Economic Commentary – January 2017

May I begin this edition by wishing all of our clients a happy and prosperous 2017. 2016 certainly presented us with many challenges, but I am pleased to announce that Gould Financial Planning managed to negotiate these challenges whilst also;

  • Achieving British and International standards accreditation. These awards are reflective of the hard work all of our Directors and staff have put into making our business what it is today. I hope that our clients are comforted by the fact that our processes and infrastructure is certified as adhering to these very high standards.
  • Being shortlisted by New Model Adviser as one of the top 100 adviser practises within the UK. Again, we are extremely proud that the efforts of all our staff have been able to propel Gould Financial Planning to these heights and we relish the prospect of continuing to enhance our service to you in the years ahead.

 

When we add to this the continuing progress made by our staff, including Hollie Coomer becoming Chartered and only a short time away from becoming a Fellow of the CII, we feel that there are many reasons to be positive about the future.

However, a word of warning…..

“Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security.” John Allen Paulos.

John Allen Paulos is an American Mathematician who has spoken about, amongst other topics, misconceptions of probability and logic. As more and more of the variables in financial markets become skewed and difficult to predict due to a range of factors including unprecedented monetary policy, so reverting as close to the mean position as is possible becomes the safest course of action to take. As asset allocators we interpret this to mean that diversification of assets, in 2017, is more relevant than ever in reducing the effect of the growing risks present in the modern world and ensuring your accumulated wealth remains capable of providing for you and your family.

If 2016 presented us with great uncertainty via both an EU referendum and controversial US presidential election, then 2017 too could theoretically have a few shocks in store for us. Firstly, the fallout from the biggest events of 2016 will begin to take shape; Article 50 has yet to be triggered and Trump has yet to be inaugurated! Secondly, we are facing potentially pivotal elections in France and Germany which could provide yet more feathers in the pluming populist cap.

Whilst these “meso-level” issues provide the potential for shocks, the longer running “macro” themes we are concerned about should also be taken into account. As technology and financial markets evolve around us, we continue to see what we perceive as new macro risks emerging; risks which financial markets may not have encountered for some time, or possibly even at all, and risks to which the reaction from financial markets cannot be confidently predicted.

“As Information Technology continues its relentless progress, we can be certain that financial innovators, in the absence of regulations that constrain them, will find ways to leverage all those new capabilities—and, if history is any guide, it won’t necessarily be in ways that benefit society as a whole.” Martin Ford.

We discussed in our last quarterly edition the rise of the robots and whilst to some extent this is covering old ground, it has been very noticeable that the topic is gaining more press coverage since we first started discussing this growing risk with our clients in the latter stages of 2015 and throughout last year. We have read studies which predict that about 60% of occupations could have 30% or more of their constituent activities automated; suggesting that it is not only factory line jobs which are at risk. Indeed, we are seeing the emergence of “robo-advice” in our own industry which presents a risk to us! Even some well paid jobs present opportunities for robots.

This is a risk which developed economies may well find ways to absorb, but the financial fallout from this growing trend is difficult to predict – even for superpowers like the US. At the extreme end of the possibilities is a society where the lower skilled are unable to earn a living under the current system.

“Paper money is liable to be abused, has been, is, and forever will be abused, in every country in which it is permitted”. Thomas Jefferson.

Another rising risk which we feel could be playing out is the devaluing of the paper monetary system.  Monetary policy in many developed nations is running out of steam; there are only so many cuts that can be made to interest rates and so much money which can be printed before the value of this paper loses its perceived value. The continued filtering of this created wealth to the top of the tree presents real political risks to governments and ultimately, in our view, this means that policy will soon have to change.

As trust in the current system falls so policymakers will have to attempt something different and interest rates will then have to go up. This in turn spells bad news for most bond markets which have enjoyed a bull-run of well over a quarter of a century, and whilst a correction is arguably long overdue the risk of contagion is almost beyond comprehension. Our clients will already be aware that we have been encouraging increasing allocations in gold; in part to hedge against this growing risk, in addition to gold’s negative correlation to, in particular, US equity markets.

