Investment Review
February 2011
OVERALL
We have to remember that these are the main factors that drive the stockmarkets:
Sentiment - in the short term by fear and greed. So with all the noise of indebtness of the western world and the current problems in the Middle East such as Egypt, commentators are indicating that the world is in turmoil and investing especially in Emerging Markets is questionable.
Inflation - question of which - inflation, stagflation or disinflation
Gross Domestic Product - GDP - the future and expected growth rates for each economy.
Another consideration, which affects sentiment, in my view, is the western insistence that our politicians and our media believe our form of democracies works for all cultures! I do not fully agree!!
Firstly if we look at ourselves, has it really worked in the past 50 years? Look at our ballooning debt, look at our decimated manufacturing base to the extent we now import coal and energy (from Russia and Libya to name a few)!
Secondly China has developed alot since Chairman Mao left. It is a controlled economy but they have a long term plan, their people are better off than 20 years ago and they have a higher saving ratio than we have.
I have no fear of investing overseas as their capitalism does work such as in Singapore. Do they have the encroaching "red tape/ health and safety/bureaucracy" that the European Commission seems to spread?
Making money unfortunately does not grow in a straight line! This can be said about our own businesses as we might splurge on an investment idea, this will hit profits in the short term but if the investments philosophy was made for the right strategy then in a year or two it will pay off and the profits will be better hence dividends!!
Emerging Markets and Natural Resources and Commodities - have done well in the past 12 months yet Europe markets have not. Why?? Sentiment - see later.
Urbanisation - many of the Chinese and other Asian population are moving from the "fields" into the cities. Currently China has 91 cities with more than 1 million populations, we have 2 and the USA has 39. It is expected that in 10 years time China will have 75 cities with populations of over 5 million. Consider the whole population of New Zealand is about 4 million!! (Yes they have more sheep!!)
CONSUMERISM
I believe that in the long term the populations of the new world are going to want a better life as they have demonstrated in Egypt etc. They will need better food, better clothing TVs etc - i.e. consumerism. Many of these needs/products are still supplied by western companies such as Unilever, BMW and Louis Vuitton. The Chinese cannot get enough of the latter two and the former is investing 50% of its R&D budget in SE Asia as they cannot sell enough "soap" etc to the new world. There is an increasing amount of trade in between the new world countries so they do not need the old world so much
SENTIMENT
Sentiment drives the stockmarkets in the short term and as an example the European stockmarket has been clouded by the debt problems of Greece, Ireland etc. Yet German and French manufactures have full order books. Take the "posh" cars and luxury goods, the Chinese, Indians and Arabs etc cannot get enough of them. Consider who makes the world's Cruise liners? It is neither China nor the USA as we were used to many years ago, but it is Germany and Italy who construct them. They are in demand as the new middle classes of the world (not the old world) who want to travel. Remember the Japanese tourists of 10 years ago now it is the Chinese, the Indians and South Americans who have the money!
INFLATION
There are parts of the world with inflation in the emerging markets but they are controlling it by raising interest rates so this demand for raw materials will be lower so lower commodity prices could fall - Oil.
In UK there is talk of stagflation (inflation with negative GDP growth) but I doubt it. Yes, we have inflation in the short term at about 4% may be 5%, but in a year or so it will be back at 3% as the major long term driver of inflation is wage costs and with the current austerity packages and more out of work I cannot see wage demand being driven too high coupled to inflation figures are a year on year figure and with the recent spike in commodity prices and VAT they will be out of the figures in 12 months time.
In Japan there continues to be disinflation which is why their stockmarket market has moved sideways for the past 18 years. In 1990 they had an asset bubble in their stockmarket and properties which has to lead to a long period of disinflation which they are still in progress, plus there are other complications such as a far more aging population with no immigration (lowering age profile). Hence I continue to see little point in investing there. Consider:
- the Japanese Royal Palace was valued as the same price as the whole of the State of California!!
