governments can impose sanctions so it is important to analyse these factors before investing. Other investments can be in water treatment, water waste and water infrastructure. 

So the investable universe for water is significant and with spending likely to increase to match global demand opportunities are likely to arise. It can be hard to select specific stocks so an investment fund maybe more suitable. Probably the most well known is Pictet Water which has great experience investing in water stocks. 

A U.S. Wobble?

Over the past few weeks there has been a constant positive in the global economy and that has been the U.S. Today however, has been the first time in a little while that some core data has slightly undershot expectations. I don't consider this a moment to sell and run to safe haven assets, and it should be noted the data only disappointed slightly.

The data in question was final quarter GDP and unemployment claims, with GDP coming in at 0.4%, not the expected 0.5% and unemployment claims at 357,000, above the expected 340,000. So what does this mean for the U.S. economy? Well I don't think too much; they have witnessed quarter on quarter growth in absolute terms which is positive given the global economic backdrop. The unemployment claims figure does just reiterate that QE is unlikely to be stopped anytime soon, and this could actually be a positive for markets, which have been fuelled by money printing. 

For me the U.S. is still the leading developed nation, and with its skilled workforce, cheap energy (Reshoring) and distance from Europe should continue on its recovery path over the months and years ahead - so no need to panic just yet!

Energy - it's what keeps us moving

One commodity that affects us all on a day to day basis is oil.  We regularly keep our eyes fixed on the petrol prices hoping they will not go up.  Global energy presents an interesting and compelling argument for investment.

Most of us will remember the credit crunch and how oil crashed from record high’s down to $30 a barrel.  Since then the price of oil has risen back up to recent high’s of $125 to settle around the current level of $110 (Brent Crude).  

Oil is traded on the futures market, and as such it provides an indication of market consensus for the price of oil for the next 8 to 10 years.  What would surprise many is that the futures curve is currently in backwardation (where current prices are higher than the future) and are pricing in around $85 a barrel over the long term.  This is somewhat interesting as the market believes this current oil price will decrease, but why?  This will happen in one of two ways, supply increases or demand decreases.

Although supply side we may see an influx from the U.S in form of the shale (tight oil) estimates may be somewhat over egged.  Also what many people do not realise is the current oil depletion rate from global production as wells dry up.  This is around 400 million barrels a year, yes that’s correct 400 million!  This certainly reduces the projected 3 million peak daily shale production which is still some years off.   With the U.S, the only non OPEC nation increasing production it does not bode well for global supply.

On the demand side, this will more than likely continue to grow, and only pricing in around 1% growth a year globally would leave constraints on global supply in a few years time.

With some basis of support for oil at this current level what opportunities are out there for equities? Well, firstly the energy sector was the worst performing in the S&P 500 over the past two years and since 2009 has underperformed the MSCI world index by 51%.  Companies are forecasting profits based on an oil price of $80, and if it were to remain above $100, one could expect to see significant upside for the share prices.  Also with a large amount of money on the balance sheets for larger companies (read more on this), it is currently cheaper to buy oil via m&a rather than carrying out the exploration yourself and therefore offers further opportunities.

Natural gas is another hot area at the moment, the U.S. has this in full flow providing cheaper costs, however will this be a substitute for oil going forward? Globalisation of LNG may be more apparent as supply side issues in Europe and Asia will be overcome by increasing demand.  Certainly one to keep a close eye on.

So where can you go to take advantage of this? Investec has one of the largest commodity teams managing over $5bn and their Global Energy Fund should provide you with exposure to some excellent companies or Blackrock’s Global Funds World Energy.  This investment theme is one I have in my portfolio and until a fundamental replacement for oil is found, this in my mind is a natural long term fund to hold.

Mid Week Market Update

We're half way through the week and global equity markets have been broadly flat over this period. 

There was initial optimism following the announcement a bailout agreement had been reached. However, as markets digested the exact agreements of the terms this optimism faded and markets dipped lower as a result. The problems with Cyprus have not simply been resolved with this bailout and it is clear there could be years of pain ahead for the small Euro nation. Consumers may have experienced a hit to their savings and will now be faced with increased taxes and austerity, which will not be supportive of consumer spending. We may also see unemployment increase as businesses could face liquidity issues due to the closure of Popular bank and the banking sector shrinks.

So onto the good news! Well, not for the first time U.S. data surprised on the upside with Tuesday's Durable Goods Orders data increasing to 5.7% (consensus was 3.9%). This helped raise the S&P 500 to near all time highs, although it did fall slightly from this peak. 

Wednesday so far has disappointed in the UK, with the FTSE 100 initially rising but gains have since disappeared. UK GDP data for Q4 showed it had increased by 0.2% year on year, which was slightly below market expectations and may have caused the market to reevaluate their views on the UK recovery. 

French GDP data for Q4 showed the country had contracted by 0.3% year on year, a worrying trend for the Eurozone's 2nd largest economy. 

Our regular feature The Week Ahead should hopefully provide a 'heads-up' of some of the global data being released that week. 

The Curious Case of Gold Bullion...

