Investment Opinion from John Townsend
John Townsend's Investment Opinions January 2019
"Wall Street indexes predicted nine of the last five recessions" - the late Nobel prize-winning economist Paul Samuelson
In the last three months of 2018 we experienced a major correction in the global Equity- and Debt markets. It is the nature of a panicked market, especially one fueled by the actions of politicians of ill-will, that there will be severe overreactions. The end of 2018 saw such a panic, coupled with an avoidable trade war with China which the US is unlikely to profit from, an expected slowdown in Chinese growth from 6.6% to ‘only' 6%, a British exit from the European Economic Community, for no good reason other than xenophobia and a vague, though possibly unfounded hope, that other non-European countries will step in to fill the inevitable trading void. This is leading to the slow suicide of a once proud economy and political system and its fall into relative obscurity.
All of the above, despite a global growth rate of some 3.7% in 2018, caused embattled traders, who were waiting mainly to square off their trading positions for Christmas and the New Year to seriously overreact. Something which will cause a rebound in 2019.
A year-end correction had been expected. The developed economies had experienced some 10 Years of growth and a deep breath was to be expected. Equally, the global economies are at a late stage in their economic cycles, though not yet at the end of them, based on the experiences of history. Market sentiment cannot be predicted and when an unadvised US president follows his ‘gut instincts' based on reports on Fox news rather than the advice of his own staff, the gyrations caused by ill-considered twittered announcements produce only negative results.
Yet the US and Chinese economies are both strong and growing, there is no sign of recession there, perhaps yet. In the US, a major tax relief exercise helped to boost corporate profits for the time being, though this is unlikely to be repeated. President Trump is blaming the increase in US interest rates of 0.25% for any future weakness in growth. In China, the government has realized that a relaxation in the credit availability had helped growth in the past, but is in danger of going too far. A clampdown on loan availability from the private sector and secondary banks is taking place, which is leading to insecurity on the part of the manufacturing sector which is worrying about funding for future trade and investment. This too will find a new balance in 2019.
In Europe uncertainty is being caused not only by Brexit and where to find the billions that the UK has in the past paid to Europe to support various schemes and the ever needy southern ‘olive oil' countries. Italy and France are beginning to show signs of economic slowdown too. The French government is trying to take counter measures but is being met with predictable violent demonstrations. In Italy, a new populist government does not even want to discuss financial rectitude and the Italian economy is likely to be a source of concern in the year ahead.
The emerging markets are dependent to a large extent on the demand for their goods from the developed world. They are working hard to build some interdependence, though a decline in the developed markets will undoubtedly cause a slowdown.
The global investment markets will recover from the current panic, as the senior traders resume their work at the beginning of the year. There will be a period of calm, but the threat of a recession is never far away and portfolios should be stabilized by additional diversity to counter the buffeting to come.
Germany has been the powerhouse of the European Investment markets for several years; however the German economy has been largely focussed on engineering and technology companies. These two sectors have been suffering badly as confidence has drained from the institutional investors. The diesel scandal affecting many if not most of the car manufacturers and their declining support they are receiving from the local politicians causes concern about profitability, although not their actual survival. Technology stocks have been hit because of the general concern about this sector on a global sector. Let us be clear; there is a very good future to be seen in both the German engineering and technology sectors and investors would do well to sit on their hands here too until the malaise has passed.
Funds following mixed strategies have traditionally been a safe haven to reduce risk, yet it is this mixed strategy sector which has also taken an unexpected beating in the past crisis. 2019 should see a reduction in the proportion of a portfolio which is allocated to equities. However, past academic studies have shown that there are only some eight to ten days in an average year which offer strong growth to investors. If these days are missed, a portfolio will have minimal, though positive returns. In the same average year there are normally only some five or six days which suffer heavier losses. No one can say in advance which the profitable or losing days are. The message is that investors have to remain invested and to be patient.
Investing in cash is also not advisable in the long term. Inflation rates are rising and an investment needs to earn more than the rate of inflation, currently 1.8% in Germany in order for investors and savers to retain the spending power of their money.
The final economic recession before the start of the next cycle is now probably due in 2020, having been pushed back by the turmoil created by the present market upheaval. The timing is impossible to predict, as the event has been widely discussed, possibly resulting in a move in anticipation of the reality. The very few ‘experts' who predicted the major crash of 2007/9 are also making their predictions, though these should be discounted to some extent by the fact that so many experts are judged on the one event they possibly foresaw and not by the ones they did not.
The sectors to follow in 2019 include those where sentiment has swung against them in 2018. These are Germany, China, Japan and technology. The US equity markets are overvalued due mainly to the fact that they are supported by major local financial institutions. This gives them inadequate value for money and buffering when it comes to a down turn.
Emerging markets depend on efficient companies selling to strong economies as long as the Chinese, European and US markets continue to prosper, they will also offer adequate returns. The New Frontier Markets, those where countries are too economically small to count even as emerging markets, can produce windfall returns, but in a volatile environment the risks and the liquidity of their investments make them increasingly dangerous.
Past performance is no guarantee of future profitability.
John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.