- the stockmarket was valued at 39,000 but it fell to 15,000 by 1992. It is now at 10,250!!
-
their debt levels are higher than ours with the difference that they are exporting more than importing so have a healthy current account - we do not!!
SOVEREIGN DEBT
Government Debt - in the old world it is a concern as their widening current account is increasing as we import more that we export, against the emerging world where there are low debt ratios and account surplus!!
2010 saw the European bailout of Greece and Ireland who have both been forced into severe austerity measures. There are concerns over Spain Portugal and Belgium and of course the strain that any further bailouts would put on the IMF.
On the other hand countries like Brazil are contributing to the IMF and recently China bought into the Euro Fund to support the bailout of Greece and Ireland!!
EQUITY VALUATIONS
With out repeating myself the current equity market sentiment could be compared to the movie Jaws, because investors are extremely fearful of going back into the "water", worrying there is something sinister lurking beneath the surface hence the current market volatility. Yet despite the fear contained in markets, the inbuilt valuation mechanism supports for equities for longer-term value investors by:
- valuations equities of USA, UK Japan and Europe stockmarket are low by historical standards
- future earnings growth is positive hence dividends
- Government Bond yields are lower than equity yields.
Income - the other benefit of equities is their income, current yields for the High Yield sector of the UK Stockmarket is over 4% with the good prospect for improving profits hence dividends will rise over the next 12 months. Companies in the USA have not historically looked good at producing consistent dividends because of the tax regime, but President G Bush changed that and so far is President Obama not increasing this tax. They have some interesting companies with good dividend flows, so we are now looking at international dividend funds because:
- 25 companies in the USA over the past 25 year have always increased their dividends. Johnson and Johnson yields 3.6% and has increased their dividends for the past 47 years without interruption
- Europe - Nestle's yield is over 3% with likely income growth compared to the German Bund (equivalent to our Gilts) of 3% but income is fixed
- Fiat - yield of 3.8% yes Italian - but they own New Holland agriculture equipment with big export potential as the world needs to be more efficient in producing food.
UK Companies are:
- large multi-national companies, which face little competition in their respective markets
- 60% of their profits come from overseas operations - Unilever to name just one
2010 - STOCK MARKET PERFORMANCE
| Stock Market Indices | Change since 31 December 2009 (in dollar terms) |
| World MSCI | +14.5% |
| UK FTSE 100 | +11.6% |
| Japan | +17.4% |
| China SSEA | -12.5% |
| Hong Kong | +5.9% |
| Euro Zone (Euro 100) | +5.3% |
| Emerging Markets MSCI | +12.2% |
In 2010, the UK and US stockmarkets provided good returns far in excess of cash. The German market also showed strong performance. Some may find it surprising that the main Chinese market and the Brazilian market fell in value. This is a reminder that markets fluctuate and do not go in one direction. We should also remember that this is a 'snap shot' of performance between two specific dates and performance can look very different depending upon the two dates you choose!
PE Ratio ’Äì The Price Earnings Ratio tells investors how highly a share is priced relative to its earnings power. It divides the company's market capitalisation by its earnings, the result tells you how many times they would have to multiply the company's profits to equal the market value of the company. If the earnings ratio is higher than average, it usually suggests that the company is expected to produce above average earnings growth. In UK it is currently 12 below the long term average
COUNTRIES
UK: Inflation has increased to 4%, on a Consumer Price Index (CPI) Basis (which excludes mortgage interest rates), 5% on a Retail Price Index (RPI) Basis (including mortgage rates). Historically, interest rates would be increased to control inflation, however the inflation that we are seeing is caused by elevated commodity prices due to high demand from Asia. Therefore increasing our interest rates would have little impact and therefore we do not expect to see interest rates rise. The Government continues with its austerity measures and they will hit the retail spending and GDP growth will probably just remain positive
US: The US has extended tax cuts together with more Quantitive Easing (printing more money) as fears continue that they face a deflationary slump with High unemployment, low inflation and a depressed property market. That said, we expect the US to continue taking the measures needed to stimulate growth in the economy, the turning circle for a super tanker is large and takes time, they also have to put in the right mixture of fuel.