Cast your mind back to August/September 2011... During these volatile months Eurozone concerns regarding Greece escalated and many thought their exit from the Euro was imminent. Gold bullion, a safe haven asset, rose significantly in value over this period, with the price souring past $1,900oz in September 2011. At the same time other safe haven assets such as U.S. Treasuries and UK Gilts also rallied strongly with yields falling considerably during this period.

So what I've found interesting recently, particularly since the Cyprus bailout fiasco is the behaviour of gold bullion. Price has been stable, around $1,600oz but not provided that same protection to portfolios as it did in the summer of 2011. So what does this mean for gold's status as a safe haven asset? Well firstly it should be noted that the Cyprus bailout is less significant than Greece, and nearly 2 years on from summer 2011 the rest of the global (except Europe) economy is in a better state, so investors may not feel they need this safe haven asset. Secondly gold has other purposes than being simply a safe haven asset, it is also an inflation hedge. It could be that investors see QE coming to an end, particularly in the recovering U.S. and so inflationary pressures may ease, hence their reluctance to buy lots of gold.

For me however, I do think at this point in time gold could be a useful safe haven asset in portfolios. Other safe haven assets such treasuries and gilts are at low yields and thus you have to pay a premium for protection from these assets. Conventional government debt does not offer inflation protection, that gold should hopefully do. Coupled with this, demand from China and India for jewellery is significant and growing, and central banks continue to demand the yellow metal, to diversify away from their foreign currency reserves.

At the start of 2013 we have seen outflows from many gold ETFs, but for me this is a little premature. I'd consider holding gold until the economic landscape becomes a lot clearer and I am confident inflation will not rear its ugly head. Until then this asset, which is normally lowly correlated with equities, could be a useful position in investors portfolios...

Mixed Markets - The Importance of Sector Allocation

Global equity markets have been fairly mixed today as Cyprus concerns still remain, however the U.S offers yet again a brief reprise from this doom and gloom as durable goods orders beat expectations of 3.9% to rise 5.7%. Gains filtering through from home purchases and the auto industry have filtered down the economy.  This lagging indicator provides great insight into the structure of the economy and at present it seems to be doing quite well.  Let’s hope the FED does not withdraw the support of monetary stimulus before this ball is well and truly moving.

The markets opened cautiously as investors were unsure how to feel about the current issues in Cyprus, some uncertainty had been cleared up, however the bad taste left in European’s mouths may lead to a run on the banks.  As such, banks are to remain closed until Thursday and strict controls on capital withdrawals are expected to be implemented.  This comes after a bailout agreement that will take a substantial amount of all deposits over €100,000.  Now many people are questioning whether this policy may be used elsewhere as Slovenia is teetering on the brink of a bailout.  A further worry is that future elections within European countries will favour the anti-austerity party much more now as people do not wish to suffer the same treatment.

The divergence in equity markets merely highlights the important of market and sector selection.  Most notably, as mentioned above, housing and the auto industry have been benefiting of late in the U.S. whereas you would not want to be holding banking stocks in Europe.  Stock Picking is a hard thing to master, however there are a number of funds that manage to get this right.  Fundsmith’s equity fund has returned just under 24% over the past year investing in a concentrated portfolio of 20 global companies, one to consider for the long term.

So what now for Cyprus?

As mentioned in a previous article (Cyprus bailout) an 11th hour agreement was made late on Sunday - but what does it actually mean in the long run? Has this €10bn solved all Cypriot problems? Or will we be back here again in 6, 12 or 24 months time? 

Well for me this €10bn has simply helped a symptom, not provided a cure. It does not seem to have changed anything structurally that will lead to Cyprus kicking on as an economy, instead it has weakened their financial sector and probably deterred foreign investment. 

Historically when nations have gone bust they have defaulted on their payments and suffered short term pain. From here, they have been able to repair; they have no debt burdens to now pay and also have suffered a devaluation in currency thus supporting exports from the country. Of course it has not been this straightforward and the population have faced tough times, but eventually they have managed to recover. What we are seeing in Europe seems to be providing further emergency loans, imposing strict austerity measures and keeping the nation in the Euro, thus not allowing them to devalue their currency and start again. Cyprus is a very small Eurozone nation, but what will happen if Italy needs bailing out, or worse still France? They will require huge bailouts which just may not be feasible. 

There is no easy fix, but at some point something has to give. We either need full fiscal and monetary union, or countries need to leave the Euro and return to their own currency. The key to countries leaving the Euro would be a managed, orderly break up, although this is likely to still lead to market turmoil and banking crisis. 

The Eurozone problem is probably the greatest world economic challenge currently, and although I don't have the answers, throwing good money after bad doesn't seem the way forward. We need to provide stability in the banking system and find a way for the weaker nations to become more competitive, an edge they have lost since having a single Euro currency. 

For now let's just hope the U.S, and the rest of world can help pull Europe out of this mess, and consider a global portfolio of equities! Euro stocks may be cheap, but it could be for a good reason!

What next for Markets?