The end of the bond bull-run is something we have been concerned about for some time, and whilst in retrospect our timing was not accurate, these markets today are for the most part infinitely riskier than has been the case for 30 years or so. The maverick in me would be tempted to say that they are riskier than equity markets; however, our Compliance department would not take kindly to such heresy – oops!

“Complexity is your enemy. Any fool can make something complicated. It is hard to make something simple” Richard Branson.

Our approach has been consistent for a number of years; we will not gamble with our clients’ hard earned money. We are not fortune tellers and whilst we will have a view on where the major risks lay, so will everyone else in the market; and we cannot all be right! The focus of Gould Financial Planning has always been, and will remain that we should concentrate on what we can control;

  • Diversifying as much non-systemic risk away from your portfolio of assets as is practical and cost-effective.
  • Continually appraising the risks associated with our shortlisted investments, making adjustments as the economic landscape evolves and identifying other investment types which can further add diversification benefit.
  • Applying as much downward pressure on costs as is practical and sensible.
  • Ensuring that your wealth is invested appropriately for the risk mandate we have been given by you, our client.

 

Uncertainty still very much remains the only certainty, and in combating this as best as we can our Investment Committee makes the following observations for each of our six “headline” asset classes. Given the unique set of circumstances global markets face in our opinion, we will run this in reverse order for the first time ever!

Overseas Equity asset class

The past 6-9 months has witnessed an incredibly period of growth from virtually all assets within this space for UK investors. The short-term future of Overseas Equities however is to some extent in the hands of Mr Trump! If he manages to deliver on his campaign pledges of cutting taxes and increasing spending on infrastructure and defence, this should re-inflate the US economy which would, in turn, likely see faster interest rate rises; this could have a knock-on effect on other asset classes, but could be excellent news for the US economy and the US dollar.

The next question is whether Trump makes the US more insular. If this does happen, then the impact upon emerging markets and possibly even the developed Asian markets could be negative if they lose a proportion of their export trade.

French elections take place in quarter two of 2017, whilst Merkel appears up for the chop in quarter three. When we add developing Italian banking problems to this potential for political upheaval, it is difficult to understand how the Euro has remained so resolute.

Our conclusion is, again, whilst the outlook for the US may appear fairly positive the best approach remains to diversify between regions and currencies to ensure any nasty surprises which may be lurking around the corner have only a minimal impact upon your wealth.

In the commodity space, Trump could spell good news for the price of oil which, at the time of writing is hovering around $54 a barrel. In the absence of an increased demand we do not feel that this price is likely to rise much higher. Lower production may temporarily increase prices, but our view is that this would quickly be offset by increased US shale gas activity. However, increased US spending on infrastructure and a more buoyant Chinese economy could see an increase in demand to match this increased supply. That said, we do not feel that a return to the $120 a barrel days is likely in the near term.

We continue to advocate a reasonable weighting to physical gold. As strange as this might sound; the hope is that these investments do not perform, because this will likely mean that everything else is doing well! However, we feel that political risks make a gold holding mandatory at this point in time.

As you may have inferred from the first sections of this update, we are keen on including investments which stand to benefit from the rise of the robots! For those of our clients with the requisite appetite for risk, we will likely be recommending introducing or bolstering holdings here in the months ahead.

Verdict: Hold the optimal weighting to this asset class, cashing in profits made in the 7 months since the “Brexit” vote. Focus on diversifying assets by geography and currency. We may look to reintroduce structured products as a means of maintaining exposure to this asset class but with an element of downside protection.

UK Equity asset class

The outlook for the UK is still somewhat uncertain, and evidence of this can be found in the widening discounts of many domestically-biased UK investment trusts. If or when Article 50 is eventually triggered and the exit negotiations begin to take shape, only then will we be able to determine what the impact has been; these are unchartered waters!

What we do know is that, thus far, UK markets have generally continued about their business without too much concern for the uncertainty around them. The continued weakening of our currency has contributed to this of course; as our main exchange is essentially an international one, many companies generate a proportion of their earnings in non-sterling currencies and this, in turn, has increased the sterling value of this earnings base. If the dollar strengthens further then this could spell further good news for UK investors into FTSE 100 companies in particular.

