Economic Commentary September 2016

Remember Jimmy Connors? He was a winner, indeed in the 1970’s he was the top tennis player for a total of 268 weeks. Jimmy puts his success down to the fact that he hated to lose more than he loved to win. Actually, this is true of most of us, especially when it comes to investments.

This commentary, written in the summer of 2016 after the shock of the Brexit vote, provides the Gould Financial Planning insight into our view for the future. Simply put we are nervous about the world economic order and we have scaled back our growth projections for client portfolios for the text ten years.

Investment portfolios still need to produce real investment returns above inflation – why else would you be prepared to take investment risks. But with reduced growth rates and more uncertainty we believe that client portfolios need to have one eye on the prospect for investment losses and we should be taking steps to limit the downside.

We recently asked Natixis, an international fund management and research house to x-ray our investment process and our preferred portfolios and tell us how well we may perform in a rising market – but also what our portfolios would deliver in a falling market. They advised us that, based on 2013 – 2015 our portfolios are set up to capture between 80% and 100% of any investment upside, but in a falling market our clients are only suffering about 60% to 65% of any fall. Jimmy clearly has successfully influenced our Investment Committee decision making!

Natixis were also asked to compare the performance of our preferred portfolios to the industry standards. For each risk profile we are producing similar or better investment returns on average but at a lower risk.

So what are the big risks the UK economy faces going forward …

For certain, Brexit – to leave or not to leave – is not a big risk. This is not a black or white decision – more a question of shades of grey. To be honest, although the UK has attended the European ‘party’ it has never really joined in the activities – more a case of standing at the edge of the room by the patio windows watching the revellers get on with it (just darker than middle grey). Brexit will probably mean just ‘opening the patio doors and standing on the balcony’ (just lighter than middle grey). The UK will probably still be a member of the single market and probably still have to abide by all of the rules and still pay a hefty fee!

The four horsemen of the modern day apocalypse

There are four worrying trends that are developing that will have a huge impact on the UK economy and the political and social direction that we, alongside the rest of the western world, will have to face up to.

  1. Debt

The post war generation has been destructive in terms of both economics and the environment. We will be leaving our children a poorer world than the one that we inherited. Simply put, much of our increased standard of living has been financed by borrowing from our children. On average the total world debt, by governments, individuals, companies and banks, is running at about 3 years of GDP.

The servicing of this debt, the interest payments alone will reduce growth in the world economy by about 2% per annum in our opinion.

  1. Demography

We are living longer and the birth-rate in the developed world has fallen. This means that there are fewer ‘producers’ and more spenders. This too has an impact on economic growth

Germany reckons it needs an extra 1 million people of working age, just to cover the imbalance.

  1. Robots

Computers have become so big and so powerful, and the programmers so talented, that for any predictable job that does not require human-to-human intervention, algorithms are being written and ‘robots’ are doing the work. The economic consequences of fewer jobs and a greater disparity between the rich and the rest could be catastrophic.

Consider McDonalds, currently employing over 1 million people worldwide – the technology is already in place to turn this fast food chain into an automated just-in-time manufacturing process with hamburgers made by robots.

  1. Offshoring

Whilst migration of foreigners into the UK has been the subject of much debate in recent months, the press has been silent over the emigration of jobs. The migrant living in the UK is paying income tax and national insurance on earnings, and VAT on spending. The employer is paying national insurance and rates – and in many cases corporation tax as well. The economy is benefiting. If the jobs go the other way, the employment opportunity is lost, and the taxes disappear.

The UK government is on record as stating that between now and 2035, up to 30% of the jobs in the UK will be lost overseas.

In this context, Brexit becomes an irrelevance ….. and the four horsemen support the Gould Financial Planning view that investment returns over the next decade will be much lower than the average returns since 1945.

Looking to the more immediate future, we have US elections, French elections and German elections coming onto the horizon, and the potential is certainly there for volatility. When we couple this with the fact that governments in the developed world seem to be doing their utmost to defer the inevitable via increasingly severe monetary policy, we feel that trying to be too “clever” and going over or underweight in any particular region is becoming increasingly dangerous. We are therefore currently advocating going “back to basics”, and generally asset allocating more closely to the optimal ranges for the various asset classes.

Cash & No Risk

We have for a few years now been advocates of holding overweight cash positions in preference to medium weight “Low Risk” positions. However, the constant “kicking of the can down the road” by governments in the developed world by way of unprecedented monetary policy leads us to believe that we are likely to be in for a sustained period of low interest rates.

Put simply, a prolonged period of low interest rates and high inflation could see the developed world inflate much of its debt away, and for this reason cash potentially becomes far less attractive, if interest is negligible and inflation is eating away at its real value.

Verdict: Hold the optimal weighting to cash for the time being, but avoid fixing monies in for longer than 18 months. A sudden surge in inflation could have a seriously detrimental impact on your wealth at the current rates of interest available.

Low Risk

As our regular readers will know, we have advocated a bottom weighting to this asset class for some time. The logic here was simple; interest rates were very low and central banks had already implemented extreme monetary policy to stimulate economies. Simply, we felt that fixed income instruments were a one way bet. The Brexit vote was somewhat of a game changer in this respect, and it is now apparent that further interest rate cuts and even more extreme monetary policy is very much on the agenda.