Market optimism faded after a bailout for €10bn was hashed together on Sunday evening.   The second largest bank in Cyprus takes the fall and as expected the Eurozone remains intact (for now).   Whilst depositors first €100,000 will remain, those holding bank debt and deposits over this amount will likely loose all of their money.  With a huge chunck of the banking system taken out, questions will be asked to whether sufficient available credit to Cypriot people will be made?  The largest bank, the Bank of Cyprus will be restructured and absorb the safe deposits from Popular Bank and whilst this is a relief for many Cypriot nationals, this will almost certainly ostracise both foreign banks and overseas investors for the foreseeable future and presents a cautionary tale for other European countries teetering on the edge of economic turmoil.

Markets reacted positively this morning, bucking the biggest weekly decline in 2013 as risk on appetite crept back into view.  However with uncertainty still in front for Cyprus investors remain uneasy. 

Correlation between global equity markets has quite noticably been diverging as economic recovery shows in certain countries more than others.  This global correlation has been inherent as economic crisis has struck so often in the past 5 years following the credit crisis and last week was a prime example. 

Emerging markets have lagged significantly behind developed equities and whilst risk/reward suggests emerging market equities should outperform, it is not the case.  This is down to a number of reasons; as economic recovery gains momentum, people tend to invest in equities that they know about, from here, smaller cap equities will follow.  Emerging markets have faced some different problems as Russia lost a lot of ground over the past week with large exposure to Cyprus. 

It presents an opportunity for those who wish to increase their equity exposure, in the long run these markets offer significant upside potential and it is where I would invest.  There are a number a excellent emerging maket funds, performance of which had been superb.  First State Global Emerging Market Leaders provides exposure to top companies across these markets however, a more leveraged play would be investing in Russian equities, with historically low PE ratios and a maturing consumer base, this could be a top performer over the next few years.

Check out our Top 10 Funds of the Month for some more investment ideas.

Reshoring in the U.S.

Reshoring is a relatively new concept where jobs that were outsourced overseas in the past are now being brought back home.

We have begun to see this occur in the U.S, and it has been driven by various factors. Firstly labour costs in Emerging Markets such as China have risen over time diminishing some of the benefits of locating there. Secondly the invention of fracking has led to cheaper energy in the U.S. which has helped decrease production costs and so made it more competitive to develop at home. In general the U.S. labour market is highly skilled, and with unemployment still at 7.8% there is available supply currently.

So what are the implications of this reshoring trend we may be beginning to witness? Well firstly it is good news for the U.S. in terms of job creation, this should lead to the whole economy benefitting. The government should also benefit from increased income taxes and potential corporation taxes. Manufacturing stocks could see upside potential, as could stocks linked to consumer spending.

It's still very early days but this reshoring trend is another positive supporting the U.S recovery. Of course there could be some countries that suffer as jobs flow out of certain countries. The Emerging Markets revolution may now have some competition!

To Bailout or not to Bailout

Yet another post about Cyprus, well lets hope it’s the last!  With policy makers manically trying to put a bailout agreement together, many will be asking what is the likely outcome?  

This week saw volatility flash back into view, and it was unsurprising the Eurozone was to blame.  It was made clear Cyprus was in need of a bailout at least two weeks ago, and for many who had ventured deeper into this would have realized the extent of the bailout.

So why all the panic? This was purely down to the execution and terms of the bailout agreement.  As the banking system has such large debts they are liable to take some of the pain.  A further €5.8bn needs to be raised. However Cypriot’s and foreign investors alike reacted in outrage as up to 10% levy on depositors was announced.  After being shot down 36-0 by MPs, an alternative agreement is now being drafted ahead of Monday’s deadline.

So what is the likely path?  Unfortunately, it will be the depositors that will have to take some of the burden.  There just isn’t enough money elsewhere that would result in a manageable bailout.  As such, it may be that a larger levy will be made on those above the current €100,000 deposit guarantee (£85,000 UK).  This will cause less outrage for those living in Cyprus, however those wealthy foreign investors will have a significant haircut.

If this is the route agreed upon, markets will soon calm down and we can expect a rise back up to new highs.  Economic data continues to improve out of the U.S and people will be waiting to increase positions once volatility has reduced.  As such, one can take advantage of this by adding a European equity fund.  Yes this may be counter intuitive right now, however, over the last week smaller companies have lost a lot of ground, and as such oversold.   Funds such as Barings European Select will be a great addition to portfolios and will capture some of this upside potential investing in value companies.  Fundamentally, Europe still offers access to a number of quality companies benefiting from global operations.  Whilst they are listed in Europe, this is not where primary earnings come from.

If you think Cyprus will fail to come up with a bailout agreement by Monday, there are ways to manage your risk, check out Portfolio Hedging – it’s not for the faint hearted.

Eurozone - the uncertainty is back

Europe continued to be the main focus around global markets today as the ECB gave a March 25^th deadline for Cyprus to come up with a plan to raise a further €5.8bn.

The mood was further dampened by poor manufacturing data out of Germany and France, the bears gained momentum as similarities to last year show.

Whilst last year did not have the momentum of money moving into equity markets, and an improvement in the U.S, we did see equity markets rise at the start of the year over optimism that the worse was over for the Eurozone.  Then... equity markets fell off a cliff as worries Greece would vote in an anti-austerity government causing the possible break-up of the Eurozone.  This did not happen, however with its neighbour Cyprus banging on the door, we could see a similar situation.