We will watch with interest what, if any, reaction the Bank of England makes to the Fed’s interest rate rises; particularly if further increases take place throughout the year. With our weaker currency boosting exports and increasing the cost of imports, this could see an uptick in inflation, and this in turn could see an increase in interest rates.

Verdict: Hold the optimal weighting to this asset class; again, cashing in profits made in the months since the “Brexit” vote. We may look to reintroduce structured products as a means of maintaining exposure to this asset class but with an element of downside protection.

Mixed asset class

As you will know, our approach here continues to be to identify funds with differing investment strategies; all of which we feel will be more effective in limiting losses during a downturn than maximising growth during an upturn. Resultantly, our Mixed portfolios are likely to trail the markets when they are rising sharply, but we fully expect this relative value to be added on the way back down.

We are favouring mixed asset funds with a global focus and have recently shortlisted further funds which we feel could add value in the event of a market downturn. We have also placed an increasing importance in reducing costs; something which we strongly feel will become increasingly important in a lower growth environment.

In an uncertain environment, passing a proportion of wealth into the hands of managers who have a daily contact with the action could be a wise move in our view as they will be able to react quickly and appropriately to any changes which cannot currently be foreseen.

Verdict: Hold the optimal weighting, ensuring that assets are diversified across the three core investment strategies; Upside, Downside and Absolute.

Property asset class

Returns from UK property have been more subdued in recent times, owing largely to the uncertainty created from the “Brexit” vote. Whilst our returns have been impacted by this relative to our chosen benchmark, generally our property portfolios have still made positive returns because we have recommended diverse portfolios with a multi-country, multi-currency approach.

Whilst we are still advocating a blended property portfolio, our current house view is that the bias should be towards physical infrastructure projects, primarily based in the UK. We feel that this type of fund represents a lower risk than commercial property in the UK at the moment, due to continued government spending and prolonged low interest rates.

Verdict: Hold the optimal weighting to property on the whole, sacrificing some of the UK commercial property exposure in favour of infrastructure and overseas commercial property.

Loans & Debt asset class

It is here where we feel the bigger markets risks currently sit. We published an article at the back end of 2016 which provides a detailed view of our concerns – http://gouldfp.com/news/the-name-is-bond/

To briefly summarise, we no longer feel this asset class represents a “low risk” of fluctuations in capital value and we have therefore renamed it “Loans & Debt”. In the process this has opened up the possibility of shortlisting funds which we have always liked, but we did not feel fitted the profile of a “low risk” fund.

We will therefore be shortlisting new funds in this space throughout quarters 1 and 2 which, in the opinion of our Investment Committee, are less sensitive to an environment of interest rate rises and carry greater potential to add value to your wealth.

Verdict: We are still recommending an exposure below the mid-range here; however, following completion of our research and revamped shortlist we will no longer be recommending bottom or zero weightings here.

Cash & No Risk asset class

As a result of being below the optimal weighting in “Loans & Debt” the default position is that our portfolios will remain overweight in cash. The potential for continued low interest rates and higher inflation causes us concern with maintaining this approach long term, and we are very interested to see how the next six months plays out; will inflation take off in the UK? If so, will it be accompanied by interest rate rises?

We continue to scour the market for “Loans & Debt” opportunities which will provide low risk of capital loss but an increased risk of capital fluctuations, and when the time is right we will recommend that our clients holding overweight cash positions look to reshape their portfolios in order to effectively combat the wasting impacts of inflation.

Verdict: Remain overweight – for now! But do not look to tie down monies for sustained lengths of time.

Debts

As ever, our view remains that repayment of debts should be prioritised. Low interest rates and booming equity markets have arguably (and perhaps understandably) made this less of a priority in recent years. However, rising interest rates in the US (as seems likely) could well see other developed nations follow, and we would therefore urge our clients to prioritise repayment of debt above all else.