Japan: The long hoped for recovery in Japan has stalled due to weaker exports following a reduction in overseas demand, competition from other countries such as South Korea and fluctuations in exchange rates. Worries about the recovery prompted government intervention in currency markets in September 2010 selling Y2, 125bn of its currency ($26bn) and in January 2011, the independent credit ratings agency Standard & Poors downgraded Japans credit rating due to debt levels and their ability to meet their financial commitments.
Europe - having bailed out Greece and Ireland, eyes are now on Spain Portugal and Belgium. Being part of the Euro, creates challenges for the individual nations who are all in different economic positions, but are constrained by the same monetary policy. However Germany and some other core EU Countries are displaying underlying economic strength and are benefiting from strong exports. It would not benefit Germany coming out of the Euro as if they reverted to the Mark the currency would go "sky high" so price their machinery exported would not be competitive.
China: was one of the world's fasted growing economies in 2010 overtaking Japan as the world's second-largest economy. As with many of the 'Emerging Markets' (e.g Brazil) focus has shifted from stimulating growth to managing inflation and preventing economies from overheating. This was always going to be an issue, but if managed with the right fiscal and monetary policies, they can continue to provide strong performance, although we should expect bumps along the road.
Russia: the Russian economy continues to grow and bettered there governments expectations for 2010, growing at 4%. They have a low debt to GDP ratio of about 10% one of the lowest of any large country in the world. The Russian government is determined to increase growth and is targeting 7 to 8 percent in the next few years. We expect growth to continue due to the wealth of Natural Resources in Russia, however we should be aware that this is being led by state-owned natural monopolies. Consumer income is rising, however they seem reluctant to spend and changes are needed in terms of privatisation of state owned monopolies and an increase in consumer confidence to sustain the economy long term and avoid the boom and bust cycle.
Emerging Markets - why I am so positive towards these markets? There are several factors but mainly that the populations are becoming more urban, more middle class so wish to have the trappings such as better food and better clothing hence the rise in consumers.
Commodities - world food prices reached their highest level ever recorded in January 2011 and are expected to keep rising. Oil prices are around $100 a barrel, Copper prices hit $10,000 a tonne amid fears of a severe supply shortfall and sugar hit a 30 year high on fears that cyclone Yasi might affect Australia's major cane plantations. Commodity prices fluctuate, but the world continues to demand resources. China and other emerging markets are growing their infrastructures at a phenomenal rate and as they develop, their population establishes a better standard of living and increases their desire for goods, services and commodities.
OTHER FACTORS
Investor Confidence - there are two interesting indices that give some forecast of what is happening in the world:
The Baltic Dry Index - charts the cost of freight going by sea, and is therefore a good measure of trade/world growth:
This is still 69% below its peak in 2009 (although, the peak was extraordinary?)
Currently in Line with the Long term average
Movement is slowly downwards so leading to slower world economic growth
The VIX index - a US Equity volatility index - is a good guide to investor confidence in the past.
Worst level - 80 - December 2008
Long term average is about 20
currently at 16
WHERE THEN TO GO FOR INCOME?
In a survey recently carried out by Which? They found that 87% of savings accounts available six years ago now pay 0.5% or less. Cash ISA savers earned as little as £5 in 2010 if they failed to move their money.
To make matters worse, inflation rose to 3.7% in December and it is expected that this will increase to 4% following the recent VAT increase. Therefore the capital value is being eroded by 3.2% to 3.5% per annum.
Of course we recommend that every investor has a cash safety net in their portfolio for capital expenditure. However holding too much cash can cause significant damage to your wealth and for those looking for an income they will have seen income levels fall off the proverbial cliff.
Corporate Bonds - are debt instruments, whereby you loan capital to companies in return for a fixed level of interest over a specified period. The average yield from a UK Corporate Bond Fund at present is 4.8%. We are currently using corporate bonds within portfolios to provide income and to reduce overall risk. However there are concerns over a possible reversal in yields.