Many have a fairly heavy weighting to equities within their portfolios, and this would have turned out nicely over the past 6 months.  But questions may be rolling through the minds of many investors as doubts whether the Eurozone can keep funding bailouts spread.  With Germany’s elections coming up in December, Merkel is somewhat on the back foot about using tax payer’s money to bailout countries which have been reckless with their economic policy.  Anti-austerity political parties in many countries are gathering momentum as seen in the most recent election in Italy and it is a concern this may happen in Germany, resulting in a Eurozone without a leading economy.  A lot can happen until then, but it will play a fundamental role in the future of the Eurozone.

This year will certainly be a bumpy ride for the Eurozone, and with Cyprus issues to be resolved, uncertainty over an Italian government and economic issues in France (read more on this soon) let’s hope the end result is positive.

I still maintain a positive outlook for equity markets over 2013, and as long as these issues are resolved quickly, it will draw focus away from the negatives and look forward to the possibilities the future holds!

Check out our Top 10 Funds of the Month to see which funds we rate highly.

The Budget and Bubbles...

The UK budget was announced yesterday and really it was a bit of a let down. There were no bold policies to tackle unemployment, no venturing from the austerity path and really it seems that the UK is going to attempt to muddle through the current problems and that growth, at best, is going to be very slow, if not declining.

There was one interesting point though that I think it's worth commenting on and this is with regards to UK housing. The coalition has pledged up to £130bn for mortgages where buyers can only afford 5% deposits - in effect they are guaranteeing high risk mortgages. The reason to me why this is quite alarming is that high risk (or sub prime) mortgages in the US were what brought on the credit crunch. In effect banks were lending money to people who simply shouldn't have been lent money; this created demand for housing, forcing up prices. Once it became apparent houses were over valued and that many people could not maintain mortgage payments house prices tanked, triggering the start of the credit crunch. 

Since then, it has been a lot harder, and rightly so to acquire a mortgage, with banks demanding bigger deposits. So it seems a little strange that the coalition is now willing to support these house buyers who regular banks would deem not fit for a mortgage. 

For now we will have to wait and see what happens. Home builders such as Taylor Wimpey saw their stock price rally yesterday on the back of this news, with markets foreseeing demand for housing and new homes growing.

The U.S. Economy - Doves Away!

The FED announced the continuation of $85bn monthly asset purchases as an improvement in the housing market and manufacturing helped support the recovery.  Since the start of the year, rising confidence and improved data have pushed equity markets to record levels; however this is a cautionary tale.   There are still many headwinds facing the U.S economy.  With mortgage rates at extremely low levels (30 year 3.63%!) asset bubbles can creep up on you quickly.  Borrowing rates, be it Treasuries, Investment Grade or High Yield debt, are extremely low and one trigger could cause it all to come crashing down. 

Whilst Ben Bernanke has made it clear over the past week that he and the FED remain dovish, it is justifiable that many members of the Federal Open Market Committee remain wary of the medium to long term implications of such aggressive monetary policy. 

If you remember, it was not that long ago when inflation rates were over 10%, way off the 3% currently, and with such high inflation, the main control was raising interest rates.  At this current time, raising the interest rate could be catastrophic for a number of asset classes; mainly bonds and cripple any hope of economic recovery.

There are little signs in the short term of inflationary pressures in the U.S (different tale for the UK), however TIPS (Treasury Inflation Protected Securities) can provide you with some protection if you are wary.

Unemployment is the main focus at the moment and whilst it is reducing, this is not at the levels seen prior to the credit crisis in 2008.  It is unlikely we will see growth rates like them for a long time, however progress is progress and it should not be dismissed.  Forecasts for 2013 unemployment have been nudged lower, and monetary stimulus will continue until it reaches around 6.5%. 

With record low mortgages and improving economic conditions in the U.S, it provides a glimmer of hope of a global economic recovery and we should make hay whilst the sun doth shine, even if it isn’t that bright…

UK Jobless Data....Disappoints!

Most people's focus today is on George Osborne and the UK Budget but there is also other important data out today; UK Jobless Data. So what is UK Jobless Data? It is a measure of the number of people who claim unemployment benefits but are actively seeking work. The figure serves as a useful barometer for the state of the UK labour market and can be a good forward indicator for UK economic growth.  

The absolute figure released today showed claims had fallen by 1,500 - a positive. However, the forecast was for a fall in claims by 5,000 so the number has disappointed in terms of analysts estimates. 

So how could this number be interpreted? One could argue that the economy is stalling and that people are not moving into work fast enough. If unemployment remains stubbornly high it drags on the economy; the UK government has to fund the unemployed through welfare payments and also misses out in potential income tax revenues. A more bullish investor may find solace in the fact that people are finding work, hence a decline in the number - it may be slow but the economy is on the right path.

For policy makers, I suspect the likely implication is that this number helps highlight the precarious state of the UK economy and may encourage the BoE to consider expansionary policies, such as further Quantitative Easing. This would be supportive of equity markets, but I suspect weaken Sterling (inflation and currency) could lead to further inflationary pressures.

