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Investment Opinion from John Townsend

John Townsend's Investment Opinions July 2019

"Truth is always strange, stranger than fiction" - Lord Byron

Tainted politics is taking an undue place in the financial Markets: President Trump's one man and teamless US government (with the support of a very few loyal , ambitious, but not especially capable henchmen) and Boris Johnson's directionless accession to the prime minister's position in the United Kingdom both carry the hallmarks of an incoherent, disruptive and anarchistic style. To this end both countries are at risk of descending into economic and political chaos with no clear direction and no ability to protect themselves in the event of a coherent threat, whether economic or political. Mr Johnson, who once failed at a career in Journalism largely for manufacturing stories, has been unflatteringly described by his past editors. He has, by all accounts, all the moral direction of a windsock.

The US President, a self-described dealmaker, is imposing tariffs on his own international allies with Europe and Japan in particular bearing the brunt of his newly imposed penalties. There is no logic to these tariffs, other than an attempt by Mr Trump to flex his muscles in the run up to the next US presidential election. The biggest danger of his actions is that the opposing countries could feel themselves forced to devalue their currencies. In any event, it seems that the United States is also planning to devalue the US Dollar to make US exports more competitive. This devaluation competition would be destructive to all western trade.

The threatened trade war with China started by the US president (because trade wars are apparently easy to win) seems to have had little effect on China. Here the annual growth rate has slipped from 6.5% to 6.2%, though this is probably as much due to internal changes made to their economic policy by the Chinese government than any effect the US tariffs are inflicting. The 6.2 % level is still within the limits set by the Chinese government of between 6.0% and 6.5 %. Here it should be noted that the US president seems to have misunderstood the cash flow from imposing tariffs, which is an additional cost to the US consumer not to the Chinese suppliers.

The US economy is buoyant at present and interest rates seem to be set for a decrease of 0.25% again after a similar sized increase in September of 2018. There are however economic clouds on the horizon which could cause weakness in the US economy. With money being so inexpensive to borrow, there are many US companies expanding through investment, but equally there are also many which are keeping themselves afloat with heavy borrowing. This is potentially troubling for the high yield (and therefore higher risk) investment funds which seek extra performance by investing in non-investment grade companies. They will suffer badly when interest rates begin to rise once more and the US economy weakens. I have chosen to avoid these funds in my client portfolios.

Inflation rates both in the US and in the Eurozone are at very low levels, (1.8% and 1.3% respectively). Growth is equally low at around 1% per year. It is hard to see, given how much money is being made available at present, that inflation will rise appreciably or at all. Interest rates in Europe have also been structured to stay low, even after Mr Draghi leaves his role as the head of the European Central Bank. Mrs Lagarde will have little freedom to raise Euro interest rates when she takes over. The EU does however now have two problem members, Italy and Poland, which could affect political stability. Both have vocal anti EU Political voices. Low interest rates will undoubtedly help Italy to stay afloat, without that country having to make any difficult internal economic adjustments. Poland, which is the EU's biggest net recipient of cash, does not pay interest on their EU support and so will be less affected by any future rise in interest rates. In truth neither can afford to leave the shielding wings of Europe, but they can and do stir up unnecessary controversy with their demands which appeal to their local constituents.

The US president's irrational decision to unilaterally cancel the Joint Comprehensive Plan of Action (JCPOA), a multilateral agreement to limit the production of Iranian nuclear material, was in truth intended as a cancellation of yet another measure signed by President Obama, who Trump loathes. Quite why former president Obama is disliked so intensely by Mr Trump is not clear, but the measures the former put in place have been cancelled wholescale without replacement.

Iran has an intractable problem in that it has different internal factions who compete for power and often do not talk to each other. There is the officially recognised government, with whom the foreign governments interact, but there is also the Iranian Revolutionary Guard Corps, with whom foreigners do not communicate, which is the spine of the current political structure and is a major player in the Iranian economy. The IRGC has taken its own violent steps against oil tankers in the Arabian Gulf and the kidnapping of a British vessel in international waters in revenge for the seizing of an Iranian vessel full of oil destined for Syria. The revolutionary guards are not under government control and western foreign ministers' speaking sternly to their Iranian counterparties has very little effect. The other parties are mainly religious while having an effect the Iranian people, are not important in the international field. It would have been much wiser to have left the treaty untouched.

Saudi Arabia and its allies in the Gulf are the implacable enemies of the Iranians. This has much to do with the Sunni (Saudi et al) versus Shia (Iran and Northern Arab states) conflict within Islam. The Saudis have garnered the support of US president Trump and his son-in-law and feel themselves strong enough to take military and economic measures without regard to other international opinion. This has many of the hallmarks of the League of Nations between the two world wars.

There is however good news from the Emerging markets sector, especially in the Asian region, where good fund managers with capable analysts are now achieving good sustainable returns. In an ever more complex investment market, it is essential to use only those fund managers who have adequate corporate analysis teams and can take decisions based on 'bottom up' as well as 'top down' criteria. There are many excellent companies to be invested in. The big US and European companies are covered by several teams of analysts and cannot make a move without causing a reaction. Smaller, non-US and European, Companies have far fewer analysts watching them and therefore allow more room for valuable research results.

The Japanese economy is proceeding quietly along its own path. Western economic powers are lamenting the increased 'Japanisation' of their economies. The Japanese central bank however has been supporting its domestic economy with low interest rates and adequate financial liquidity for many years. This has included buying Japanese government debt and the equities of many big Japanese companies. The second biggest holder of Japanese government debt is the ubiquitous housewife Mrs. Watanabe, it is unlikely that these investors will ever wish to offload their investments and Japanese paper will therefore, despite being relatively unexciting, produce a steady return. While these measures have not led to a high growth rate, they have encouraged corporate profitability and Japanese companies are now healthy.

The Chinese growth rate has reduced slightly to 6.2%. But the Chinese government is working to change the direction of the economy, reduce domestic debt and he domestic dependence on loans from the unregulated banking sector. US tariffs are having only a limited effect, with most goods, such as agricultural commodities which the Chinese used to buy from the US and are now the subject of revenge tariffs, being bought from other countries. Foreign car companies however, especially those with factories in China and those selling cheaper models, are suffering badly with demand for their vehicles drying up. I suspect this is likely to be temporary as the economy gets used to the new government borrowing policies. Again the emphasis on investing in Chinese company risk is to have very highly trained and experienced analysts.

There are still major discussions relating to the difference between passive investments such as ETFs which actively follow a real or artificial index and Active investments such as managed funds. Passive funds theoretically have lower costs as they have no front end fees and no management fees, they do however have the costs of switching their investments when the indices change, though these costs are rarely if ever publicised. Actively managed funds, especially when carefully analysed and well managed, have the advantage of earning a positive margin over an index, known as Alpha. They are normally compared on a net basis after all fees and charges. A client orientated portfolio of actively managed funds is therefore likely to perform better than a portfolio of supermarket index funds. I am a firm believer in seeking out medium term 'Alpha' and combining uncorrelated strategies into portfolios with above average returns.

The key to successful and profitable investing in the fund markets is to plan ahead, to stay calm in financial storms and to use the best quality managers who deliver consistent Alpha and as far as possible do not all invest in the same stocks and strategies, thereby avoiding 'bunching' of risk.

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.

Townsend@insure-invest.de
www.insure-invest.de

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.

Townsend@insure-invest.de
www.insure-invest.de