Emerging market debt funds are now available to investors with a current yield of around 5.6%. These economies are in a healthier state than many of the developed countries and we see these funds forming part of a diversified portfolio.
Commercial Property - investing in commercial property is another way to produce income with fund yields currently at around 3.8%. There is also potential for capital growth although we do not see this as the best option for the growth investor.
Equity Income - Dividends - .Equity investment can be volatile as we have seen recently, however they provide a rising income as a hedge against inflation and potential for capital growth. A diverse portfolio of global equities is currently yielding around 4.5%. Emerging market funds are now available paying a dividend yield, for example the yield on one Asian income fund is currently 5.5% and the fund grew in value by 33% in 2010.
COMPARATIVE RETURNS OVER TEN YEARS
Over the past Ten years the annualised growth rate of:
| Funds | With income paid out | With income reinvested | Current Yield |
| Base Rates | 0.0% | 2.5% | 0.5% |
| BlackRock UK Income (income increased by 5% pa) | 2.4% | 6.7% | 4.7% |
| BlackRock Gilt and Fixed Interest | 0.3% | 3.91% | 1.9% |
| Invesco Corporate Bond (income has stayed the same) | 1.5% | 5.6% | 5.1% |
| Henderson Property Fund | -1.8% | 3% | 4.5% |
| Aberdeen Emerging Markets (no income) | 16.0% | 16.0% | nil |
| Fidelity SE Asia (no Income) | 12.7% | 12.7% | nil |
| Fidelity European (no Income) | 7.7% | 7.7% | nil |
Other assets can provide income with the potential for growth and we recommend you consider Equity Income Funds which are likely to provide an income of over 4% and future dividend growth over the long term. These investments are considered higher risk than cash because their capital value fluctuates, however dividends tend to remain fairly consistent. For example Johnson & Johnson an American company have not lowered their dividend payment in 35 years!
We do not put too much value on short term past performance, but instead look to the future potential long term returns accepting that there will be fluctuations along the way. Have confidence and remain invested.
TAX SAVING PRODUCTS
| ISAs | PENSIONS | Venture Capital Trusts (VCT) |
Enterprise Investment Schemes (EIS) | |
| Aim of Product | Saving money with no tax breaks on the way in but provides tax free income |
Saving money with tax breaks on the way but provides 25% tax free sum and residual fund is taxed |
Saving money with tax breaks on the way in and provides tax free income plus you get your capital back |
Defers capital gains tax Reduces income tax Mitigates IHT tax |
| Investment Risk | From low to high and can mix all by a spread of investments | From low to high and can mix all by a spread of investments | High - invests in Small Companies (AIM Market) and Private Venture Capital and Media companies | High - invests in Small Companies (AIM Market) and Private Venture Capital and Media companies |
| Income tax relief on Investment | Nil | 20% plus if a: 50% taxpayer another 30% 40% taxpayer another 20% |
30% | 20% |
| Access to Capital | Yes | Only after 55 and then only 25% | Yes |
Yes (has to be held for at least 3 years) |
| Tax Treatment on Income paid | No tax to pay Can be reinvested tax free |
No tax to pay Can be reinvested tax free |
No tax to pay | No Dividends |
| Tax free exit | Yes | 25% | Yes | Yes |
| Limits on Investment per annum | £10,200 | £20,000 currently £50,000 next tax year | £200,000 | £500,000 |
| Minimum Holding Period | None | To age 55 | 5 years | 3 years |
| On Death | Passes to spouse as a non ISA and is part of your wealth | Passes IHT Tax free to spouse or beneficiary | Part of the estate | Passes IHT Tax Free to spouse or beneficiary |
| Growth | Tax Free | Tax Free | Tax Free | Tax Free |
| Capital Gains Tax and Losses | Yes | Yes | Yes | Yes but must be held for 3 years |