So it seems there has been job creation in the UK recently, but this has lagged market expectations - is it time for further policy measures targeted specifically at employment? The U.S undertook similar policy which so far seems to have worked well...  

Does Austerity Work?

With the UK Budget being announced this week all eyes will be on George Osborne. Over recent years the UK, along with many other nations, have implemented severe austerity measures in order to reduce public debt following previous years of excess spending.

There has been great debate as to whether austerity measures actually work. Within the UK the government hoped that as they cut spending and reduced public sector jobs, the private sector would grow and pick up the slack. However, what we have seen is that the private sector has not been strong enough to fully step in. The results of this has been that the austerity measures imposed have not been quite as severe as originally planned, and that the general UK consumer has been squeezed. This has led to poor growth numbers and some argue highlights that austerity just doesn't work. 

So what else can the Government do? One argument is to spend heavily on projects such as infrastructure. In the short term this would increase public debt, but could be facilitated at very low interest rates. The spending would create jobs, which through the multiplier effect would lead to the money flowing through the economy. Improving our infrastructure would also make the country more attractive to businesses and we may see more companies choosing to locate in the UK, which would help with employment and also corporation taxes. The success of spending is not guaranteed, but given the failure of austerity it could be worth a shift in policy.

What's next for Cyprus?

It was a shaky start to the markets today as uncertainty remained over whether the banking levies in Cyprus were going to be implemented.  Politicians finally voted on the issue and revealed what I had expected, “no thank you!”  Outcry from both foreign investors and Cypriots made it painfully clear; this was a poor choice of tactic when formulating a bailout agreement. 

It is all very well when it’s not your money on the line, however the game changes entirely when it is.  The 36-0 vote against the levy is a relief to many, however what next? There is the sudden realization that without a bailout agreement, Cyprus is in big trouble.  With very little bargaining power, this small country is backed into a corner and may have to rethink the offer made by the IMF and European Commission. 

It is remarkable how such a small country (representing 0.5% of the Eurozone) can cause such a problem.  This stems from possible contagion risks surrounding this country, if the deal continues to be rejected and no further offer is made, the country will most certainly leave the Eurozone, taking its banks down with it.  Fear will then spread to whether other countries, such as Greece will follow suit as the people give up on harsh austerity measures.  With fragile political states of Spain and Italy still in the fray, will they then follow? It can be a slippery slope in these situations and will weigh on many investors’ minds for the next few weeks.   

The Euro weakened on the back of this news as the future of the Eurozone was questioned, it at least provides a slight relief for exporters as the currency falls from recent highs.

On a positive note, U.S housing starts increased to the most in two years providing a glimmer of hope in the global recovery.  

An uncertain time again, seems somewhat familiar to last year...

Cyprus Bailout - Haircuts for Depositors!

We've seen other Eurozone nations bailed out since the Credit Crunch but the Cyprus bailout is different - this is the first time that depositors in banks are being hit and there could be severe implications..

Firstly let me try and explain what is actually going on with this 'bailout'. As things currently stand Cyprus is to receive a €10bn rescue loan, however in return for this there is a one off tax pillage on savers, which should raise €5.8bn. Depositors of more than €100,000 will face a 9.9% levy whilst depositors below  €100,000 will be hit with a 6.75% levy. 

Now it seems strange that an economy that contributes only 0.2% of Eurozone GDP can impact the news and global markets so much. However the key word here is 'contagion' and there is a fear that the levy on savers applied here, could be rolled out to other Eurozone nations requiring bailouts. We have already seen markets reacting today, with global equities tumbling, and yields on peripheral European debt rising and safe haven government bond yields falling (Germany, UK, USA).

So what should investors be mindful of? Well if you hold bank stocks, stock selection in this sector will become even more important. If we see cracks appearing in other nations, savers may begin to withdraw savings on mass as expectations may arise that they may face levies. This run on banks will cause bank stocks to tank, particularly the banks who are facing liquidity constraints from withdrawals. Over the short term I think it reminds investors that we are by no means in the clear yet regarding the Eurozone, and there are still many obstacles. It may lead to some profit taking and equities may fall over the coming week, and yields in riskier debt increase. Some may see this blip as an opportunity to buy in and this could lead to cash being rotated into some of the stocks and bonds that may have been oversold (Buying on the dips)

For me I'm just grateful that the UK is able to print money and that my savings are based in UK banks, which seem safe.... For now!

Speculation, it's what markets run on

Today started in a panic as Cyprus announced a levy against depositors. The Euro fell against all major currency peers and the word spread of Cypriots rushing to ATMs to withdraw their money. At first glance it sounds bad, however the actual implications for global markets were more speculative.  The real cause of markets falling was contagion risk and the possibility of a run on the banking system in Europe.  

If you haven’t guessed it already, the markets are driven by human emotions not just the facts and the two most powerful drivers are greed and fear.  Today was clearly the latter and with a measured approach you could have capitalised on this. 

From my trading days, I learnt a few lessons about this, the futures markets are a constant battle against your peers, be it to be first in the queue on a certain price or strategies for obtaining profits. The psychology of investing plays a fundamental role and understanding how people react to news can help you make important decisions.