As a long term play, we still feel that this asset class is higher risk than has historically been the case; however, on the basis that global funds with a flexible mandate in multi-currencies form the core of a portfolio, we are less uncomfortable now than we were 12or even 6 months ago. We still feel that government bonds should be avoided but that a flexible strategic bond fund manager has the capability to add value in these market conditions.

We remain keen on holding Floating Rate Notes (FRNs) as an insurance policy of sorts against rising interest rates.

Verdict: The optimal range remains the absolute maximum we wish to recommend; however, we no longer feel that this asset class carries the same level of risk in the short to medium term so long as fund selections are made extremely carefully!


In the wake of the “Brexit” vote, UK commercial property assets suffered from an initial shock as investors sought to pull their money out of London property in particular, due to the thought of empty office space in London amongst other concerns. However, arguably this initial downturn was an overreaction and many UK commercial property funds have since re-established stability.

Nonetheless, our Investment Committee has made the decision to allocate monies more evenly across the property sub-sectors in response to the Brexit vote, giving higher weightings to both infrastructure and overseas commercial property funds. Infrastructure in particular, in our opinion, continues to seem like a good place to be; government spending globally remains high in this area and with interest rates in the developed world still very low and showing little sign of increasing any time soon (the US excepted), we feel this sector could continue to generate good returns.

Verdict: Look for the optimal weighting, reduced from top weight in recent times. Give a higher allocation to infrastructure and overseas commercial property to increase diversification of asset and currency.


Many managers in this space have a flexible enough mandate to preserve value in choppy waters in our view. We feel that funds can generally be categorised as either a) a fund that should do well in normal market conditions (upside), b) funds that should do well in difficult market conditions (downside), or c) funds that are aiming to perform all of the time (absolute).

Generally, these strategies will not perform in tandem and we therefore feel that holding an equal weighting to all three strategies is the best way of ensuring a steady return from your Mixed assets on the whole.

Verdict: Again, look for the optimal weighting and hold a broadly equal exposure to the three Mixed strategies.

UK Equity

The fallout from Brexit has thus far not proven to be particularly negative for UK shares after the initial sell-off on day one. Our primary index, the FTSE 100, has a very international flavour and many of the companies listed earn a proportion of their profits in non-sterling currencies. The weakening of sterling therefore was ultimately positive for many of these companies.

The smaller, more domestically-focused companies arguably face a trickier time with investor sentiment taking a bit of a hit. We have seen this in the investment trust market in particular with many small and mid-cap trusts trading at widening discounts to their Net Asset Value. With interest rates being cut further and more economic stimulus on the way from the Bank of England, conditions for these smaller companies could remain favourable in our opinion.

Verdict: Optimal weighting. The fallout from Brexit still remains unclear and whilst we do not feel the long term impacts will be particularly negative, there could be shorter term shocks along the way. Therefore continuing to hold a balanced portfolio which holds an exposure to all aspects of the UK market is the sensible approach.

Overseas Equity

The weakening of sterling provided a welcome shot in the arm to the value of practically all overseas equity holdings with very few exceptions. In the developed world we feel that the US looks expensive but as the world’s largest economy and with governments effectively deciding for themselves on which direction their stock markets should be heading, there is a clear possibility that it could become more expensive still! We still feel that developed equities represent a more stable investment than the other overseas equity options, but will leave the decision making upon individual countries up to the fund managers.

A recovering oil price coupled with a weaker dollar has led to some respite for emerging markets. With the “Trump effect” also providing a risk of a weaker dollar we feel that emerging markets could continue their recovery for a while yet, particularly now that the negative sentiment towards these markets is turning somewhat.

The commodities sector remains a difficult one to call. We do not feel a sustained recovery in the price of oil is likely in the absence of significantly higher demand; $50 a barrel is profitable for the US shale industry and therefore over-supply is likely to again rear its head once prices creep above this level in our view. Given the global uncertainty already mentioned, we are advocating increasing gold exposure as a hedge against falling markets; somewhat perversely, the hope is very much that these assets do not perform! If gold is going down, there is a good chance that everything else could be going up – but protecting your overall financial wealth is our top priority.

The outlook for overseas smaller company funds remains good in our opinion. The policy of central banks in Japan, Europe and now the UK as well make conditions for smaller company growth very favourable indeed in our opinion. The real risk here in our view is at a headline level; populations could ultimately lose faith in policymakers as eternal quantitative easing sees the equality gap widen, and this is where the long term danger lies in our view.

For specialist funds, we will be looking to sell out of pharmaceutical and biotech funds. With the large US-bias and the potential for this sector of the market to review its “predatory” drug pricing, we feel the risks of short term loss currently outweigh the clear potential for long term gains. Instead, we are currently recommending investments into Robotics and Cyber Security. We feel these two themes could yield strong growth in the long term, even if both stories take a few years to play out.

Verdict: Optimal weighting. Look to hold a balanced portfolio comprising of the different sectors, the allocations to which will be determined by your risk profile