An overreaction to bad news is usually the case, and it is not until people weigh the news and data when a correct price is established.  As mentioned in buying on the dips, after major news, be it company specific or global, heavy sell offs present opportunities.                 

On the flip side, over the weekend, news emerged about a possible £8bn bid for M&S by Qatari Investors.  Subsequently the share price rose 7% on Monday and whilst there have been reports this is not true, it just goes to show the power speculation has. 

As the saying goes, “speculate to accumulate!”

Importing inflation

We have spoken previously about currencies and how a depreciating currency can be a benefit in many ways, not least making exports more competitive. However, one of the bi-products can be 'importing inflation'. 

Think about the price of petrol at your local garage, I bet it has become more expensive over recent weeks?! This is not due to a spike in the oil price, simply it's down to Sterling weakening against the USD and therefore making oil (priced in USD) more expensive. This will be occurring with many other imports, not just oil. 

It is often the case that with this type of inflation consumers do not fully feel the effects for a year or so, as prices do not change instantaneously, and so it could be that the real pinch of inflation occurs in 2014. CPI (consumer price index) last peaked in September 2011 at 5.4%. Given the poor state of the recovery it didn't lead to wage inflation. High levels of wage inflation can be very bad for businesses as costs (wages) spiral out of control. At this point in time I still don't feel employees have enough bargaining power to demand large wage increases should high levels of inflation occur, but it could be one to watch. Businesses with pricing power, which have the ability to pass costs onto consumers are normally desirable in this situation as they can maintain margins.

Having a strategy to implement in your portfolios to hedge against inflation could be something worth considering....

An Alternative to Cash?

A question many people are asking at the moment is, “where can I put my money when cash is returning so little”?

Well the answer is pretty limited… For investors not wanting to take any risk, fixed term deposits are the ideal place, however with the best rates at around 2% per annum it is hardly a viable option for those trying to match liabilities or at least beat inflation at 3%. 

Investors are being forced to take more risk than they would prefer.  So let’s look at the alternatives.

• ·         Fixed Interest/Bonds – these will offer little more than cash at the moment, government debt is yielding around 2%, and investment grade corporates are not much higher.  High Yield will be your best alternative at around 5-6% per annum.  With yields at record lows, long duration funds will be very sensitive to interest rate rises.  Therefore I would be fairly against this option, unless you can access short duration funds, such as AXA U.S High Yield Short Duration Fund.
• ·         Equities – there are a number of high yielding equities out there, however this is a risky option.  A number of UK equity income funds yield above 4% per annum, with some up towards 6-7%.  This option has the potential for added capital growth as well.  If you are looking to go for this option, more defensive funds such as Troy Trojan Income would be my choice.  This has excellent performance over the long term with a relatively low volatility.
• ·         Absolute Return Strategies - whilst these do not provide an income this may be suitable for those who do not require liability matching.   Absolute return strategies aim to provide absolute returns over the medium to long term.  Typical return aims are LIBOR + 4-6% per annum.  This is not as secure as holding cash however downside risk is fairly low as a multi asset approach is combined with derivative strategies.  This sector has been growing as more people seek alternatives to cash, it also acts as a great diversifier in any investment portfolio.   A number of examples are Standard Life’s Global Absolute Return Strategies which is now over £20bn in size, Insight’s Absolute Insight Fund which is a combination of absolute return funds offering a more diverse holding and Newton Real Return.

This hopefully provides you with a few alternatives to cash, but the reality of it is, until interest rates increase, more risk will have to be taken to obtain returns.

What next for the High Street?

The decline of the UK High Street is there for everyone to see. Walk round your local town centre and I'm sure you will notice many more vacant units than 5 or 10 years ago. Prime retail zones like Oxford Street in London buck this trend but in many other regions in the UK it is apparent. 

The High Street has faced two main headwinds. One has been the Credit Crunch; in a nutshell reducing consumer's ability to spend. Second has been the Internet; online shopping from sites such as amazon has boomed in recent years making the High Street redundant. Without expensive property and staff costs these online businesses can drive down price, stealing market share. Recently we have seen Comet and Peacocks close down, highlighting the structural shift occurring in this sector. 

So what does this mean to investors? Well one thing to consider is property investments. Retail property may not be the best investment currently as empty rates are likely to be at highs historically and there could be a lack of rental growth as demand falls. Retail stocks with businesses in structural decline should also be avoided; they may look cheap but they are likely to be 'value traps' and keep getting cheaper! 

Opportunities could arise from retail businesses with a strong online presence. Amazon is a prime example of this type of successful online business model. 

It is not all doom and gloom for the UK High Street and this was highlighted by John Lewis who recently announced strong profit growth as well as staff bonuses of 17% across the whole business. This company has integrated successfully into the online market whilst also benefiting from the success of Waitrose. Strong management has seen this business adapt and change and this dynamic approach has seen it succeed and grow market share when many peers have struggled.

For now let's make the most of the UK High Streets, in 10years time the landscape could look a lot different.

The importance of income

For many investors assets that produce a natural income are often highly desirable. Typically people automatically gravitate towards bonds and property for this income, however given the potential headwinds facing these asset classes equity income may become more desirable.

Since the credit crunch UK Equity Income funds have been very popular. I think this is for two main reasons. Firstly in a low growth environment income becomes a bigger part of total return and helps underpin portfolio growth and does help offset any erosion in capital. The second reason is down to the nature of business that pays dividends. These businesses are usually seen as 'defensives' with stable and predictable cash flows, allowing them to return cash to investors on a regular basis. Since the credit crunch many investors have favoured these more defensive businesses that are more resilient during economic downturns. 

There are many funds available to investors wishing to have exposure to UK Equity Income stocks. Probably the most famous is Neil Woodford's Invesco Perpetual Income and High Income funds. These funds hold stocks like AstraZeneca (c.6% yield), British American Tobacco (c. 4% yield) and Rolls Royce (c. 3.5% yield). I would argue however that this fund is now too large and that some of the smaller, more nimble funds are likely to perform better and also contain less stock specific risk. Neil Woodford has large allocations to a handful of companies which could add a layer of risk. Unicorn UK Income has been the stand out performer over recent years, and other funds such as Royal London UK Equity Income also have excellent track records. 

So when looking for income from investments, equities should be considered. Many businesses are available on attractive yields, and often grow these dividends as well as having the potential for capital growth, something bonds don't offer. Many corporates are also flush with cash on their balance sheets so we may see special dividends, with even more cash returned to investors!

Rural Expansion and the Control of Urbanization

The process of economic development usually begins in the capital city, or most built up areas.  As we have seen with China over the last decade, rapid expansion occurred within its major cities prompting a necessity for huge investment in infrastructure and housing.

This pathway to becoming a developed economic country is a tricky one as acceleration within urban areas can cause the economy to collapse onto itself if this occurs too quickly.

China, over the past decade has had double digit growth as a cheap workforce stormed this huge nation into a competitive superiority over other developed countries.  As with all things, this cannot go on forever.  Industry and construction fuelled demand on a global scale for raw materials and machinery boosting company profits around the world.  Infrastructure spending in China was vast, Bejing’s underground railway had only two lines up until the start of the century, today there are 15 lines spanning  300 miles, with just under 8 million people using it daily and further expansion planned.  As with the underground system, housing has expanded at a similar pace.  With urban areas reaching capacity, there are a number concerns around the state of the economy in China.  The property market has seen rapid price increases and the government has warned it may increase taxes on second homes in order to curb further inflows into the property market.

The problem arises from rapid expansion in the urban areas, with little development outside.  This results in a greater demand for the built up areas causing a further divide.   This process is unsustainable and will eventually lead to asset bubbles and subsequent crashes.  A tempered approach is needed to structurally grow the rural areas as well.   In China this is starting to occur, but savvy infrastructure spending is a necessity.  

China has a long way to go in developing its vast nation further, but with wage increases and growth slowing, a number of hurdles are still to come.  The property and banking sectors are in my opinion the areas of major concern.  Such a rapid demand for new homes and mortgages begs the question, can these people repay their debt?  If this is not controlled, it may lead to a banking crisis similar to what we saw in 2008.

Enough about China… Another major economic player is Latin America.  Brazil especially has seen similar rises in its urban areas (maybe not at such an extreme pace).  With a majority of the wealth within its major cities, there will come a point where more rural areas begin to follow suit.

Wage inflation has started to occur and demand for more mature food stuffs are on the up.  There is much development still needed. The amenities available in rural areas are slim, and this follows through into demand for temporary measures such as generators.  Companies benefiting from this specifically are Aggreko, the largest generator maker globally.  Also, JCB announced strong demand for their vehicles(diggers) as construction ahead of the Rio Olympics is well under way.  After some good results recently, it is inherent demand in emerging markets is on the up and up. 

Emerging market investment funds will be your best bet to capture some of this upside.  First State Global Emerging Market Leaders would be my choice, however with such a pull on infrastructure spending still such a necessity, First States Global Listed Infrastructure fund is prime for growth.

These rapidly expanding countries have the size and ability to become some of the leading economies in the world, however it will not be a smooth ride and the management of growth throughout the whole country is needed.

Technology - Onwards and Upwards!

As I look around I am surrounded by technology, from mobile phones to laptops to a washing machine.  All of which have been developed over a relatively short space of time, and it is now hard imagine a life without it all.

Today the technology industry brings in around $500bn worth of revenue each year and this still expanding!  As we become more dependent on advancements in technology it offers a great investment prospect going forward.

Most investors would remember the Tech boom in the mid to late 90s, this is when everything really started kicking off and a mass investment into advancing tech products was made.  Since then we have seen companies such as Google and Apple rise to become some of the biggest companies in the world.   

Unfortunately technology doesn't stand still, as Apple has seen recently, with a gap until their next product, many investors have become wary of future revenue generation and subsequently the share price has fallen.  The likes of Samsung have taken this challenge in their stride.  With a number of avenues, their new Galaxy S4 phone has been released only 6 months since their last.

Probably the most famous company now is Apple, and it is worth mentioning.  As one of the largest companies in the world, their revenue growth has been second to none.  With as much cash as Poland it is hard to see this company disappearing any time soon.  With many doubting their future product line, it is only a matter of time before they produce another.  With huge resources at their disposal, it is definitely one to hold onto for the long term.

Technology is as we all know very changeable, and when investing in such companies it is important to have a diverse number from this sector.  Encompassing some of the core companies mentioned already I would recommend investing in AXA Framlington Global Tech, which has been an excellent performer over the long term, or alternatively Cavendish Technology. 

For years to come this sector will be hugely profitable and would be a good addition to any portfolio.  

Asset Managers - a leveraged way to play a rising market

Over the past 12 months the number of available asset classes which have produced competent returns has been diminishing and as a result many have moved into equities.  This increased flow of money into equities has proved great news for asset managers as they make up significant proportion of equity investments.

The asset managers came under pressure after the credit crisis as many ran to cash to protect themselves from heavy losses. Unsurprisingly share prices collapsed along with the market. Since then assets have been slowly building back up gathering pace over the past year. A number of companies have reported increased profits as a result.

Increasing demand for equity funds has rolled through from institutional, retail investors and Wealth Managers.   As the asset managers have experienced gains at the end of the line, further towards the front, Wealth Managers have experienced a similar trend.  Since the introduction of the Retail Distribution Review (RDR) at the start of 2013 this separated the good from the bad and a number of wealth managers have taken this in their stride increasing assets under management.

Namely Brooks MacDonald, announcing an increase of 44% in discretionary assets over the year and raising their dividend is a prime example. Also St James’ Place and Hargreaves Lansdown have also benefited all be it from slightly different avenues.

With banks still having a number of structural issues, many investors are wary of jumping back in. These other alternatives to the financial sector have great growth potential, especially as these mid cap stocks have room to grow and increase their dividends going forward.

This rotation into equities may have only just begun which is great news for both asset and wealth managers a like.  Without going out and buying a number of these stocks directly, I would suggest purchasing Guinness' Global Money Manager Fund that invests solely in asset managers and has performed very well over the past year, returning 34%!

Auto Sales - A Sign of Improvement

Construction and industry are what many great nations have been built on. In the midst of the industrial revolution the first automotive was created in 1806, since then they have played a fundamental role in the growth of the global economy.  Now around 62 million cars are sold around the world each year. 

During the credit crisis one of the most affected sectors hit was the automotive industry.  As many see cars as a luxury, new car purchases crashed to the floor.  A number of companies sought emergency loans, most notably GM Motors, Ford and Chrysler receiving a record bailout from the U.S and Canadian government of around $85bn. 

These big three have recovered somewhat since 2008, however global competition has been ever increasing.   Since the start of the Eurozone, Germany its primary contributor has benefited hugely and as one of the major producers of cars they have seen profits rise significantly on the back of a weaker currency. 

Asia follows suit as currency plays a key role in exports.  Japan has historically been a major producer of cars, such as Toyota and Honda.  However, these companies have been hampered over recent years by the strengthening Yen and until recently has had trouble competing with the likes of South Korea and China. Since the introduction of the new Prime Minister, Shinzo Abe, the Yen has weakened significantly by around 20% and this will inadvertently roll through to company profits. 

The gathering pace in automotive industry should start to show in company profits by April, and a number of funds are well positioned for this.  Aberdeen Japan Growth and JOHCM Japan have a heavy weighting in the automotive sector and would be my pick.

Over the past twelve months, we have seen consecutive rises in auto sales and this is a good sign the global recovery is gathering pace.  This lagging indicator has a powerful message and is one to look out for.

Mergers and Acquisitions – A Pathway to Growth

Since the credit crisis M&A activity has been fairly low as companies aimed to strengthen their balance sheets and reduce debt levels.  Over the past five years, this global restructuring has meant these companies are in some respects the strongest they have ever been.

The start of this year has seen a rapid increase in M&A activity as companies utilize high levels of cash to expand.  Such companies as Dell and private equity firm Silver Lake Partners agreeing a leveraged buyout to take the company private.  Virgin Media, also agreed a takeover by Liberty Global for $23.3bn, and Warren Buffet’s Berkshire Capital acquired Heinz for $23bn to take it private.  

Larger companies have historically had no problem in achieving good year on year growth, however markets have now changed and in many countries growth is anaemic.  The changing demographics weigh on government spending and will inadvertently reduce expansion and demand for many businesses for years to come.  A possible area for companies to expand are to takeover business which are in the growth phase, allowing larger companies to capitalise on growth elsewhere without having to expand existing operations.  

So why now, what has caused this activity to pick so much since last year? Markets have calmed significantly and volatility has been gradually decreasing.  There is a slight correlation between M&A and volatility and this is inherent in the great start we have had this year.

There are a number of factors which are helping company mergers and acquisitions.  Interest rates are at historic lows, and yields on even the highest yielding debt are the lowest it has ever been.  For M&A particularly this is a good thing, companies can borrow large sums of money for a leveraged buy out. 

As the larger companies try not to stagnate, we may see a lot of their small competitors prime for the taking and a number of funds could benefit from this.  Mainly funds in the mid cap space will be best placed to see takeover bids as they have a more consistent growth rate.  Funds such as Schroder U.S Mid Cap and Royal London UK Equity Income could do well from this over the next few years.